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  • 2007

    • 07-65 FINRA Amends NYSE Rule 409(f) (Statements of Accounts to Customers) to Eliminate the Requirement to Include the Name of the Securities Market on which a Transaction is Effected; Effective Date: January 1, 2008

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      Regulatory Notice

      Notice Type

      Rule Amendment

      Referenced Rules & Notices

      NASD Rule 2320
      Notice 07-35
      NTM 01-22
      NYSE Info Memo 07-84
      NYSE Rule 409
      Regulation NMS
      SEC Rule 10b-10
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Technology
      Key Topic(s)

      Confirmations
      Statements of Accounts

      PLEASE NOTE: The FINRA rulebook currently consists of both NASD Rules and certain NYSE Rules that FINRA has incorporated, including NYSE Rule 409. The incorporated NYSE Rules apply solely to members of FINRA that are also members of NYSE on or after July 30, 2007, referred to as "Dual Members." Dual Members also must comply with NASD Rules. Until the adoption of a consolidated rulebook, FINRA's Regulatory Notices will address both NASD and the incorporated NYSE Rules.

      Amendments to NYSE Rule 409(f)

      Executive Summary

      Effective January 1, 2008,1 Dual Member firms will not be required to disclose the name of the securities market on which the transaction was effected on confirmations or reports as required under NYSE Rule 409(f). This change makes permanent the temporary relief that was granted in March 2007 and extended until January 1, 2008. The text of the amended rule is set forth in Attachment A to this Notice.

      Questions concerning this Notice should be directed to the FINRA Office of General Counsel, at (202) 728-8071.

      Background & Discussion

      On March 20, 2007, NYSE granted temporary relief, until September 30, 2007, from the application of NYSE Rule 409(f) regarding the disclosure of the name of the securities market on which a transaction was effected.2 The temporary relief was extended by FINRA and by NYSE until January 1, 2008.3 FINRA has filed a rule amendment for immediate effectiveness to make this relief permanent as of January 1, 2008.

      NYSE Rule 409(f) (Statements of Customer Accounts) requires that confirmations of all transactions (including those made over-the-counter and on other exchanges) in securities admitted to dealings on the NYSE, sent by Dual Members to their customers, indicate the settlement date of the transaction and the name of the securities market on which the transaction was effected. This requirement also applies to confirmations or reports from an organization to a correspondent, but does not apply to reports made by floor brokers to the member organization from which the orders were received.4

      Following the SEC's adoption of Regulation NMS (Reg NMS), an increasing number of orders, or portions of orders, routed to a given market for execution are rerouted to other markets that, at that time, display a better quotation. This process, which often is necessary due to the requirements of the Order Protection Rule under Reg NMS, may lead to relatively small orders receiving executions in multiple market centers.5 This creates an operational challenge for Dual Members to capture the name of the market of execution on a timely basis for inclusion on the transaction confirmation as required by NYSE Rule 409(f).

      Because of this challenge, both FINRA and NYSE granted temporary relief from the application of NYSE Rule 409(f) regarding the disclosure of the name of the securities market on which a transaction was effected. In granting the relief, FINRA and NYSE stated that they would continue to reassess the utility of NYSE Rule 409(f) in the current regulatory environment.

      FINRA has concluded that, because of member firms' existing best execution and disclosure requirements, the usefulness of including on a confirmation or correspondent report the securities market on which a transaction in a security admitted to dealings on the NYSE was effected does not outweigh the operational difficulties of capturing the information following the adoption of Reg NMS. Specifically, the duty of best execution requires Dual Members to exercise diligence to obtain the best price when routing customer trades for execution.6 In this regard, NASD Rule 2320 (Best Execution and Interpositioning) requires every FINRA member to employ reasonable diligence in ascertaining best execution in the execution of a transaction.7 In addition to existing best execution obligations, Reg NMS imposes disclosure obligations on broker-dealers regarding the handling of customer orders.8 Because of these existing obligations, FINRA has eliminated from NYSE Rule 409(f) the requirement that confirmations and correspondent reports for transactions in securities admitted to dealings on the NYSE include the securities market on which the transaction was effected. Dual Members are, however, still required to indicate the settlement date of each transaction on customer and correspondent confirmations and correspondent reports for all transactions (including those made over-the-counter and on other exchanges) in securities admitted to dealings on the NYSE.


      1. FINRA filed this amendment with the Securities and Exchange Commission (SEC) for immediate effectiveness on December 21, 2007, with an operative date of January 1, 2008. See SR-FINRA-2007-037.

      2. See NYSE Information Memorandum 07-28 (March 20, 2007).

      3. See FINRA Regulatory Notice 07-35 (August 2007); NYSE Information Memorandum 07-84 (August 2, 2007).

      4. See also SEC Rule 10b-10.

      5. The Order Protection Rule requires trading centers, including broker-dealers that internally execute orders, to establish, maintain, and enforce written policies and procedures reasonably designed to protect against "trade-throughs" of protected quotations in NMS stocks. See Rule 611(a) under Reg NMS, 17 CFR 242.611(a).

      6. See, e.g., Securities Exchange Act Release No. 51808 (June 9, 2005), 70 FR 37496, 37537-38 (June 29, 2005) (discussing the duty of best execution in relation to Reg NMS).

      7. As stated in NASD Notice to Members 01-22, members generally may execute such diligence on either a trade-by-trade basis or through the regular and rigorous review of the execution quality of various market centers.

      8. SEC Rule 606(b) requires a broker-dealer to disclose to its customer upon request "the identity of the venue to which the customer's orders were routed for execution in the six months prior to the request, whether the orders were directed orders or non-directed orders, and the time of the transactions, if any, that resulted from such orders." See Rule 606(b) under Reg NMS, 17 CFR 242.606(b). SEC Rule 607 requires a broker-dealer that acts as agent for a customer to disclose, in writing, upon opening a new account and on an annual basis thereafter, the firm's policies regarding receipt of payment for order flow and the firm's policies for determining where to route customer orders that are the subject of payment for order flow. See Rule 607 under Reg NMS, 17 CFR 242.607(a).


      ATTACHMENT A

      New language is underlined; deletions are in brackets.

      Rule 409. Statements of Accounts to Customers

      (a) through (e) No change.
      (f) Confirmation of all transactions (including those made "over-the-counter" and on other exchanges) in securities admitted to dealings on the Exchange, sent by members or member organizations to their customers, shall [indicate] clearly set forth with a suitable legend the settlement date of each transaction]and bear the name of the securities market on which the transaction was made]. This requirement also applies to confirmations or reports from an organization to a correspondent, but does not apply to reports made by floor brokers to the member organization from whom the orders were received.

      [All confirmations shall contain a suitable legend clearly setting forth all required information.]

    • 07-64 SEC approves amendments to NASD Rule 3010(g)(1) to Exempt Locations that Solely Conduct Final Approval of Research Reports; Effective Date: December 19, 2007

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      Office of Supervisory Jurisdiction Definition

      Regulatory Notice

      Notice Type

      Rule Amendment

      Referenced Rules & Notices

      NTM 07-12
      NASD Rule 3010
      NYSE Information Memo 05-74
      NYSE Information Memo 06-13
      Suggested Routing

      Corporation Finance
      Legal
      Registration
      Senior Management
      Branch Office
      Key Topic(s)

      Office of Supervisory Jurisdiction
      Research Reports
      Supervision
      Uniform Branch Office Definition

      Executive Summary

      Effective December 19, 2007, locations that solely conduct final approval of research reports are exempt from the definition of Office of Supervisory Jurisdiction.1 NASD Rule 3010(g)(1), as amended, is set forth in Attachment A.

      Questions concerning this Notice should be directed to Rachael Grad, Counsel, Office of General Counsel, at (202) 728-8290.

      Background & Discussion

      The SEC has approved an amendment to NASD Rule 3010(g)(1) to exempt from the definition of Office of Supervisory Jurisdiction (OSJ) those locations that solely conduct final approval of research reports.2 The amendment allows FINRA to classify such locations consistently under both NASD and the incorporated NYSE rules.

      In July 2006, amendments to the branch office definition under NASD Rule 3010(g)(2) went into effect (Uniform Branch Office Definition).3 The Uniform Branch Office Definition was developed by FINRA (then NASD), the NYSE and the North American Securities Administrators Association (NASAA) to establish a broad national standard. In conjunction with the new Uniform Branch Office Definition, a new Form BR was introduced to provide a more efficient, standardized method for member firms to register branch office locations.

      While FINRA and the NYSE sought to adopt consistent interpretations of the new Uniform Branch Office Definition, they classified differently locations where final approval by a principal of research reports occurs. Under NASD rules, final review of advertising or sales literature (which includes research reports) makes a location an OSJ, and therefore a branch office. The NYSE rules, however, do not include an OSJ definition, and NYSE stated in Information Memos 05-74 and 06-13 that it deems a location where a member firm stations a Series 16 qualified supervisory analyst solely to review research reports as a "non-sales" location, which is an express exclusion from the Uniform Branch Office Definition.4 Because of the definition of OSJ set forth in NASD Rule 3010(g)(1), FINRA could not classify such locations as "non-sales" locations under NASD rules, unless the review of the research reports conducted from such locations constituted something less than final approval.5

      The SEC recently approved the amendment to NASD Rule 3010(g)(2) to exclude locations that solely conduct final approval of research reports from the definition of OSJ. As a result of this amendment, FINRA is of the view that a location where a member firm conducts final approval of research reports may be considered a "non-sales" location for purposes of NASD Rule 3010(g)(2), the Uniform Branch Office Definition, provided no other activities at such location would require branch office registration.


      1 See Securities Exchange Act Release No. 56585 (October 1, 2007) 72 FR 57081 (October 5, 2007) (Notice of Filing of Proposed Rule Change Relating to Amending the Definition of Office of Supervisory Jurisdiction in NASD Rule 3010(g)(1) to Exempt Locations that Solely Conduct Final Approval of Research Reports; SR-FINRA-2007-008).

      2 NASD Rule 3010(g)(1) defines the term OSJ to mean any office of a member at which any one or more of the following functions take place: (a) order execution and/or market making; (b) structuring of public offerings or private placements; (c) maintaining custody of customers' funds and/or securities; (d) final acceptance (approval) of new accounts on behalf of the member; (e) review and endorsement of customer orders, pursuant to NASD Rule 3010(d); (f) final approval of advertising or sales literature for use by persons associated with the member, pursuant to NASD Rule 2210(b)(1); or (g) responsibility for supervising the activities of persons associated with the member at one or more other branch offices of the member.

      3 See Securities Exchange Act Release No. 52403 (September 9, 2005); 70 FR 54782 (September 16, 2005) (Order Granting Approval of Proposed Rule Change Relating to Proposed Uniform Branch Office Definition; SR-NASD-2003-104).

      4 See NYSE Information Memo 05-74 (October 6, 2005) (Branch Office Definition) ("An example of a non-sales location would be where a member or member organization stations a Series 16 qualified supervisory analyst in an office of a foreign affiliate, solely to review research reports") and NYSE Information Memo 06-13 (March 22, 2006) (Joint Interpretive Guidance from NYSE and NASD Relating to the Uniform Branch Office Definition, Question and Answer #5).

      5 Compare NYSE Information Memo 06-13 (March 22, 2006) (Joint Interpretive Guidance from NYSE and NASD Relating to the Uniform Branch Office Definition, Question and Answer #5) with NASD Notice to Members 06-12 (March 2006) (Uniform Branch Office Definition, Question and Answer #5).


      Attachment A

      New language is underlined.

      3010 Supervision

      (g) Definitions
      (1) "Office of Supervisory Jurisdiction" means any office of a member at which any one or more of the following functions take place:
      (A) order execution and/or market making;
      (B) structuring of public offerings or private placements;
      (C) maintaining custody of customers' funds and/or securities;
      (D) final acceptance (approval) of new accounts on behalf of the member;
      (E) review and endorsement of customer orders, pursuant to paragraph (d) above;
      (F) final approval of advertising or sales literature for use by persons associated with the member, pursuant to Rule 2210(b)(1), except for an office that solely conducts final approval of research reports; or
      (G) responsibility for supervising the activities of persons associated with the member at one or more other branch offices of the member.

    • 07-63 FINRA Adopts Rule Amendments Relating to Reporting of Odd-Lot Transactions; Effective Date: March 3, 2008

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      Odd-Lot Transactions

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      Section 3 of Schedule A to the By-Laws
      NASD Rules 4200, 4200A, 4200C and 4200E
      NASD Rules 4632, 4632A, 4632C and 4632E
      NASD Rule 6610
      NASD Rules 6130, 6130A, 6130C and 6130E
      NASD Rule 6620
      NTM 07-23
      Regulatory Notice 07-38
      Regulation NMS
      Section 31 of the Exchange Act
      Suggested Routing

      Compliance
      Finance
      Legal
      Operations
      Registered Representatives
      Senior Management
      Systems
      Trading
      Key Topic(s)

      Alternative Display Facility
      Odd-Lots
      OTC Reporting Facility
      Regulatory Transaction Fees
      Trade Reporting
      Trade Reporting Facilities

      Executive Summary

      Effective Monday, March 3, 2008, when reporting odd-lot transactions1 to a FINRA Trade Reporting Facility (TRF), the Alternative Display Facility (ADF) and the OTC Reporting Facility (ORF) (collectively referred to as the "FINRA Facilities"), firms:

      1) will no longer use the special ".RO" trade report modifier to indicate that an odd-lot transaction is reported for regulatory transaction fee purposes and
      2) must report odd-lot transactions marked for media dissemination (i.e., "for publication" or as "tape eligible"), as applicable.

      The text of the amended rule language is available at http://www.finra.org/RulesRegulation/RuleFilings/2007RuleFilings/P037160.

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

      Background & Discussion

      Today, with the exception of OTC Equity Securities, as defined in NASD Rule 6610, firms do not report odd-lot transactions to FINRA for purposes of public dissemination.2 Firms are, however, required to report such transactions for regulatory transaction fee purposes and must use a special ".RO" trade report modifier (the ".RO modifier") to indicate that the transaction is reported pursuant to Section 3 of Schedule A to the By-Laws (Section 3). FINRA uses the .RO modifier to identify odd-lot transactions that are required to be included in FINRA's calculation of its Section 31 obligation to the Securities and Exchange Commission (SEC).3

      With the implementation of Regulation NMS and a new trade report messaging format,4 firms are required to include the .RO modifier on trade reports of odd-lot transactions in the same information level (or byte) as other regulatory modifiers. Thus, in certain instances, firms may be faced with prioritizing and determining which modifier should be included in the trade report submitted to FINRA. This can lead to confusion, inaccuracies and inconsistencies in trade reporting which, in turn, can impair FINRA's ability to produce a complete and accurate audit trail. FINRA has determined that the .RO modifier can be eliminated because the FINRA Facilities can systematically identify odd-lot transactions based on the number of reported shares.5

      Accordingly, on October 10, 2007, FINRA filed with the SEC for immediate effectiveness a proposed rule change6 to amend its trade reporting rules7 to eliminate the requirement that firms use the .RO modifier on reports of odd-lot transactions. FINRA also amended its trade reporting rules8 to require that firms report odd-lot transactions marked for media dissemination (i.e., "for publication" or as "tape eligible"), as applicable.9 Thus, instead of appending the .RO modifier on reports of odd-lot transactions that are subject to a regulatory transaction fee, firms should mark those reports as "tape eligible." FINRA will include odd-lot trades in covered securities reported as "tape eligible" in the aggregate dollar amount of its covered sales for purposes of calculating its Section 31 obligation to the SEC. However, although odd-lot transactions will be marked "tape eligible," the FINRA Facilities will suppress such transactions from public dissemination.10

      With the exception of the changes described above, firms should continue to report odd-lot transactions as they do today. FINRA is clarifying that firms are not required to mark an odd-lot transaction report as "tape eligible" pursuant to the rule amendments if that report would not be marked with the .RO modifier today. For example, firms should continue to submit non-tape (or clearing-only or non-tape, non-clearing) reports, as applicable, to reflect the offsetting leg of a riskless principal transaction11 or agency transaction where a firm is acting as agent on behalf of another member firm.12 In such instances, the first leg would be reported to FINRA as "tape eligible" and would be assessed a Section 3 fee, and the second offsetting leg would be reported to FINRA as a non-tape (clearing-only or non-tape, non-clearing) entry and would not be assessed a Section 3 fee.

      Additionally, FINRA notes that the rule amendments do not affect the status of odd-lot transactions under Regulation NMS; in particular, the application of the Regulation NMS Order Protection Rule.13

      The rule amendments become operative on Monday, March 3, 2008.


      1 For purposes of the trade reporting rules, an odd lot is less than a "normal unit of trading," which is defined as "100 shares of a security unless, with respect to a particular security, NASD determines that a normal unit of trading shall constitute other than 100 shares." See NASD Rules 4200, 4200A, 4200C and 4200E.

      2 See NASD Rules 4632(e), 4632A(i), 4632C(e) and 4632E(f). Pursuant to NASD Rule 6620, odd-lot transactions in OTC Equity Securities are required to be reported to FINRA for purposes of publication.

      3 Pursuant to Section 31 of the Securities Exchange Act of 1934, FINRA and the national securities exchanges are required to pay transaction fees and assessments to the SEC that are designed to recover the costs related to the government's supervision and regulation of the securities markets and securities professionals. FINRA obtains its Section 31 fees and assessments from its membership, in accordance with Section 3.

      4 See NASD Notice to Members 07-23 (May 2007).

      5 Firms should note that they are still required to use special trade report modifiers to indicate that away-from-the-market sales and exercises of OTC options are reported in accordance with Section 3 (the ".RA" and ".RX" modifiers, respectively).

      6 See Securities Exchange Act Release No. 56669 (October 17, 2007), 72 FR 60398 (October 24, 2007) (notice of filing and immediate effectiveness of SR-FINRA-2007-017).

      7 See NASD Rules 6130(g), 6130A(c), 6130C(f) and 6130E(f).

      8 See NASD Rules 4632(e), 4632A(i), 4632C(e) and 4632E(f).

      9 Firms should consult the applicable technical specifications for details on how to report trades for media dissemination to a particular FINRA Facility, as the specific reporting requirements may differ across facilities.

      10 FINRA notes that today, with the general exception of certain high-priced securities, transactions of fewer than 100 shares are not publicly disseminated by FINRA or the appropriate exclusive securities information processor.

      11 See NASD Rules 4632(d)(3)(B), 4632A(e)(1) (C)(ii), 4632C(d)(3)(B), 4632E(e)(3)(B) and 6620(d)(3)(B).

      12 See FINRA Regulatory Notice 07-38 (August 2007).

      13 See Question 7.03, Division of Market Regulation: Responses to Frequently Asked Questions concerning SEC Rule 611 and Rule 610 of Regulation NMS (June 8, 2007 update).

    • 07-62 Revisions to the Series 23, 24, 42, 55, 62, 72 and 82 Examination Programs; Implementation Date: February 12, 2008

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      Qualification Examinations

      Regulatory Notice
      Notice Type

      Qualifications Exam Updates
      Referenced Rules & Notices

      NASD Rule 1022(a)
      NASD Rule 1032(d, e, f, g, h)
      NYSE Rule 342.13
      Suggested Routing

      Compliance
      Legal
      Operations
      Registration
      Training
      Key Topic(s)

      Qualification Examinations
      General Securities Principal Sales Supervisor Module (Series 23)
      General Securities Principal (Series 24)
      Limited Representative—Corporate Securities (Series 62)
      Limited Representative—Equity Trader (Series 55)
      Limited Representative—Government Securities (Series 72)
      Limited Representative—Options (Series 42)
      Limited Representative—Private Securities Offerings (Series 82)

      Executive Summary

      FINRA has revised the following examination programs:

      •   General Securities Principal Sales Supervisor Module (Series 23);
      •   General Securities Principal (Series 24);
      •   Limited Representative—Options (Series 42);
      •   Limited Representative—Equity Trader (Series 55);
      •   Limited Representative—Corporate Securities (Series 62);
      •   Limited Representative—Government Securities (Series 72); and
      •   Limited Representative—Private Securities Offerings (Series 82).1

      The changes are reflected in the study outlines on FINRA's Web site at www.finra.org/brokerqualifications/exams. The changes will appear in examinations starting on February 12, 2008.

      Questions concerning this Notice may be directed to:

      •   Carole Hartzog, Lead Qualifications Analyst, Testing and Continuing Education Department (TCE), at (240) 386-4678;
      •   Elaine Warren, Senior Qualifications Analyst, TCE, at (240) 386-4679;
      •   Eva Cichy, Qualifications Analyst, TCE, at (240) 386-4680; or
      •   Karen Bescher, Qualifications Analyst, TCE, at (240) 386-4677.

      Background and Discussion

      Section 15A(g)(3) of the Securities Exchange Act of 1934 (Exchange Act) requires FINRA to prescribe standards of training, experience and competence for persons associated with FINRA member firms. In accordance with that provision, FINRA has developed examinations, and administers examinations developed by other self-regulatory organizations, that are designed to establish that persons associated with FINRA member firms have attained specified levels of competence and knowledge. FINRA periodically reviews the content of the examinations to determine whether revisions are necessary or appropriate in view of changes pertaining to the subject matter.

      FINRA and committees of industry representatives recently reviewed the Series 23, 24, 42, 55, 62, 72 and 82 examination programs. As a result of these reviews, and as discussed in greater detail below, FINRA has revised the examination programs to reflect changes to the laws, rules and regulations covered by the examinations and to better reflect the duties and responsibilities of the individuals who are taking these examinations.

      Series 23 (General Securities Principal Sales Supervisor Module)

      The Series 23 is a limited qualification examination that 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 Series 23 examination, in combination with the General Securities Sales Supervisor (Series 9/10) examination, is 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 FINRA. The Series 23 examination covers material from the Series 24 examination not otherwise covered under the Series 9/10 examination.

      Among other revisions, FINRA has changed the references to the FINRA and the Nasdaq Stock Market LLC (NASDAQ) rules in the Series 23 study outline to reflect NASDAQ's separation from FINRA (then known as NASD). In addition, FINRA has added sections on:

      •   SEC Regulation M-A (Mergers and Acquisitions)
      •   SEC Regulation S-K
      •   SEC Regulation S-X
      •   SEC Regulation NMS
      •   SEC Regulation SHO
      •   the Sarbanes-Oxley Act
      •   SEC Rule 3a4-1 (Associated Persons of an Issuer Deemed Not to Be Brokers)
      •   SEC Rule 405 (Definitions of Terms)
      •   NASDAQ Initial Public Offering Process (NASDAQ Head Trader Alert 2005-096)
      •   NYSE Rule 392 (Notification Requirements for Offerings of Listed Securities)
      •   NASD IM-2110-7 (Interfering With the Transfer of Customer Accounts in the Context of Employment Disputes)
      •   NASD IM-2210-6 (Requirements for the Use of Investment Analysis Tools)
      •   NASD Rule 2111 (Trading Ahead of Customer Market Orders)
      •   NASD Rule 2290 (Fairness Opinions)
      •   NASD Rule 2370 (Borrowing From or Lending to Customers)
      •   NASD Rule 2441 (Net Transactions with Customers)
      •   NASD Rule 5110 (Transactions Related to Initial Public Offerings)

      FINRA has changed the title of Section 1 of the study outline from "Supervision of Investment Banking Activities" to "Supervision of Investment Banking, Underwriting Activities and Research," and the title of Section 4 from "Sales Supervision; General Supervision of Employees; Regulatory Framework of NASD" to "Sales Supervision and General Supervision of Employees."

      Further, FINRA has modified the number of questions in each section of the study outline as follows:

      •   Supervision of Investment Banking, Underwriting Activities and Research: increased from 25 to 30 questions;
      •   Supervision of Trading and Market Making Activities: decreased from 29 to 24 questions;
      •   Supervision of Brokerage Office Operations: decreased from 16 to 12 questions;
      •   Sales Supervision and General Supervision of Employees: increased from 19 to 23 questions; and
      •   Compliance with Financial Responsibility Rules: no change to the number of questions (11).

      FINRA has made similar changes to the Series 23 selection specifications and question bank. The number of questions on the Series 23 examination remains at 100, and candidates continue to have 21/2 hours to complete the exam. Also, each question continues to count as one point, and each candidate must correctly answer 70 percent of the questions to receive a passing grade.

      Series 24 (General Securities Principal)

      Pursuant to NASD Rule 1022(a), each associated person of a member firm who is included within the definition of principal in NASD Rule 1021(b), and each person designated as a Chief Compliance Officer on Schedule A of Form BD (Uniform Application for Broker-Dealer Registration), is required to register with FINRA as a General Securities Principal, or in such other limited principal registration categories, as may be appropriate.2 An associated person also may be required to register as a General Securities Principal due to other FINRA rule requirements.3 The Series 24 examination is the FINRA examination that qualifies an individual to function as a General Securities Principal. An associated person seeking to register as a General Securities Principal also must register as either a General Securities Representative (Series 7) or, depending on the scope of his or her supervisory responsibilities, as a Limited Representative—Corporate Securities (Series 62).4

      Among other revisions, FINRA has changed the references to the FINRA and NASDAQ rules in the Series 24 study outline to reflect NASDAQ's separation from FINRA (then known as NASD). In addition, FINRA has added sections on:

      •   SEC Regulation M-A
      •   SEC Regulation S-K
      •   SEC Regulation S-X
      •   SEC Regulation NMS
      •   SEC Regulation SHO
      •   the Sarbanes-Oxley Act
      •   SEC Rule 3a4-1
      •   SEC Rule 405
      •   NASDAQ Initial Public Offering Process (NASDAQ Head Trader Alert 2005-096)
      •   NYSE Rule 392
      •   NASD IM-2110-7
      •   NASD IM-2440-2 (Additional Mark-Up Policy for Transactions in Debt Securities, Except Municipal Securities)
      •   NASD IM-2210-6
      •   NASD Rule 2111
      •   NASD Rule 2290
      •   NASD Rule 2370
      •   NASD Rule 2441
      •   NASD Rule 5110

      FINRA has changed the title of Section 1 of the study outline from "Supervision of Investment Banking Activities" to "Supervision of Investment Banking, Underwriting Activities and Research," and the title of Section 4 from "Sales Supervision; General Supervision of Employees; Regulatory Framework of NASD" to "Sales Supervision and General Supervision of Employees."

      Further, FINRA has modified the number of questions in each section of the study outline as follows:

      •   Supervision of Investment Banking, Underwriting Activities and Research: increased from 23 to 33 questions;
      •   Supervision of Trading and Market Making Activities: decreased from 39 to 31 questions;
      •   Supervision of Brokerage Office Operations: decreased from 34 to 29 questions;
      •   Sales Supervision and General Supervision of Employees: increased from 38 to 43 questions; and
      •   Compliance with Financial Responsibility Rules: decreased from 16 to 14 questions.

      FINRA has made similar changes to the Series 24 selection specifications and question bank. The number of questions on the Series 24 examination remains at 150, and candidates continue to have 31/2 hours to complete the exam. Also, each question continues to count as one point, and each candidate must correctly answer 70 percent of the questions to receive a passing grade.

      Series 42 (Limited Representative—Options)

      Pursuant to NASD Rule 1032(d), each associated person of a member firm who is included within the definition of representative in NASD Rule 1031(b) may register with FINRA as a Limited Representative—Options and Security Futures if: (1) the individual's activities in the investment banking and securities business of the member firm are limited solely to the solicitation or sale of option or security futures contracts, including option contracts on government securities as that term is defined in Section 3(a)(42)(D) of the Exchange Act, for the account of a broker-dealer or public customer; (2) the individual also registers as either a Limited Representative—Corporate Securities (Series 62) or Limited Representative—Government Securities (Series 72); (3) the individual passes the Series 42 qualification examination; and (4) the individual completes a firm element continuing education program that addresses security futures before engaging in any security futures business.

      Among other revisions, FINRA has changed the Series 42 study outline to add sections on NASD IM-2110-7 and NASD Rules 2370 and 2790 (Restrictions on the Purchase and Sale of Initial Equity Public Offerings).

      FINRA also has decreased the number of sections covered by the Series 42 outline from five to four. Further, FINRA has modified the section headings and the number of questions in each section of the outline as follows:

      •   Section 1, Terminology, Types of Options, Investment Strategies and Taxation (20 questions);
      •   Section 2, Handling Options Accounts (14 questions);
      •   Section 3, Trading and Settlement Practices (10 questions); and
      •   Section 4, Qualifications and Business Conduct of Registered Options Representatives, Reporting and Recordkeeping Requirements (6 questions).

      FINRA has made similar changes to the Series 42 selection specifications and question bank. The number of questions on the Series 42 examination remains at 50, and candidates continue to have 11/2 hours to complete the exam. Also, each question continues to count as one point, and each candidate must correctly answer 70 percent of the questions to receive a passing grade.

      Series 55 (Limited Representative—Equity Trader)

      Pursuant to NASD Rule 1032(f), each associated person of a member firm who is included within the definition of representative in NASD Rule 1031(b) is required to register with FINRA as a Limited Representative—Equity Trader if, with respect to transactions in equity, preferred or convertible debt securities effected otherwise than on a securities exchange, such person is engaged in proprietary trading, the execution of transactions on an agency basis or the direct supervision of such activities. There is an exception from the Limited Representative—Equity Trader requirement for any associated person of a member firm whose trading activities are conducted principally on behalf of an investment company that is registered with the SEC pursuant to the Investment Company Act of 1940 (Investment Company Act) and that controls, is controlled by or is under common control with the member firm. The Series 55 examination is the FINRA examination that qualifies an individual to function as a Limited Representative—Equity Trader. Before registration as a Limited Representative—Equity Trader may become effective, the individual must be registered as either a General Securities Representative (Series 7) or Limited Representative—Corporate Securities (Series 62).

      Among other revisions, FINRA has changed the references to the FINRA and NASDAQ rules in the Series 55 study outline to reflect NASDAQ's separation from FINRA (then known as NASD). FINRA also has added sections on NASD Rules 2441 and 5110.

      FINRA has changed the title of Section 2 of the study outline from "NASDAQ Display, Execution and Trading Systems" to "Display, Execution and Trading Systems." Further, FINRA has modified the number of questions in each section of the study outline as follows:

      •   NASDAQ and Over-the-Counter Markets: increased from 41 to 42 questions;
      •   Display, Execution and Trading Systems: decreased from 17 to 12 questions;
      •   Trade Reporting Requirements: increased from 19 to 22 questions; and
      •   General Industry Standards: increased from 23 to 24 questions.

      FINRA has made similar changes to the Series 55 selection specifications and question bank. The number of questions on the Series 55 examination remains at 100, and candidates continue to have 3 hours to complete the exam. Also, each question continues to count as one point, and each candidate must correctly answer 70 percent of the questions to receive a passing grade.

      Series 62 (Limited Representative—Corporate Securities)

      Pursuant to NASD Rule 1032(e), each associated person of a member firm who is included within the definition of representative in NASD Rule 1031(b) may register with FINRA as a Limited Representative—Corporate Securities if: (1) the individual's activities in the investment banking and securities business of the member firm are limited solely to the solicitation, purchase and sale of a "security," as that term is defined in Section 3(a)(10) of the Exchange Act; (2) the individual does not engage in any activities relating to the following securities: municipal securities as defined in Section 3(a)(29) of the Exchange Act, option securities as defined in NASD Rule 2860, redeemable securities of companies registered pursuant to the Investment Company Act (except for money market funds), variable contracts of insurance companies registered pursuant to the Securities Act of 1933 (Securities Act) and direct participation program securities as defined in NASD Rule 1022(e); and (3) the individual passes the Series 62 qualification examination.

      Among other revisions, FINRA has changed the references to the FINRA and NASDAQ rules in the Series 62 study outline to reflect NASDAQ's separation from FINRA (then known as NASD). In addition, FINRA has added sections on:

      •   exchange-traded funds
      •   hedge funds
      •   unit investment trusts
      •   SEC Regulation M-A
      •   SEC Regulation S-K
      •   SEC Regulation S-X
      •   SEC Regulation NMS
      •   SEC Regulation SHO
      •   SEC Rule 405
      •   NASD IM-2110-7
      •   NASD IM-2440-2
      •   NASD IM-2210-6
      •   NASD Rule 2111
      •   NASD Rule 2370
      •   NASD Rule 2441

      FINRA has changed the title of Section 1 of the study outline from "Characteristics of Corporate Securities" to "Types and Characteristics of Securities and Investments," the title of Section 3 from "Valuing Corporate Securities" to "Evaluation of Securities and Investments," and the title of Section 4 from "Handling Customer Accounts" to "Handling Customer Accounts and Securities Industry Regulations."

      Further, FINRA has modified the number of questions in each section of the study outline as follows:

      •   Types and Characteristics of Securities and Investments: decreased from 28 to 25 questions;
      •   The Market for Corporate Securities: increased from 31 to 40 questions;
      •   Evaluation of Securities and Investments: no change to the number of questions (14); and
      •   Handling Customer Accounts and Securities Industry Regulations: decreased from 42 to 36 questions.

      FINRA has made similar changes to the Series 62 selection specifications and question bank. The number of questions on the Series 62 examination remains at 115, and candidates continue to have 21/2 hours to complete the exam. Also, each question continues to count one point, and each candidate must correctly answer 70 percent of the questions to receive a passing grade.

      Series 72 (Limited Representative—Government Securities)

      Pursuant to NASD Rule 1032(g), each associated person of a member firm who is included within the definition of representative in NASD Rule 1031(b) may register with FINRA as a Limited Representative—Government Securities if: (1) the individual's activities in the investment banking and securities business of the member firm are limited solely to the solicitation, purchase and sale of "government securities," as that term is defined in Sections 3(a)(42)(A) through (C) of the Exchange Act, for the account of a broker-dealer or public customer; and (2) the individual passes the Series 72 qualification examination.

      Among other revisions, FINRA has changed the Series 72 study outline to add sections on NASD IM-2210-6, NASD Rule 2370 and NASD Rule 2790.

      FINRA also has changed the title of Section 3 of the study outline from "Other Related Securities and Financial Instruments" to "Related Securities and Financial Instruments," and the title of Section 5 from "Legal Considerations" to "Securities Industry Regulations and Legal Considerations." Further, FINRA has modified the number of questions in each section of the study outline as follows:

      •   Government Securities: decreased from 25 to 22 questions;
      •   Mortgaged-Backed Securities: no change to the number of questions (25);
      •   Related Securities and Financial Instruments: no change to the number of questions (9);
      •   Economic Activity, Government Policy and the Behavior of Interest Rates: decreased from 16 to 13 questions;
      •   Securities Industry Regulations and Legal Considerations: increased from 10 to 15 questions; and
      •   Customer Considerations: increased from 15 to 16 questions.

      FINRA has made similar changes to the Series 72 selection specifications and question bank. The number of questions on the Series 72 examination remains at 100, and candidates continue to have 3 hours to complete the exam. Also, each question continues to count as one point, and each candidate must correctly answer 70 percent of the questions to receive a passing grade.

      Series 82 (Limited Representative—Private Securities Offerings)

      Pursuant to NASD Rule 1032(h), each associated person of a member firm who is included within the definition of representative in NASD Rule 1031(b) may register with FINRA as a Limited Representative—Private Securities Offerings if: (1) the individual's activities in the investment banking and securities business of the member firm are limited solely to effecting sales as part of a primary offering of securities not involving a public offering, pursuant to Sections 3(b), 4(2) or 4(6) of the Securities Act and the rules and regulations thereunder; (2) the individual does not effect sales of municipal or government securities, or equity interests in or the debt of direct participation program securities as defined in NASD Rule 1022(e); and (3) the individual passes the Series 82 qualification examination.

      Among other revisions, FINRA has revised the Series 82 study outline to add sections on exchange-traded funds, Private Investment in Public Equity (PIPE) offerings, NASD IM-2110-7 and NASD Rule 2370.

      FINRA also has changed the title of Section 3 of the study outline from "Analyzing Corporate Securities" to "Analyzing Corporate Securities and Investment Planning." Further, FINRA has modified the number of questions in each section of the study outline as follows:

      •   Characteristics of Corporate Securities: no change to the number of questions (13);
      •   Regulation of The Market for Registered and Unregistered Securities: no change to the number of questions (45);
      •   Analyzing Corporate Securities and Investment Planning: increased from 15 to 16 questions; and
      •   Handling Customer Accounts and Industry Regulations: decreased from 27 to 26 questions.

      FINRA has made similar changes to the Series 82 selection specifications and question bank. The number of questions on the Series 82 examination remains at 100, and candidates continue to have 21/2 hours to complete the exam. Also, each question continues to count as one point, and each candidate must correctly answer 70 percent of the questions to receive a passing grade.

      Availability of Study Outlines

      The study outlines for the revised examination programs are available on FINRA's Web site at www.finra.org/brokerqualifications/exams.


      1 See File Nos. SR-FINRA-2007-027 (Proposed Rule Change Relating to Revisions to the Series 23 Examination Program); SR-FINRA-2007-028 (Proposed Rule Change Relating to Revisions to the Series 24 Examination Program); SR-FINRA-2007-029 (Proposed Rule Change Relating to Revisions to the Series 42 Examination Program); SR-FINRA-2007-030 (Proposed Rule Change Relating to Revisions to the Series 55 Examination Program); SR-FINRA-2007-031 (Proposed Rule Change Relating to Revisions to the Series 62 Examination Program); SR-FINRA-2007-032 (Proposed Rule Change Relating to Revisions to the Series 72 Examination Program); and SR-FINRA-2007-033 (Proposed Rule Change Relating to Revisions to the Series 82 Examination Program). These rule filings were filed with the SEC for immediate effectiveness on December 12, 2007.

      2 In addition, NYSE Rule 342.13 recognizes the Series 24 examination as an acceptable alternative to the Series 9/10 examination for persons whose duties do not include supervision of options or municipal securities sales activities. FINRA has incorporated into its rulebook certain rules of NYSE, including NYSE Rule 342.13. FINRA's NYSE Rule 342.13 applies solely to those members of FINRA that also are members of NYSE on or after July 30, 2007.

      3 See, e.g., NASD Rules 3010(a)(2), 3010(a)(4) and 3012(a)(1).

      4 As a prerequisite to the Series 24 examination, FINRA also recognizes the Limited Registered Representative (Series 17), Canada Modules of the Series 7 (Series 37 and Series 38) and Limited Representative—Private Securities Offerings (Series 82) examinations.

    • 07-61 SEC Approves Exemption from TRACE Reporting Requirements for Certain "Derivative-Related Transactions"; Effective Date: December 13, 2007

      View PDF File

      Trade Reporting and Compliance Engine (TRACE)

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      NASD Rule 6210
      NASD Rule 6230
      NASD NTM 05-77
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Systems
      Trading
      Key Topic(s)

      Derivative-Related Transactions
      Reportable TRACE Transaction
      TRACE
      TRACE-eligible securities
      Transaction Reporting Exemption

      Executive Summary

      Effective December 13, 2007, "Derivative-Related Transactions" are exempt from the TRACE reporting requirements. Derivative-Related Transactions are transactions in TRACE-eligible securities resulting from the exercise or settlement of an option or a similar instrument, or the termination or settlement of a credit default swap (CDS), other type of swap or a similar instrument. At the same time, FINRA has made conforming amendments to the definition of "reportable TRACE transaction" in NASD Rule 6210(c).1

      The text of NASD Rule 6230(e) and NASD Rule 6210(c), as amended and approved by the SEC on October 26, 2007, is set forth in Attachment A of this Notice. Also, FINRA is rescinding NASD Notice to Members (NTM) 05-77 (November 2005), which concerns TRACE reporting requirements for such transactions, effective December 13, 2007.2

      Questions regarding this Notice may be directed to:

      •   Elliot Levine, Chief Counsel, Transparency Services, at (202) 728-8405;
      •   Patrick Geraghty, Director, Market Regulation, at (240) 386-4973; or
      •   Sharon Zackula, Associate Vice President and Associate General Counsel, Office of General Counsel, at (202) 728-8985.

      Background & Discussion

      Currently, the TRACE System accepts reports on transactions in TRACE-eligible securities resulting from the exercise or settlement of an option or a similar instrument, or the termination or settlement of a CDS, other type of swap or a similar instrument (collectively, Derivative-Related Transactions). As amended, NASD Rule 6230 exempts such Derivative-Related Transactions from the TRACE reporting requirements.

      FINRA determined that Derivative-Related Transactions should be exempt from TRACE reporting because the information regarding price (and yield) being reported to FINRA and disseminated to the public does not reflect currently negotiated transaction prices.3 Further, reporting and dissemination of certain Derivative-Related Transactions does not foster price discovery and may contribute to investor confusion. In addition, because prices from Derivative-Related Transactions do not contribute to price discovery, the costs of continuing to require such reporting, including potential investor confusion, support exempting such transactions from TRACE reporting and dissemination.

      In a related amendment to NASD Rule 6210(c), FINRA simplified the defined term, "reportable TRACE transaction," to exclude generally any transaction exempted under NASD Rule 6230(e).

      Because such Derivative-Related Transactions will no longer be reported, FINRA also is rescinding NASD NTM 05-77 (November 2005), which provides guidance regarding the reporting of such transactions to TRACE. NASD NTM 05-77 is rescinded effective December 13, 2007.


      1 See Securities Exchange Act Release No. 56709 (October 26, 2007), 72 FR 61924 (November 1, 2007); File No. SR-FINRA-2007-07.

      2 See NASD Notice to Members 05-77 (November 2005).

      3 For example, the price of a transaction in a TRACE-eligible security executed as a result of the settlement of a CDS is agreed upon at the time of execution of the CDS.


      ATTACHMENT A

      Below is the text of the rule change. New language is underlined; deletions are in brackets.

      6200. TRADE REPORTING AND COMPLIANCE ENGINE (TRACE)

      6210. Definitions

      The terms used in this Rule 6200 Series shall have the same meaning as those defined in [NASD's By-Laws]FINRA's By-Laws and NASD's Rules unless otherwise specified.

      (a) through (b) No Change.
      (c) The term "reportable TRACE transaction" shall mean any secondary market transaction in a TRACE-eligible security except transactions exempt from reporting as specified in Rule 6230(e).[transactions in TRACE-eligible securities that are listed on a national securities exchange registered under Section 6 of the Securities Exchange Act of 1934, when such transactions are executed on, and reported to the exchange and the transaction information is disseminated publicly.]
      (d) through (j) No Change.

      * * * * *

      6230. Transaction Reporting

      (a) through (d) No Change.
      (e) Transactions Exempt From Reporting

      The following types of transactions shall not be reported:

      (1) through (4) No Change.
      (5) Transactions resulting from the exercise or settlement of an option or a similar instrument, or the termination or settlement of a credit default swap, other type of swap, or a similar instrument.
      (f) No Change.

    • 07-60 FINRA Announces Relief Relating to Customer and PAIB Reserve Formula Computations and Required Deposits around the December 2007 Month-End Holidays

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      Financial Reporting Relief

      Regulatory Notice
      Notice Type

      Guidance
      Referenced Rules & Notices

      SEC Rule 15c3-3
      Suggested Routing

      Capital and Accounting Staff
      Compliance
      Chief Financial Officer
      Executive Representative
      Legal
      Senior Management
      Key Topic(s)

      Customer Reserve Formula Computation
      FOCUS Filing
      PAIB Reserve Formula Computation
      Reserve Bank Account Deposit

      Executive Summary

      Because the 2007 Christmas and 2008 New Year's Day holidays occur on Tuesdays, many employees of member firms may take off the preceding Mondays. This may impair firms' ability to prepare accurate computations of the amounts required to be reserved pursuant to SEC Rule 15c3-3. As such, FINRA is notifying member firms that staff of the Division of Trading and Markets of the SEC is granting an optional one-day extension to firms for making the deposit of amounts required to be reserved pursuant to SEC Rule 15c3-3. These reserved amounts are based on the Customer and PAIB reserve formula computations prescribed by SEC Rule 15c3-3(e)(3) and computed as of Friday, December 21 and Friday December 28, 2007.1

      Questions regarding this Notice should be directed to:

      •   Bernadette Chichetti, Senior Principal Associate, Risk Oversight & Operational Regulation (ROOR), at (212) 656-6934;
      •   Anthony Lucarelli, Senior Principal Associate, ROOR, at (212) 656-5764; or
      •   Susan DeMando, Associate Vice President, Financial Operations Department, at (202) 728-8411.

      Background and Discussion

      Weekly Reserve Formula Computation Deposit Requirement

      Because the 2007 Christmas and 2008 New Year's Day holidays occur on Tuesdays, SEC staff is granting an optional one-day extension to member firms for making the requisite SEC Rule 15c3-3 Reserve Bank Account deposit(s) based on the Friday, December 21 and Friday, December 28, weekly Customer and PAIB reserve formula computations. This extension recognizes the fact that many employees of firms may take off on Monday, December 24 and Monday, December 31.

      The revised deadlines are noted below:

      Revised Weekly Reserve Formula Computation Deposit Requirement

      Week Ending Original Deadline Extension Date
      Friday, December 21 Wednesday, December 26 Thursday, December 27
      Friday, December 28 Wednesday, January 2 Thursday, January 3

      Month-End Reserve Formula Computation Deposit Requirement

      Member firms that report their financials and file a FOCUS report as of the last business day of each month would be required to compute their month-end Customer and PAIB reserve formula calculations as of Monday, December 31, 2007, and to make any requisite SEC Rule 15c3-3 Reserve Bank Account deposit(s) on Thursday, January 3, 2008. Further, pursuant to SEC Rule 15c3-3(e)(3)/01 (Weekly Computation), firms that prepare such month-end Customer and PAIB reserve formula computations as of Monday, December 31, would not be required to prepare the weekly Customer and PAIB reserve formula computations as of the following Friday, January 4, 2008.

      As a result of the optional one-day extension on the weekly computations, member firms that report their financials as of the last business day of the month and also elect to use the one-day extension, may be subject to a double deposit(s) on Thursday, January 3, 2008. The double deposit(s) would result from the weekly and month-end Customer and PAIB reserve formula computations required to be computed as of Friday, December 28 and Monday, December 31, respectively. To avoid this duplication, firms may elect to prepare their Friday, January 4, weekly Customer and PAIB reserve formula computation in lieu of the Friday, December 28, weekly computations. This option is only available for December 2007 for firms that report their financials as of the last business day of the month.


      1 Paragraph (e)(3) of SEC Rule 15c3-3 requires a broker-dealer to prepare the reserve formula computations, necessary to determine the amount required to be deposited as specified in paragraph (e)(1) of SEC Rule 15c3-3, to be made weekly, as of the close of the last business day of the week, and the deposit so computed to be made no later than one hour after the opening of banking business on the second following business day.

    • 07-59 FINRA Provides Guidance Regarding the Review and Supervision of Electronic Communications

      View PDF File

      Regulatory Notice

      Notice Type





      Guidance
      Referenced Rules & Notices

      NASD Rule 2210
      NASD Rule 2211
      NASD Rule 3010
      NASD Rule 3110
      NTM 98-11
      NTM 99-03
      NTM 07-30
      NYSE Information Memo 98-3
      NYSE Information Memo 07-54
      NYSE Rule 342
      NYSE Rule 410
      NYSE Rule 440
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Senior Management
      Training
      Key Topic(s)

      Correspondence—General
      Electronic Communications
      Supervision

      Supervision of Electronic Communications

      Executive Summary

      In June 2007, FINRA (then NASD and NYSE Member Regulation)1 issued for comment proposed guidance regarding the review and supervision of electronic communications. FINRA received 16 comment letters, with a majority of commenters supporting the guidance. FINRA is now issuing the final guidance, which is set forth in Attachment A.

      Questions concerning this Notice should be directed to:

      •   Patricia Albrecht, Assistant General Counsel, Office of General Counsel, at (202) 728-8026;
      •   Donald K. Lopezi, Deputy Director, Examinations Program, at (202) 728-8132;
      •   Stephen Kasprzak, Principal Counsel, Risk Oversight and Operational Regulation, at (212) 656-5226; or
      •   Cory Figman, Senior Special Counsel, Risk Oversight and Operational Regulation, at (212) 656-4893.

      Background and Discussion

      In June 2007, FINRA issued for comment proposed guidance setting forth principles for member firms to consider when developing supervisory systems and procedures for electronic communications that are reasonably designed to achieve compliance with applicable federal securities laws and self-regulatory organization (SRO) rules.2 FINRA received 16 comment letters in response to the proposal.3 After carefully considering these comments, FINRA is now issuing final guidance in substantially the form set forth in the proposal.

      A majority of commenters supported the proposed principle-based guidance,4 with many considering it to be balanced, flexible and technologically neutral.5 One commenter further noted that the proposed guidance reflected, in large measure, best practices already integrated within many firms' supervisory practices and procedures.6

      Another commenter that favored the principles-based aspect of the proposed guidance nonetheless raised concerns regarding the scope of communications subject to supervision.7 In particular, the commenter disagreed with the classification of text messaging as a form of electronic communication requiring supervision, citing the general inability of firms' electronic surveillance systems to capture text messages. The commenter stated that each firm should be entitled to apply a risk-based principled approach to determine whether communications such as text messaging need to be included in its supervisory system.

      FINRA appreciates the supervisory challenges firms face given the ever-increasing pace of change in electronic communications technology. However, as FINRA noted in the context of addressing the supervision and recordkeeping requirements for text messaging, a member firm's obligations to supervise electronic communications are based on the content and audience of the message, rather than the electronic form of the communication.8 Consequently, as indicated in the proposed and final guidance, FINRA expects a firm to have supervisory policies and procedures to monitor all electronic communications technology used by the firm and its associated persons to conduct the firm's business. To that end, a firm should consider, prior to implementing new or different methods of communication, the impact on the firm's supervisory system, particularly any updates or changes to the firm's supervisory policies and procedures that might be necessary.9 In this way, firms can identify and timely address any issues that may accompany the adoption of new electronic communications technologies. Finally, firms are reminded that they have a separate, but equally important, obligation to ensure that their use of electronic communications media enables them to make and keep records, as required by SEC Rules 17a-3 and 17a-4, NASD Rule 3110 and NYSE Rule 440.10

      Several commenters questioned whether the proposed guidance imposes new supervision requirements.11 In this regard, one commenter interpreted the guidance as potentially requiring firms to review all internal electronic communications.12 The guidance neither creates new supervisory requirements nor requires the review of every communication. Rather, it sets forth principles that firms should consider in developing supervisory systems and procedures for electronic communications to aid in accomplishing that they are reasonably designed to achieve compliance with applicable federal securities laws and SRO rules. With respect to the review of internal electronic communications, the guidance states that—with the exception of the enumerated areas requiring review by a supervisor—a firm may use risk-based principles, including an examination of existing review processes, to determine the extent to which review of any internal communications is necessary.

      Other commenters noted that some firms, especially small firms with limited resources, might find it difficult to implement all aspects of the guidance (e.g., firms with insufficient funds may not be able to purchase lexicon-based or random sampling review programs).13 However, the principles-based guidance generally allows firms the flexibility to design supervisory review procedures for electronic communications that are appropriate to each firm's business model (including whether the manner of review will be automated, manual review or a combination of various methods).

      The final guidance regarding the review and supervision of electronic communications is set forth in Attachment A.


      1 The Financial Industry Regulatory Authority (FINRA) was created in July 2007 through the consolidation of NASD and the member regulation, enforcement and arbitration functions of the NYSE. The FINRA rulebook currently consists of both NASD Rules and certain NYSE Rules that FINRA has incorporated (Incorporated NYSE Rules).

      2 See NASD Notice to Members 07-30 (June 2007); NYSE Information Memo 07-54 (June 14, 2007).

      3 James L. Harris, Chief Operating Officer, Libertas Capital, Inc. (June 22, 2007) (Libertas Letter); Charles D. Weeden, Managing Partner, 17a-4, LLC (June 27, 2007) (17a-4 Letter); Judith A. Wilson, Compliance Attorney, 1st Global (July 3, 2007) (1st Global Letter); Peter J. Chepucavage, General Counsel, Plexus Consulting (on behalf of the International Association of Small Broker Dealers and Advisors) (July 9, 2007) (IASBDA Letter); Bill Singer (July 10, 2007) (Singer Letter); Robert L. Tuch, Officer and Managing Counsel, Nationwide Financial Services, Inc. (July 11, 2007) (Nationwide Letter); Neville Golvala, Chief Executive Officer, ChoiceTrade (July 11, 2007); Ira D. Hammerman, Senior Managing Director & General Counsel, Securities Industry and Financial Markets Association (July 12, 2007) (SIFMA Letter); Tamara K. Salman, Senior Associate Counsel, Investment Company Institute (July 12, 2007) (ICI Letter); David Cohen, Senior Vice President, Orchestria Corp. (July 13, 2007) (Orchestria Letter); Marleen Scheffy, Chief Compliance Officer, Perlinski & Associates (July 13, 2007); E. Anthony Reguero, Chairman, ACTIONS, Inc. (July 13, 2007) (ACTIONS Letter); Lisa Roth, Chairman, National Association of Independent Broker-Dealers (July 16, 2007) (NAIBD Letter); Jill W. Ostergaard, Managing Director, Morgan Stanley (July 16, 2007) (Morgan Stanley Letter); Robert Pease, Vice President, MessageGate, Inc. (July 20, 2007) (MessageGate Letter); Elaine Mandelbaum, Managing Director & Deputy General Counsel, Citigroup Global Markets, Inc. (July 30, 2007) (CGMI Letter).

      4 See, e.g., Libertas Letter; IASBDA Letter; Nationwide Letter; SIFMA Letter; ICI Letter; Orchestria Letter; NAIBD Letter; Morgan Stanley Letter; CGMI Letter.

      5 See, e.g., Nationwide Letter; SIFMA Letter; ICI Letter; Morgan Stanley Letter; CGMI Letter.

      6 See SIFMA Letter.

      7 NAIBD Letter.

      8 See NASD Notice to Members 03-33 (July 2003) (citing Exchange Act Release No. 37182 (May 9, 1996), 61 FR 24643 (May 15, 1996) (Use of Electronic Media by Broker-Dealers, Transfer Agents, and Investment Advisers for Delivery of Information) and Exchange Act Release No. 38245 (January 31, 1997), 67 FR 6469 (February 12, 1997) (Reporting Requirements for Brokers or Dealers Under the Securities Exchange Act of 1934)).

      9 See also NASD Notice to Members 05-49 (July 2005) (Safeguarding Confidential Customer Information).

      10 See NASD Notice to Members 03-33 (July 2003).

      11 See, e.g., ChoiceTrade Letter; ACTIONS Letter.

      12 See ACTIONS Letter.

      13 See IASBDA Letter; Singer Letter; NAIBD Letter.


      ATTACHMENT A

      FINRA Guidance Regarding Review and Supervision of Electronic Communications

      I. Introduction

      Technological innovations in the area of electronic communications1 have altered how people deliver, receive and store communications. These innovations have brought, and continue to bring, new challenges to members2 in the establishment of supervisory systems and procedures for electronic communications that are reasonably designed to achieve compliance with applicable federal securities laws and self-regulatory organization (SRO) rules.3

      With these challenges in mind, FINRA is issuing this guidance for members to consider when developing such systems and procedures. This guidance does not specifically address every regulatory issue that may arise in connection with the supervision of electronic communications. Further, FINRA recognizes that policies and procedures may differ among members depending on their business model (e.g., size, structure, customer base and product mix).4
      II. Review and Supervision of Electronic Communications

      At one time, FINRA (then NASD and NYSE Member Regulation) required that members review all correspondence of their registered representatives pertaining to the solicitation or execution of any securities transactions. In 1998, recognizing that the growing use of electronic communications such as email made adherence to this requirement difficult, FINRA amended its rules to allow members the flexibility to design supervisory review procedures for correspondence with the public that are appropriate to the individual member's business model.5

      In considering this guidance, members generally may decide by employing risk-based principles the extent to which the review of incoming, outgoing and internal electronic communications is necessary in accordance with the supervision of their business. However, members must have policies and procedures for the review by a supervisor of employees'6 incoming, outgoing and internal electronic communications that are of a subject matter that require review under FINRA rules and federal securities laws. For example (without limitation):
      (1) NYSE Rule 472(b)(3) and NASD Rule 2711(b)(3)(A) require that a member's legal and compliance department be copied on communications between non-research and research departments concerning the content of a research report; NYSE Rule 472(a) and NASD Rules 2210 and 2211 require pre-approval by a principal of specified communications with the public;
      (2) NYSE Rule 351(d) and NASD Rule 3070(c) require the identification and reporting of customer complaints; NYSE Rule 401A requires that the receipt of each complaint be acknowledged by the member to the customer within 15 business days; and
      (3) NYSE Rule 410 and NASD Rule 3110(j) require the identification and prior written approval of every order error and other account designation change.
      When employing risk-based procedures to review electronic communications, members should consider how to effectively:
      (1) "flag" electronic communications that may evidence or contain customer complaints, problems, errors, orders or other instructions for an account; or evidence conduct inconsistent with FINRA rules, federal securities laws and other matters of importance to the member's ability to adequately supervise its business and manage the member's reputational, financial and litigation risk;
      (2) identify such other business areas the member may identify as warranting supervisory review; and
      (3) educate employees to understand and comply with the member's policies and procedures regarding electronic communications.
      In adopting such supervisory review procedures, existing interpretive material directs members to, among other things:7
      •   Identify the types of correspondence that will be pre-or post-reviewed;
      •   Identify the organizational position(s) responsible for conducting reviews of the different types of correspondence;
      •   Monitor the implementation of, and compliance with, the member's procedures for reviewing public correspondence;8
      •   Periodically re-evaluate the effectiveness of the member's procedures for reviewing public correspondence and consider any necessary revisions;9
      •   Provide that all customer complaints, whether received via email or in other written form, are reported to FINRA in compliance with the FINRA reporting requirements;10
      •   Prohibit employees from the use of electronic communications unless such communications are subject to supervisory and review procedures developed by the member;11 and
      •   Conduct necessary and appropriate training and education.
      Member electronic communications related to a member's business are subject to its overall supervisory and review procedures.12 They are also subject to FINRA rule requirements specifically addressing communications with the public.13

      The growth of electronic communications has raised the need for further interpretative guidance. For ease of use, the guidance that follows is divided into six categories:
      •   Written Policies and Procedures
      •   Types of Electronic Communications Requiring Review
      •   Identification of the Person(s) Responsible for the Review of Electronic Communications
      •   Method of Review for Correspondence
      •   Frequency of the Review of Correspondence
      •   Documentation of the Review of Correspondence
      A. Written Policies and Procedures

      The path towards an effective supervisory system starts with clear policies and procedures for the general use and supervision of electronic communications, both internal and external, which are updated to address new technologies. For example, a general electronic communications policy written five years ago may well not include policies to regulate employees' use of technologies such as weblogs14 and podcasting15 to communicate with the public.

      From a general procedural perspective, members should provide their employees with the following:
      •   Quick and easy access to electronic communication policies and procedures through, for example, the member's intranet system. (Members should make clear to all employees that they are responsible for complying with these policies and procedures upon their employment. Updates to such policies should be made accessible to all employees in a timely manner, pursuant to the member's procedures.)
      •   A clear list of permissible electronic communication mechanisms (including a clear statement that all other mechanisms are prohibited). For example, if employees are permitted to utilize only the member's email and instant messaging system, then this should be clearly and unambiguously stated in the member's policies and procedures. Members should also make clear if certain communication mechanisms may only be used for communications between employees of the member (versus mechanisms that may also be used for communications with the public). Members should be cognizant that vague language addressing these issues may leave room for unwanted individual interpretation.
      •   Specific language explaining to employees the potential consequences of non-compliance (e.g., disciplinary action).
      •   Training on a regular and as-needed basis. Members should include information in their training and compliance programs describing examples of permissible and prohibited technologies. In addition, while all employees should receive training with respect to the member's general electronic communication policies and procedures, there may be certain employees whose training should be further tailored to their specific business function. For example, a member may implement additional prohibitions on internal communications between business units that are privy to certain non-public information (e.g., investment banking and research and proprietary trading).
      B. Types of Electronic Communications Requiring Review

      External Communications

      As discussed above, members must have reasonable policies and procedures for the supervisory review of electronic communications that require review under FINRA rules16 and federal securities laws. Members may employ risk-based principles to determine the extent to which additional supervisory policies and procedures are required to adequately supervise their business and manage the member's reputational, financial and litigation risk.

      Members also are required to establish policies and procedures regarding the forms of electronic communications that they permit employees to use when conducting business with the public and to take reasonable steps to monitor for compliance with such policies and procedures.

      Traditionally, members have limited employees' electronic communications with customers to a member-supplied email address that is connected to the member's communication network. However, as technology has evolved, employees now have a myriad of ways to communicate electronically with the public. To the extent members prohibit certain types of communication media, consideration should be given to taking technological steps to block or otherwise regulate their external and internal use. In particular, members should consider the following options:
      •   Non-Member Email Platforms—Employees have the ability to communicate via email through means other than their member-issued email address by accessing email platforms through the Internet (e.g., through AOL or Yahoo mail) and through third-party communication systems such as Bloomberg and Reuters. If a member permits employees to communicate with customers through these systems or through other non-member email addresses, the member is required to supervise and retain those communications. Some members prohibit, through policies and procedures, employees from accessing non-member email platforms for business purposes, and require employees to certify on an annual or more frequent basis that they are acting consistent with such policies and procedures. Where possible, some members have chosen to block access to these email platforms through their networks. Thus, an employee would be able to access the Internet but not the email functionality. Members utilizing this blocking functionality should periodically conduct tests to ensure that it is functioning as designed or intended.

      Similarly, FINRA expects members to prohibit, through policies and procedures, communications with the public for business purposes from employees' own electronic devices unless the member is capable of supervising, receiving and retaining such communications.17 Absent a prohibition, members should consider requiring pre-approval for the business-related use of any personal electronic communications device. The approval process might require a detailed business justification for using the personal device and an annual re-certification of the approval that includes a re-evaluation of the business justification for its use. In addition, members should consider obtaining agreements from employees authorizing the member to access any such personal electronic communications devices. Members should also consider prohibiting, where appropriate, the use of personal electronic communication devices in certain sensitive firm locations (e.g., where material non-public information could be accessed).
      •   Message Boards—There are various publicly accessible message boards related to the securities industry. Members may consider blocking access by their employees to these message boards18 to prevent them from communicating through these boards for business purposes.
      •   E-Faxes—The use of traditional facsimile machines has started to decline as E-fax software has developed. FINRA views E-faxes as electronic communications and, thus, members should supervise them accordingly.19
      When a member permits the use of any technology, the member's system of supervision should be reasonably designed to achieve compliance with applicable laws, rules and regulations.

      Internal Communications

      As stated above, with the exception of the enumerated areas requiring review by a supervisor, members may decide, employing risk-based principles, the extent to which review of any internal communications is necessary in accordance with the supervision of their business.

      Subject to any such specific rule requirement mandating reviews, in reaching a risk-based assessment regarding the review of internal communications, consideration should be given to, for instance: detecting when a member's information barriers are not working to protect customer or issuer information; protecting against undue influence on research personnel contrary to FINRA rules; and segregating the member's proprietary trading desk activity from all or part of the other operating areas of the member.20

      In addition, members may consider various relevant existing processes, such as:
      •   Conflict-management efforts—Steps taken to reduce, manage or eliminate potential conflicts of interest, including implementing firewalls to prevent electronic communications between certain individuals/groups or monitoring communications as required by FINRA rules (e.g., between non-research and research departments) or as otherwise appropriate. Members should review to determine whether adequate information barriers are in place.
      •   Reviews of internal electronic communications that occur in connection with branch or desk examinations and regulatory inquiries, examinations or investigations.
      •   Reviews of internal electronic communications that occur in connection with transaction reviews, internal disciplinary reviews and reviews relating to customer complaints or arbitration.
      •   Reviews of internal electronic communications that occur as a result of issues identified in connection with external electronic communication reviews.
      C. Identification of the Person(s) Responsible for the Review of Electronic Communications

      Members' procedures for review of electronic communications (internal and external) should address the following:
      •   Members' procedures should clearly identify the person(s) responsible for performing the reviews. Evidence of review can be satisfied by use of a log or other record from the electronic communication system that identifies the reviewers.
      •   The supervisor/principal must evidence his or her supervision as required by FINRA rules.21
      •   In the course of supervising electronic communications, a supervisor/principal may delegate certain functions to persons who need not be registered.22 However, the supervisor/principal remains ultimately responsible for the performance of all necessary supervisory reviews, irrespective of whether he or she delegates functions related to the review. Accordingly, supervisors must take reasonable and appropriate action to ensure delegated functions are properly executed and should evidence performance of their procedures sufficiently to demonstrate overall supervisory control.23
      •   Where review functions are delegated, the procedures must provide a protocol to escalate regulatory issues to the designated supervisor or other appropriate department.
      •   All reviewers must have sufficient knowledge, experience and training to adequately perform the reviews. Members should be able to demonstrate that the reviewers meet these criteria. This could include: prior supervisory or other experience, years of service in the industry, professional licenses, completion of firm and regulatory element training, product knowledge, educational degrees, knowledge of member products and services, lecturing at, or attending, industry seminars and courses, other training, length of service at the member, familiarity with member systems and tools and prior regulatory experience.
      •   Unless a member's size and/or structure (e.g., a sole proprietor) is such that the member has no other reasonable alternative for reviewing an individual's electronic communications, an individual may not conduct supervisory reviews of his or her own electronic communications.
      D. Method of Review for Correspondence

      Members should develop review procedures that are both reasonably designed to achieve compliance with applicable securities laws, regulations and FINRA rules and appropriate for their business and structure, consistent with the principles set forth in this guidance. In addition, members should monitor for compliance with their supervisory procedures' prescribed frequency, timeliness and quantity parameters.

      Regardless of the method utilized, members should alert their reviewers as to the issues to be raised and material to be examined, including acceptable content. For example, members should make reference to the content standards in NYSE Rule 472 and NASD Rule 2210 and provide guidance concerning other applicable areas of concern (e.g., the use of confidential, proprietary and inside information; anti-money laundering issues; gifts and gratuities; private securities transactions; customer complaints; front-running; and rumor spreading). When reviewing customer complaints, members should look for indicia that a customer has received a communication that is not in conformance with the member's policies and procedures.

      In addition, where members permit the use and receipt of encrypted electronic communications, they must be able to monitor and supervise those communications and must educate reviewers on how this can be accomplished. (See "Combination of Lexicon and Random Review of Electronic Correspondence" below.)

      Furthermore, members must be able to review electronic correspondence in all languages in which they conduct business with the public. Therefore, if the reviewer is not fluent in the language used in an email, the member should require proper independent interpretation and review (i.e., not by the author/recipient of the correspondence).

      Under limited circumstances, members should consider having their legal and/or compliance departments re-review emails that have already been reviewed by line supervisors and their delegatees in certain situations. Re-review might be advisable when specific problems have been identified at a branch office resulting, for instance, in a registered representative becoming the subject of an internal investigation. Members should also consider re-reviewing selected electronic communications as part of their standard branch office inspection program.

      Against this background, members may consider the following methods of review:
      •   Lexicon-Based Reviews of Electronic Correspondence—Members using lexicon-based reviews (those based on sensitive words or phrases, the presence of which may signal problematic communications) of correspondence should utilize an appropriate lexicon, take reasonable security measures to keep the list confidential and periodically evaluate the efficacy of the lexicon. Members must make informed decisions regarding how best to utilize the surveillance tools they have chosen. Thus, a member that conducts lexicon-based reviews may determine that it is not necessary to review each and every lexicon "hit" in order to maintain an effective review system. The rationale for such determinations should be maintained as part of the member's policies and procedures.

      Members should also consider regular periodic reviews of the lexicon system to determine whether any changes/updates are necessary, such as adding or deleting phrases and/or words. Members should periodically inquire as to the effectiveness of the system, especially if the system is that of a vendor.24 Members are responsible for ensuring that the system utilized is functioning properly. As discussed more fully below, if a member does not have confidence in the effectiveness of its lexicon system, a supplemental random review of electronic communications should be considered.

      Members should consider targeted concentrated reviews of employees' emails when warranted (e.g., when concerns are raised in connection with regulatory examination findings, internal audits, customer complaints or regulatory inquiries).

      When assessing the effectiveness of a lexicon-based system, members should consider the following features:
      (a) A meaningful list of phrases and/or words (including industry "jargon") based on the size of the member, its type of business, its customer base and its location (including any branch offices that may require the inclusion of certain foreign language components). The lexicon system should be comprehensive enough to yield a meaningful sample of "flagged" communications.
      (b) Ability to add and delete phrases and words on an ongoing basis.
      (c) Ability to review attachments and identify attachments that could circumvent lexicon-based reviews.
      (d) Ability to restrict access to the phrases and/or words that make up the lexicon system.
      (e) Ability to conduct searches that exclude any trailers or disclaimers used by the member, as these trailers or disclaimers often contain sensitive words such as "guarantee" (e.g., "firm does not guarantee") which would "flag" every such email.
      •   Random Review of Electronic Correspondence—Members may choose to use a reasonable percentage sampling technique, whereby some percentage of the electronic communications generated by the member is reviewed. There is no prescribed minimum or fixed percentage that is required by regulation. However, the amount of electronic communications chosen for review must be reasonable given the circumstances (for example, member size, nature of business, customer base and individual employee circumstances). In this regard, members conducting random reviews may consider factors such as:
      (a) Percentage of Electronic Correspondence Based on a Branch Office, Department or Business Unit—For a branch office, department or business unit, a member could establish a percentage of electronic communications requiring review that is based on its size, type of business, customer base and location (including its sales locations), which includes emails from each individual in that branch office, department or business unit.
      (b) Percentage of Electronic Correspondence for Each Individual—For each individual in a branch office, department or business unit, a member could establish a percentage of emails requiring review based on its size, type of business, supervisory structure (including whether certain locations are supervised remotely), customer base and location including its branch offices. Members should not necessarily limit themselves to reviewing the same percentage of emails for each employee. For example, an individual with disciplinary history or subject to special supervision may warrant a review encompassing a higher percentage of emails.
      •   Combination of Lexicon and Random Review of Electronic Correspondence—Given the strengths and weaknesses of any single review tool, members should consider complementary review techniques. For instance, members should note that while lexicon system-tracking capabilities have become considerably more sophisticated and effective over the past few years, as of this writing they are incapable of reading documents or document attachments that are password protected or encrypted. Further, the use of image files, such as "jpgs," can be used to pass information through lexicon filters undetected. In addition, a registered representative determined to circumvent a lexicon system may be able to do so by simply avoiding the use of words likely to "trigger" the system.
      •   Standards Applicable to All Review Systems—The manner and extent to which review tools are utilized is a determination to be made by each member, based on its business model. However, to best assure the effectiveness over time of any system, members should incorporate ongoing evaluation procedures to identify and address any "loopholes" or other issues that may arise as the means of transmitting sensitive information "under the regulatory radar" become more sophisticated and difficult to capture. Members' written procedures should delineate the additional reviews that will be conducted when such issues are identified. Members utilizing automated tools or systems in the course of their supervisory review of electronic communications must have an understanding of the limitations of such tools or systems (for example, see the potential limitations of lexicon systems noted above) and should consider what, if any, further supervisory review is necessary in light of such limitations.25
      E. Frequency of the Review of Correspondence
      •   Frequency of correspondence review may vary depending on the business. For instance, the frequency of review should be related to the type of business conducted (i.e., the market sensitivity of the activity); the type of customers involved; the scope of the activities; the geographical location of the activities; the disciplinary record of covered persons; and the volume of the communications subject to review.
      •   Members should prescribe reasonable timeframes within which supervisors are expected to complete their reviews of correspondence, taking into consideration the type of review being conducted and the method of review being used. When determining the reasonableness of such timeframes, members should carefully consider the type of business their firm is conducting and the extent to which a review's usefulness, in the context of that business, is diminished by the passage of time. For example, a member with a primarily retail customer base may need to conduct more frequent reviews than a member that exclusively conducts institutional business.
      F. Documentation of the Review of Correspondence
      •   Members must evidence their reviews, whether electronically or on paper,26 and be able to reasonably demonstrate that such reviews were conducted.
      •   The evidence of review should, at a minimum, clearly identify the reviewer, the communication that was reviewed, the date of review and the steps taken as a result of any significant regulatory issues that were identified during the course of the review. Members should remind their reviewers that merely opening the communication will not be deemed a sufficient review.
      III. Conclusion

      As noted above, FINRA is issuing this guidance to assist members in the establishment and maintenance of supervisory systems for electronic communications that are reasonably designed to achieve compliance with the federal securities laws and self-regulatory organization rules. Members must recognize, however, that this guidance is not all-inclusive and does not represent all areas of inquiry that a member should consider when establishing and maintaining a supervisory system for electronic communications, including any existing and future electronic communications technology that this guidance may not address. In addition, members are advised that this guidance does not serve to establish a safe harbor with respect to potential supervisory or compliance deficiencies.

      1 For purposes of this guidance, "electronic communications," "email" and "electronic correspondence" may be used interchangeably and can include such forms of electronic communications as instant messaging and text messaging. Notwithstanding such use of terminology, as further detailed herein, the manner of application of FINRA rules specifically addressing particular communications with the public (see, e.g., NASD Rules 2210 and 2211 and NYSE Rules 342 and 472) will depend on the type of communication.

      2 For purposes of this guidance, the term "member" refers to members of the Financial Industry Regulatory Authority (FINRA), which was created in July 2007 through the consolidation of NASD and NYSE Member Regulation. The FINRA rulebook currently consists of both NASD Rules and certain NYSE Rules that FINRA has incorporated (Incorporated NYSE Rules). The Incorporated NYSE Rules apply solely to dual members of FINRA and the NYSE.

      3 See NYSE Rule 342 (Offices—Approval, Supervision and Control) and NASD Rule 3010 (Supervision).

      4 FINRA has fashioned rule provisions that, where appropriate, take into account variations in members' size or business model. See, e.g., NYSE Rules 342.23 (Offices—Approval, Supervision and Control—Internal Controls) and 472(m) (Communications with the Public —Small Firm Exception). See also NASD Rules 3012 (Supervisory Control System) and 2711 (Research Analysts and Research Reports).

      5 See NYSE Information Memo 98-3 (January 16, 1998) and NASD Notices to Members 98-11 (January 1998) and 99-03 (January 1999). See also NYSE Rule 342.17 (Offices—Approval, Supervision and Control—Review of Communications with Public) and NASD Rule 3010 (Supervision). Additionally, NASD Rule 2211 (Institutional Sales Material and Correspondence) defines "correspondence" as any written letter or electronic mail message distributed by a member to (1) one or more existing retail customers, and (2) fewer than 25 prospective retail customers within any 30 calendar-day period.

      Members are not required to approve outgoing "correspondence" prior to use unless the correspondence is sent to 25 or more existing retail customers within a 30 calendar-day period and makes a financial or investment recommendation or otherwise promotes a product or service of the member. NASD Rule 2211 also allows members to adopt supervisory procedures for communications distributed only to certain institutional investors that do not require principal pre-use review and approval.

      6 For purposes of NASD rules, the term "employees" includes all associated persons.

      7 See NYSE Information Memo 98-3 (January 16, 1998) and NASD Notice to Members 98-11 (January 1998).

      8 FINRA recognizes that, as appropriate evidence of review, email related to members' investment banking or securities business may be reviewed electronically and the evidence of the review may be recorded electronically (see NYSE Information Memo 98-3 and NASD Notice to Members 98-11).

      9 See also NYSE Rule 342 and NASD Rule 3012, requiring implementation of a supervisory control system.

      10 See NYSE Rule 351(d) (Reporting Requirements) and NASD Rule 3070(c) (Reporting Requirements).

      11 For example, FINRA expects members to prohibit, through policies and procedures, communications with the public from employees' home computers unless the member is capable of supervising and retaining such communications.

      12 See NYSE Rules 342.16 and 342.17 (Offices-Approval, Supervision and Control—Supervision of Registered Representatives and Review of Communications with the Public) and NASD Rules 2210 (Communications with the Public) and 2211 (Institutional Sales Material and Correspondence). See also NASD Rule 3010 (Supervision) and NASD Rule 3010(d) (Review of Transactions and Correspondence). (FINRA staff notes its intention to propose amendments to NASD Rule 3010(d)(2) to eliminate outdated distinctions between certain hard copy and electronic communications and to reflect this guidance.)

      13 See NASD Rules 2210 and 2211. See also NASD Guide to the Internet for Registered Representatives, available at www.finra.org/RulesRegulation/IssueCenter/Advertising/p006118. See also NYSE Rule 472(a), which requires pre-approval for any advertisement, market letter, sales literature, communication or research report that is distributed or made available to a customer or the public by a member.

      14 A "weblog" (often referred to as a "blog") is a web-based publication consisting primarily of periodic reports (generally in reverse chronological order). Similar to other media, blogs often focus on particular subjects (e.g., politics) and combine text, images and links to other blogs, web pages and other media related topics.

      15 "Podcasting" is a method of distributing multimedia files (i.e., audio or video content) over the Internet for playback on mobile devices and personal computers.

      16 See Section II, page 5 of this guidance.

      17 Firms should be aware that pursuant to NYSE Rule 342.10(B) and NASD Rule 3010(g)(2), employees working at their primary residences and relying on the exception from branch office registration cannot use their personal email accounts to communicate with potential or existing customers from such locations; electronic communications from such locations must be made through the member's electronic system consistent with the terms of the exception. See generally NYSE Information Memos 05-74 (October 6, 2005) and 06-13 (March 22, 2006) and NASD Notice to Members 06-12 (March 2006).

      18 FINRA views message boards as advertisements under NASD Rule 2210, and such board postings must be approved prior to use and in writing by a registered principal. (See "Ask the Analyst About Electronic Communications," NASD Regulatory & Compliance Alert, April 1996.)

      19 FINRA views E-faxes sent to 25 or more prospective retail customers within a 30 calendar-day period to be sales literature under NASD Rule 2210, and they must be approved prior to use and in writing by a registered principal. FINRA also requires principal pre-use approval for E-faxes sent to 25 or more existing retail customers within any 30 calendar-day period that make any financial or investment recommendation or otherwise promote a product or service of the member. See NASD Notice to Members 06-45 (August 2006).

      20 See NYSE Information Memo 91-22 (June 28, 1991) and NASD Notice to Members 91-45 (June 1991) (Joint NASD/NYSE Memo on Chinese Wall Policies and Procedures).

      21 See, e.g., NASD Rules 3010(d)(1), 2210 and 2211 and NYSE Rules 342(b)(2) and 472.

      22 Cf. NASD Notice to Members 99-03 (January 1999) (allowing unregistered persons who have received sufficient training to review written, non-electronic correspondence).

      23 See NYSE Rules 342(b) and 342.13 and NASD Rule 3010.

      24 Members that outsource technical support functions related to their electronic review process (e.g., the development and/or implementation of a lexicon system) should carefully pre-evaluate the vendor as well as monitor the effectiveness of such vendor's services on an ongoing basis. See also NASD Notice to Members 05-48 (July 2005) (Members' Responsibilities When Outsourcing Activities to Third-Party Service Providers).

      25 See NYSE Information Memo 98-3 (January 16, 1998).

      26 See, e.g., NASD Rules 3010(d)(1), 2210 and 2211 and NYSE Rules 342.16, 342.17 and 472.

    • 07-58 FINRA Solicits Comments on Proposed Guidance Regarding International Prime Brokerage Practices; Comment Period Expired: January 10, 2008

      View PDF File

      International Prime Brokerage

      Regulatory Notice

      Notice Type



      Request for Comment
      Referenced Rules and Notices

      SEC 1994 No-Action letter on prime brokerage
      SEC Rule 15c3-3
      SEC Rule 10b-10
      Reg SHO
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Key Topics

      Foreign prime broker
      International Prime Brokerage

      Executive Summary

      Given the growth of the international prime brokerage (IPB) business, FINRA recently interviewed representatives from many of the largest prime brokerage firms to determine how this business is conducted. The interviews covered the various practices used by the prime brokers and how they differed from practices used in domestic prime brokerage, as outlined in the SEC's 1994 No-Action letter.1 For purposes of this Notice and the Proposed Guidance, international prime brokerage is defined as the practice whereby a foreign domiciled customer executes transactions through a member firm (the executing broker) that are settled and carried by another member (the international prime brokerage custodian) on behalf of its affiliated foreign broker-dealer (the foreign prime broker or FPB).

      FINRA's review found inconsistencies between member firms with regard to legal documentation/agreements, settlement practices, books and records, and other areas important in defining the roles and obligations of the parties when a prime broker customer (who is generally foreign domiciled) purchases or sells U.S. securities with a foreign prime broker and a U.S. executing broker.

      In an attempt to establish consistency among our member firms, share best practices, and apply fair and consistent standards to all firms that are active in this business, FINRA is soliciting comments from member firms and other interested parties on our Proposed Guidance regarding the IPB practices described herein.

      As outlined in Attachment A, the Proposed Guidance extends the existing requirements set forth by the SEC in the 1994 No-Action letter to IPB transactions relating to: (1) account arrangement, (2) delivery instructions, (3) affirmation of trades, (4) books and records, (5) documentation, (6) confirmation of trades, (7) notification and (8) net capital.

      Questions regarding this Notice should be directed to Bernadette Chichetti, Senior Principal Associate, Risk Oversight & Operations Regulation (RO&OR), at (212) 656-6934; or Yui Chan, Managing Director, RO&OR, at (212)656-8115.

      Request for Comments

      FINRA encourages all interested parties to comment on the Proposed Guidance. Comments must be received by January 10, 2008. Members and other interested parties can submit their comments using the following methods:

      •   Mailing comments in hard copy to the address below; or
      •   Emailing comments to pubcom@finra.org.

      To help FINRA process and review comments more efficiently, you should only use one method to comment on this proposal; however, if you wish to submit comments using more than one of the methods listed above, you should indicate that in the submissions.

      Comments sent by hard copy should be mailed to:

      Barbara Z. Sweeney
      Office of the Corporate Secretary
      FINRA
      1735 K Street, NW
      Washington, DC 20006-1506

      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 FINRA Web site. Generally, comments will be posted on the FINRA Web site one week after the end of the comment period.2


      1. See SEC No-Action letter of January 25, 1994 to SIA Prime Broker Committee.

      2. Personal identifying information, such as names or email addresses, will not be edited from submissions. Submit only information that you wish to make publicly available. See Notice to Members 03-73 (November 2003) (Online Availability of Comments) for more information.


      ATTACHMENT A

      International Prime Brokerage (IPB) Definitions:

      •   Foreign prime broker (FPB) is a foreign broker-dealer.
      •   Prime Broker Customers are foreign domiciled (PB customers).
      •   International Prime Broker Custodian (IPBC) is a carrying/clearing member which is an affiliate of and acts as custodian for the FPB in these international prime broker transactions.
      •   Executing broker (EB) is a member.
      •   Securities transactions are subject to applicable federal securities laws.

      Proposed Guidance for IPB Best Practices

      1. ACCOUNT ARRANGEMENT

      The IPBC should enter into an omnibus cash account agreement with its FPB to establish an IPBC account for the aggregate trades of all the PB customers of the FPB. The IPBC will be responsible for affirmation and settlement for the PB customer transactions of the FPB and both the IPBC and the EB will be responsible for Reg. SHO compliance.
      2. DELIVERY INSTRUCTION

      The EB will direct the settlement of the transactions to be effected in the DTC account of the IPBC, which will settle the transactions on behalf of the FPB.
      3. AFFIRMATION OF TRADES

      The EB will confirm the trades, via the "Omgeo TradeSuite/CNS Interface for Prime Brokers," with the IPBC. The PB customer, by T+1, will notify the FPB of the particulars of the trade. This data is then relayed by the FPB to the IPBC.

      The IPBC, upon receipt of the trade data from the "Omgeo TradeSuite/CNS Interface for Prime Brokers," will either affirm or DK the trade with the EB. In addition, consistent with the provisions of the 1994 No-Action letter,1 the IPBC can disaffirm a previously affirmed trade. If the IPBC disaffirms or DKs a trade, then the transaction will continue to be treated as a customer transaction on the books of the EB. If the disaffirmed or DKed trade is a short sale, the EB will treat the transaction as if it had been executed in a customer margin account.
      4. BOOKS & RECORDS

      As stated above, the IPBC will establish an omnibus cash account in the name of the FPB on its books and records. This account will contain, in aggregate, all the trades for the PB customers of the FPB. On settlement date, this account should be paid in full. There are no restrictions on the FPB from withdrawing fully paid securities from this account.

      Furthermore, the cash omnibus account established in the name of the FPB should be treated as a customer account by the IPBC for purposes of SEC Rule 15c3-32 and, thus, should be subject to the possession or control and customer reserve formula computation requirements of the rule. However, credit balances pertaining to any short sales should remain in a separate omnibus margin account in the name of the FPB in order to protect the IPBC from customer risk, as PB customers typically do not deposit margin with the FPB as customers of a foreign broker-dealer are exempt from the requirements of FRB Regulation T3 and other margin—related regulations. The FPB may enter into a separate securities borrowed transaction to cover the short sales in the margin omnibus account.
      5. DOCUMENTATION
      •   Revised Form 150: Instead of an agreement between the FPB and EB, the IPBC should execute SIFMA Form 150 on International Prime Brokerage (SIFMA Form 150 may need to be revised) with the EB. In addition, the IPBC and its FPB should enter into a separate IPB agreement that specifies the obligations and responsibilities of each party in this custodian arrangement.
      •   Agreement between FPB and its PB Customers: The FPB should have an agreement with its PB customers.
      •   Revised Form 151: Agreement between the EB and its PB Customers: The EB should have an agreement (SIFMA Form 151 may need to be revised) with its customers that specifies the obligations and responsibilities of the parties regarding the IPB arrangement.
      •   Agreement between Introducing EB and its Carrying/Clearing Member: If the EB is an introducing member, it should inform its carrying/clearing firm that it intends to act as an EB in an IPB relationship. Furthermore, a contract must be executed between the introducing EB and its carrying/clearing member that specifies the obligations and responsibilities of each party in the IPB arrangement.
      6. CONFIRMATION OF TRADES

      The EB should send directly to the PB customer of the FPB a confirmation of each trade placed with the EB pursuant to this prime broker arrangement. Such confirmation should comply with the specific requirements of SEC Rule 10b-10.4 Alternatively, the EB may send the confirmation to the PB customer in care of the FPB if the PB customer has instructed the EB to do so in writing through an instrument separate from the prime broker agreement. In addition, on the day following the transaction, the FPB should send to the PB customer a notification of each trade placed with the EB under a prime broker arrangement, based upon information provided by the PB customer.
      7. NOTIFICATION

      The IPBC should notify its designated examining authority (DEA) in writing within thirty days from the date of issuance of the final guidance if it intends to act as an IPBC. In addition, any member firm intending to act as the EB in an IPB arrangement should provide written notice to its DEA prior to commencing such activity.
      8. NET CAPITAL
      •   A member firm acting as an IPBC should have net capital of at least $1,500,000.5
      •   A member firm acting as an EB clearing international prime broker transactions or a member firm clearing international prime broker transactions on behalf of an introducing EB should have net capital of at least $1,000,000.6

      1. See SEC No-Action letter of January 25, 1994 to SIA Prime Broker Committee.

      2. 17 CFR 240.15c3-3

      3. 12 CFR 220.1

      4. 17 CFR 240.10b-10 and see SEC No-Action letter of January 25, 1994 to SIA Prime Broker Committee.

      5. See SEC No-Action letter of January 25, 1994 to SIA Prime Broker Committee.

      6. See Id.

    • 07-57 SEC Approves a Proposed Rule Change Relating to Representation of Parties in Arbitration and Mediation; Effective Date: December 24, 2007

      View PDF File

      Representation of Parties in Arbitration and Mediation

      Regulatory Notice

      Notice Type


      Rule Amendment
      Referenced Rules & Notices

      Rule 12208 (Customer Code)
      Rule 13208(Industry Code)
      Rule 14106 (Mediation Code)
      Suggested Routing

      Compliance
      Legal
      Key Topics

      Arbitration
      Code of Arbitration Procedure
      Code of Mediation Procedure
      Dispute Resolution
      Mediation

      Executive Summary

      The SEC has approved amendments to Rule 12208 of the Code of Arbitration Procedure for Customer Disputes (Customer Code) and Rule 13208 of the Code of Arbitration Procedure for Industry Disputes (Industry Code), and has approved new Rule 14106 of the Code of Mediation Procedure to address representation of parties in arbitration and mediation cases.1

      The amendments apply to any case in which parties provide FINRA with notice of representation on or after December 24, 2007. If an attorney or representative files a pleading, or otherwise acts on behalf of a party in a case in the FINRA dispute resolution forum, then FINRA will consider these actions as sufficient notice of representation. If parties have provided such notice of representation to FINRA prior to the effective date, then the new rules do not apply. If they have not given such notice prior to the effective date, then the new rules do apply. The text of the amendment is set forth in Attachment A.

      Questions concerning this Notice should be directed to Mignon McLemore, Assistant Chief Counsel, FINRA Dispute Resolution, at (202) 728-8151 or mignon.mclemore@finra.org.

      Background and Discussion

      The rule changes clarify the issue of representation of parties in FINRA dispute resolution proceedings. The prior rules stated only that "all parties shall have the right to representation by counsel at any stage of the proceedings." The rules did not provide any guidance on the kind of representatives who were permitted to practice in the dispute resolution forum; nor did they provide guidance on the qualifications those representatives must have to participate in the forum. Moreover, the prior rules did not address a growing trend in American jurisprudence: the multi-jurisdictional practice of law, which occurs when attorneys, licensed in one United States (U.S.) jurisdiction, practice law in a jurisdiction in which they are not licensed.

      To address these issues, FINRA filed a proposal with the Securities and Exchange Commission (SEC) on September 14, 2006. Amendments 1 and 2 were filed on November 9, 2006 and February 23, 2007, respectively. The SEC published the proposal for comment in the Federal Register on April 13, 2007.2 After FINRA submitted its response to comments, the SEC approved the proposal on September 26, 2007.3

      FINRA has amended Rules 12208 and 13208 of the Customer and Industry Codes, respectively, and adopted Rule 14106 of the Mediation Code (referred to collectively as "the rules") to address representation of parties in arbitration and mediation. The rules provide that:

      •   parties may represent themselves;
      •   parties may be represented by an attorney, provided certain criteria are met; or
      •   parties may be represented by a person who is not an attorney, unless state law prohibits such representation or the person is currently suspended or barred from the securities industry in any capacity, or is currently suspended from the practice of law or disbarred.

      In addition, the rules provide that issues regarding qualifications of a representative are to be governed by applicable law.

      Each provision of the changes to the rules is discussed below.

      Representation by a Party

      The rules codify current practice by explicitly stating that parties may represent themselves in an arbitration or mediation proceeding. Likewise, the rules state that a member of a partnership may represent a partnership; and a bona fide officer of a corporation, trust or association may represent the corporation, trust or association in an arbitration or mediation proceeding.

      Representation by an Attorney

      Parties may be represented in an arbitration or mediation by an attorney at law in good standing and admitted to practice in any jurisdiction in the U.S., including the District of Columbia, or any commonwealth, territory or possession of the U.S., unless state law prohibits such representation. Thus, under this provision, if a party chooses to be represented by an attorney, the attorney must be licensed to practice law in a U.S. jurisdiction, be in good standing and comply with the applicable laws of the U.S. jurisdiction in which the hearings are held.4

      Under this provision, neither the staff nor the arbitration panel5 is required to verify the attorney's compliance with state law. If state law prohibits such representation, the parties may raise the issue with the panel. Parties also may seek court or regulatory agency relief. In the absence of a court order, the arbitration proceeding shall not be stayed or otherwise delayed pending resolution of such issues.

      If a party chooses to be represented by an attorney, either the party or the attorney must notify FINRA in writing of the attorney's intent to appear, and provide the attorney's contact information.6 The party or attorney may satisfy this requirement by providing this information in the initial pleadings7 filed with the Director of Arbitration (Director) or by means of the online filing system (www.finra.org/onlineclaimfiling).8

      Representation by Others

      Parties may be represented in an arbitration or mediation by a person who is not an attorney, unless:

      •   state law prohibits such representation;
      •   the person is currently suspended or barred from the securities industry in any capacity; or
      •   the person is currently suspended from the practice of law or disbarred.

      This provision allows a relative, friend or associate to represent or assist a person (e.g., an elderly or disabled person) with his or her arbitration or mediation. Investors can also find affordable legal representation at law school securities arbitration clinics.9

      Under this provision, neither the staff nor the arbitration panel is required to verify the non-attorney's compliance with state law. If state law prohibits such representation or if the non-attorney representative is currently (i) suspended or barred from the securities industry or (ii) suspended from the practice of law or disbarred, the parties may raise the issue with the panel. Parties also may seek court or regulatory agency relief. In the absence of a court order, the arbitration proceeding shall not be stayed or otherwise delayed pending resolution of such issues.

      If a party chooses to be represented by a non-attorney representative, either the party or the representative must notify FINRA in writing and provide the representative's contact information. The party or representative may satisfy this requirement by providing this information in the initial pleadings filed with the Director or by means of the online filing system (www.finra.org/onlineclaimfiling).10

      Effective Date Provisions

      The amendments to Rules 12208 and 13208 of the Customer and Industry Codes, respectively, and new Rule 14106 of the Mediation Code will become effective on December 24, 2007, and will apply to any case in which parties provide FINRA with notice of representation on or after December 24, 2007. If an attorney or representative files a pleading, or otherwise acts on behalf of a party in a case in the FINRA dispute resolution forum, then FINRA will consider these actions as sufficient notice of representation. If parties have provided such notice of representation to FINRA prior to the effective date, then the new rules will not apply. If they have not given such notice prior to the effective date, then the new rules will apply.


      1. Exchange Act Release No. 56540 (Sept. 26, 2007), 72 Federal Register 56410 (Oct. 3, 2007) (File No. SR-NASD-2006-109).

      2. Exchange Act Release No. 55604 (April 9. 2007), 72 Federal Register 18703 (April 13, 2007).

      3. See note 1.

      4. While the multi-jurisdictional practice of law may be permitted in many jurisdictions, it may constitute a violation of certain states' unauthorized practice of law provisions.

      5. The term "panel" means the arbitration panel, whether it consists of one or more arbitrators. See Rule 12100(q) of the Customer Code and Rule 13100(q) of the Industry Code.

      6. If parties file an arbitration claim in California, their attorneys must provide a notice of intent to appear in the initial pleading submitted to FINRA Dispute Resolution. The notice in California arbitrations includes information similar to what is requested here. See FINRA's Notice to Attorneys and Parties Represented by Out-of-State Attorneys at www.finra.org/ArbitrationMediation/ResourcesforParties/NoticestoParties/index.htm.

      7. A pleading is a statement describing a party's causes of action or defenses. The following documents are considered pleadings: a statement of claim, an answer, a counterclaim, a cross claim, a third-party claim and any replies.

      8. In this case, if a party chooses to be represented by an attorney and the attorney files a pleading or otherwise acts on behalf of a party in the FINRA dispute resolution forum, then FINRA will consider these actions as sufficient notice of representation.

      9. A securities arbitration clinic can help an investor who has a smaller claim but is unable to hire an attorney, provided the investor qualifies for assistance. For more information on clinic locations and eligibility requirements, see "How to Find an Attorney" at www.finra.org/ArbitrationMediation/StartanArbitrationorMediation/HowtoFindanAttorney/index.htm

      10. In this case, if a party chooses to be represented by a person who is not an attorney and this representative files a pleading or otherwise acts on behalf of a party in the FINRA dispute resolution forum, then FINRA will consider these actions as sufficient notice of representation.


      ATTACHMENT A

      New language is underlined, deletions are in brackets.

      Code of Arbitration Procedure for Customer Disputes,
      Code of Arbitration Procedure for Industry Disputes,
      and
      Code of Mediation Procedure

      * * *

      Customer Code

      12208. Representation of Parties

      (a) Representation by a Party

      Parties may represent themselves in an arbitration held in a United States hearing location. A member of a partnership may represent the partnership; and a bona fide officer of a corporation, trust, or association may represent the corporation, trust, or association.
      (b) Representation by an Attorney

      At any stage of an arbitration proceeding held in a United States hearing location, all parties shall have the right to be represented by [counsel during any stage of an arbitration] an attorney at law in good standing and admitted to practice before the Supreme Court of the United States or the highest court of any state of the United States, the District of Columbia, or any commonwealth, territory, or possession of the United States, unless state law prohibits such representation.
      (c) Representation by Others

      Parties may be represented in an arbitration by a person who is not an attorney, unless:
      •   state law prohibits such representation, or
      •   the person is currently suspended or barred from the securities industry in any capacity, or
      •   the person is currently suspended from the practice of law or disbarred.
      (d) Qualifications of Representative

      Issues regarding the qualifications of a person to represent a party in arbitration are governed by applicable law and may be determined by an appropriate court or other regulatory agency. In the absence of a court order, the arbitration proceeding shall not be stayed or otherwise delayed pending resolution of such issues.

      ***

      Industry Code

      13208. Representation of Parties

      (a) Representation by a Party

      Parties may represent themselves in an arbitration held in a United States hearing location. A member of a partnership may represent the partnership; and a bona fide officer of a corporation, trust, or association may represent the corporation, trust, or association.
      (b) Representation by an Attorney

      At any stage of an arbitration proceeding held in a United States hearing location, all parties shall have the right to be represented by [counsel during any stage of an arbitration] an attorney at law in good standing and admitted to practice before the Supreme Court of the United States or the highest court of any state of the United States, the District of Columbia, or any commonwealth, territory, or possession of the United States, unless state law prohibits such representation.
      (c) Representation by Others

      Parties may be represented in an arbitration by a person who is not an attorney, unless:
      •   state law prohibits such representation, or
      •   the person is currently suspended or barred from the securities industry in any capacity, or
      •   the person is currently suspended from the practice of law or disbarred.
      (d) Qualifications of Representative

      Issues regarding the qualifications of a person to represent a party in arbitration are governed by applicable law and may be determined by an appropriate court or other regulatory agency. In the absence of a court order, the arbitration proceeding shall not be stayed or otherwise delayed pending resolution of such issues.

      * * *

      Code of Mediation Procedure

      14100—14105. No change.

      14106. Representation of Parties

      (a) Representation by a Party

      Parties may represent themselves in mediation held in a United States hearing location. A member of a partnership may represent the partnership; and a bona fide officer of a corporation, trust, or association may represent the corporation, trust, or association.
      (b) Representation by an Attorney

      At any stage of a mediation proceeding held in a United States hearing location, all parties shall have the right to be represented by an attorney at law in good standing and admitted to practice before the Supreme Court of the United States or the highest court of any state of the United States, the District of Columbia, or any commonwealth, territory, or possession of the United States, unless state law prohibits such representation.
      (c) Representation by Others

      Parties may be represented in mediation by a person who is not an attorney, unless:
      •   state law prohibits such representation, or
      •   the person is currently suspended or barred from the securities industry in any capacity, or
      •   the person is currently suspended from the practice of law or disbarred.
      (d) Qualifications of Representative

      Issues regarding the qualifications of a person to represent a party in mediation are governed by applicable law and may be determined by an appropriate court or other regulatory agency. In the absence of a court order, the mediation proceeding shall not be stayed or otherwise delayed pending resolution of such issues.

      [14106] 14107. Mediator Selection

      (a)—(d) No change.

      [14107] 14108. Limitation on Liability

      No change.

      [14108] 14109. Mediation Ground Rules

      (a)—(g) No change.

      [14109] 14110. Mediation Fees

      (a)—(c) No change.

      * * *

    • 07-56 Securities Industry/Regulatory Council on Continuing Education Issues Firm Element Advisory Update

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      Continuing Education

      Regulatory Notice

      Notice Type

      Guidance
      Key Topic(s)

      Continuing Education
      Firm Element
      Suggested Routing

      Compliance
      Continuing Education
      Legal
      Registration
      Senior Management
       

      PLEASE NOTE: On July 30, 2007, the Financial Industry Regulatory Authority, FINRA, began operations. FINRA was formed through the consolidation of NASD and the enforcement, member regulation and arbitration operations of NYSE Regulation. The FINRA rulebook currently consists of both NASD Rules and certain NYSE Rules that FINRA has incorporated (Incorporated NYSE Rules). The Incorporated NYSE Rules apply solely to dual members of FINRA and the NYSE. In certain instances, the Firm Element Advisory continues to use legacy references to NASD and NYSE member regulation.

      Executive Summary

      This Notice advises firms of the fourth quarter 2007 Securities Industry/Regulatory Council on Continuing Education Firm Element Advisory, which identifies regulatory and sales practice topics that firms should consider in their Firm Element training plans. Topics updated or added since the prior Advisory are indicated in the document as such.

      The updated Firm Element Advisory is available at www.cecouncil.com/publications/council_publications/FEA_2007_Semi_Annual_Update.pdf.

      Questions concerning this Notice may be directed to Joseph Sheirer, Director, Continuing Education, at (212) 656-5917; or Roni Meikle, Director, Continuing Education, at (212) 656-2156.

      Background and Discussion

      The Securities Industry/Regulatory Council on Continuing Education Firm Element Advisory is published during the second and fourth quarters of each year, and identifies regulatory and sales practice topics that firms should consider including in their Firm Element training plans. The topics are based on a review of industry and self-regulatory organizations' publications and other communications.

      The Advisory topics are not exhaustive and are intended as a guide to firms when they determine what to include in their training plans. Firms should consider the specific nature of their business, clients, products and services when creating their training plans.

      The updated FEA is available on the Council's Web site at www.cecouncil.com/publications/council_publications/FEA_2007_Semi_Annual_Update.pdf.

    • 07-55 FINRA Reminds Member Firms of Their Obligations Regarding Background Investigations of Prospective Personnel

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      Personnel Background Investigations

      Regulatory Notice

      Notice Type



      Guidance
      Referenced Rules & Notices

      Article III, Sections 3 and 4 of the FINRA By-Laws
      NASD Rule 3010(e)
      NTM 97-19
      NTM 05-39
      NYSE Interpretation Handbook Rule 345.11/01
      NYSE Rule 345.11
      NYSE Rule 346b
      Suggested Routing

      Compliance
      Executive Representatives
      Human Resources
      Legal
      Operations
      Principals
      Registered Representatives
      Registration
      Senior Management
      Training
      Key Topic(s)

      Background Investigations
      Central Registration Depository (CRD®)
      Fingerprints
      Forms U4 and U5
      Hiring Process
      Statutory Disqualification

      Executive Summary

      A critical part of the hiring process in the securities industry is the background investigation of prospective personnel. For instance, background investigations can help member firms determine whether a prospective employee is subject to a statutory disqualification or whether he or she may present a regulatory risk for the firm and customers. It is essential for firms to understand their obligations with respect to background investigations. As such, this Notice reminds member firms of their obligations under FINRA rules.

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

      Background and Discussion

      Separate, mutually exclusive provisions of the FINRA rules govern member firms' obligations regarding background investigations of prospective personnel, as described below.

      NASD Rule 3010(e)

      NASD Rule 3010(e) provides that a member firm must ascertain by investigation the good character, business reputation, qualifications and experience of a job applicant before the firm applies to register that applicant with FINRA. NASD Rule 3010(e) requires an extensive, thorough and diligent investigation of a potential applicant's background.

      Undertaking such a background investigation can help the firm detect potential issues when considering persons for employment. NASD Rule 3010(e) does not place any limits on the scope of such a background investigation. The firm must obtain all of the information necessary to determine the applicant's character, business reputation, qualifications and experience.1

      In addition, if the job applicant previously has been registered with FINRA, NASD Rule 3010(e) requires that the firm review a copy of the applicant's most recent Form U5 (Uniform Termination Notice for Securities Industry Registration) within 60 days of the filing date of an application for registration, or demonstrate that it has made reasonable efforts to do so.2

      Dual member firms of FINRA and the NYSE also are subject to NYSE Rule 345.11, which is incorporated into the FINRA rules.3

      Statutory Disqualification Provisions

      Article III, Section 3 of the FINRA By-Laws provides, among other things, that no person may become associated with a member firm, continue to be associated with a member firm or transfer association to another member firm if such person is or becomes subject to a disqualification under Article III, Section 4 of the FINRA By-Laws.4 Among other events, certain criminal convictions cause an individual to be subject to a disqualification.5 Firms have an obligation to determine whether prospective personnel, including persons who are not required to be registered, are subject to a disqualification under Article III, Section 4.

      Form U4 Requirements

      As set forth in the Form U4, the person signing the Form U4 on behalf of the member firm must certify that he or she has taken appropriate steps to verify the accuracy and completeness of the information contained in and with the Form U4. This requires thorough review of the Form U4 and appropriate steps to verify all of the information contained in and with the Form U4, such as the applicant's 10-year employment history.

      In addition, the Form U4 provides that the person signing the Form U4 on behalf of the firm must certify that the firm has communicated with all of the applicant's previous employers for the past three years and has documentation on file with the names of the persons contacted and the date of contact. Firms should be aware that complying with this Form U4 requirement does not, in and of itself, satisfy any of the other obligations regarding background investigations of prospective personnel discussed in this Notice.

      Resources

      To satisfy the obligations discussed in this Notice, firms should consider all available information gathered in the hiring process, including, but not limited to Forms U4 and U5 responses, authorized searches of the CRD, fingerprint results6 and communications with previous employers. Firms must ensure that they obtain and retain the required written consent of the applicant in connection with CRD pre-registration searches. Firms also may wish to consider private background checks, credit reports and reference letters.7

      Firms must ensure that personnel background investigations are conducted in accordance with all applicable laws, rules and regulations (including federal and state requirements) and that all necessary approvals, consents and authorizations have been obtained.


      1 Member firms must comply with Municipal Securities Rulemaking Board (MSRB) Rule G-7 regarding those applicants engaged solely in municipal securities activities.

      2 Firms also must review a job applicant's employment experience to determine if the applicant has been recently employed by a Futures Commission Merchant or an Introducing Broker that is notice-registered with the SEC pursuant to Section 15(b)(11) of the Securities Exchange Act of 1934 (Exchange Act). In such a case, the hiring member also is required to review a copy of the applicant's most recent Commodity Futures Trading Commission Form 8-T.

      3 NYSE Rule 345.11 requires member organizations to investigate thoroughly the previous record of: (1) persons required to be registered with the NYSE; (2) persons who regularly handle or process securities or monies or maintain the books and records relating to securities or monies who are not otherwise required to be registered; and (3) persons having direct supervisory responsibility over persons engaged in the above activities who are not otherwise required to be registered.

      For persons required to be registered with the NYSE, member organizations fulfill their investigative obligation by verifying the information contained in the Form U4 (Uniform Application for Securities Industry Registration or Transfer) and by reviewing the applicant's most recent Form U5, if the applicant previously has been registered. For persons subject to NYSE Rule 345.11 who are not required to be registered, member organizations fulfill their investigative obligation by verifying the information contained in the employment questionnaire or application required under SEC Rule 17a-3(a)(12). NYSE Rule 345.11 also requires member organizations to make further inquiry, where appropriate, in light of the background information developed, the position for which the person is being considered or other circumstances. See also NYSE Interpretation Handbook Rule 345.11/01.

      4 Dual member firms of FINRA and the NYSE also are subject to the disqualification provisions of NYSE Rule 346.

      5 See Sections 3(a)(39) and 15(b)(4) of the Exchange Act.

      6 Pursuant to Section 17(f)(2) of the Exchange Act and SEC Rule 17f-2, certain persons employed in the securities industry are required to be fingerprinted for purposes of a criminal background check. Firms are responsible for obtaining a prospective employee's fingerprints and certain required identifying information. Firms then submit the prospective employee's fingerprints together with the required identifying information to FINRA. FINRA, in turn, submits these fingerprints to the FBI. FINRA also makes the fingerprint results available to the employing member firm and regulators, consistent with applicable federal laws and FBI and FINRA requirements. See NASD Notice to Members 05-39 (NASD Suggests Best Practices for Fingerprinting Procedures) (May 2005).

      7 To identify registered persons with a history of customer complaints, disciplinary actions or arbitrations, firms also should consider the following "best hiring practices" set forth in NASD Notice to Members 97-19 (April 1997): (1) discuss with the applicant the nature of the applicant's prior customers and the types of securities sold while associated with prior employers; (2) obtain from the applicant explanations regarding any customer complaints and regulatory actions to determine the merit, to the extent practicable, of each before hiring; (3) ask applicants about the existence of and nature of any pending proceedings, customer complaints, regulatory investigations or arbitrations not listed in CRD; and (4) involve compliance and legal staff, as appropriate, in the hiring process, and designate an individual (above the branch manager level) or a committee to review the customer complaints, disciplinary actions or arbitrations before hiring a registered person with such a history.

    • 07-54 SEC Approves New NASD Rule 2290 Regarding Fairness Opinions; Effective Date: December 8, 2007

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      Fairness Opinions

      Regulatory Notice

      Notice Type


      New Rule
      Referenced Rules & Notices

      NASD Rule 2290
      Suggested Routing

      Compliance
      Corporate Finance
      Legal
      Senior Management
      Key Topic(s)

      Fairness Opinions
      Mergers and Acquisitions

      Executive Summary

      Effective December 8, 2007, new NASD Rule 2290 (Fairness Opinions) requires specific disclosures and procedures addressing conflicts of interest when member firms provide fairness opinions in change of control transactions, such as a merger or sale or purchase of assets.1 NASD Rule 2290, as adopted, is set forth in Attachment A of this Notice.

      Questions regarding this Notice may be directed to:

      •  Gary L. Goldsholle, Vice President and Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8104;
      •  Kathryn M. Moore, Assistant General Counsel, OGC, at (202) 974-2974; or
      •  Joseph E. Price, Vice President, Corporate Financing Department, at (240) 386-4623.

      Background and Discussion

      A fairness opinion addresses, from a financial point of view, the fairness of the consideration in a transaction. Fairness opinions are routinely used by directors of companies in connection with a change of control transaction, such as a merger or sale or purchase of assets, to satisfy their fiduciary duties to act with due care and in an informed manner.

      Although not required by statute or regulation, fairness opinions have become commonplace in change of control transactions following the 1985 Delaware Supreme Court case of Smith v. Van Gorkom,2 in which a corporate board was held to have breached its fiduciary duty of care by approving a merger without adequate information on the transaction, including information on the value of the company and the fairness of the offering price.

      In addition to providing a basis for the exercise of care by the board of directors, a fairness opinion, or information about a fairness opinion, is often provided to shareholders as a part of the proxy materials relating to a change of control transaction. Fairness opinions express a conclusion as to the whether the consideration offered in a transaction is within the range of what would be considered "fair"; such opinions generally do not offer an opinion as to whether the consideration offered is the best price that could likely be attained or reach other matters, such as solvency issues, that may arise from the transaction.

      Under the SEC's proxy rules, which apply to issuers, certain disclosures about potential conflicts of interest are provided to investor-shareholders. NASD Rule 2290 is a complementary rule that requires broker-dealers that render fairness opinions to inform investor-shareholders about the potential conflicts of interest that may exist between the firm rendering the fairness opinion and the issuer. The Rule also addresses specific procedures concerning the issuance of fairness opinions.

      Disclosures Required by NASD Rule 2290(a)

      The Rule sets forth the parameters when the disclosures are required to be contained in a fairness opinion. If a member firm knows or has reason to know, at the time a fairness opinion is issued to a company's board, that the opinion will be provided or described to the company's public shareholders, the firm must make the enumerated disclosures in the fairness opinion. A firm will be deemed to have a reason to know that the fairness opinion will be provided or described to public shareholders, if, for example, the structure of the transaction will require a shareholder vote. The fairness opinions covered by the Rule include those issued to the board of directors, and/or any special committee or other subset or committee of the board.

      Acting as Financial Advisor and Contingent Compensation

      A member firm is required to disclose if the firm has acted as a financial advisor to any party to the transaction that is the subject of the fairness opinion, and, if applicable, that it will receive compensation that is contingent upon the successful completion of the transaction, for rendering the fairness opinion and/or serving as an advisor. This requirement includes significant payments or compensation from related transactions (e.g., stapled financings) if such transactions are contingent upon the completion of the transaction for which the fairness opinion was issued. This disclosure, along with the disclosures in paragraphs (a)(2) and (a)(3), requires descriptive information rather than quantitative information. In addition, FINRA notes that none of the Rule's disclosure provisions requires a member to breach any of its confidentiality obligations.

      Other Significant Payment or Compensation

      A member firm must disclose if it will receive any other significant payment or compensation contingent upon the successful completion of the transaction. FINRA has chosen not to establish a particular dollar or percentage figure as to what may be considered "significant" out of a concern that establishing a specific figure may become a de facto standard for such payments. Given that the nature of the provision is to inform investors of conflicts of interest, and that paragraph (a)(2) is to prevent circumvention of the provisions in paragraph (a)(1), the receipt of de minimis fees (such as trading fees or other small incremental fees from account assets or activity) would not be required to be disclosed. FINRA believes that a "significant" payment or contingent compensation is one that a reasonable person, who reads a fairness opinion, would have an interest in knowing about in order to assess whether the member firm authoring the fairness opinion has a potential conflict of interest.

      Material Relationships

      A member firm is required to disclose any material relationships that existed during the past two years or that are mutually understood to be contemplated in which any compensation was received or is intended to be received as a result of the relationship between the firm and any party to the transaction that is the subject of the fairness opinion. FINRA notes that this disclosure requirement attaches to material relationships between the member firm and all parties to the transaction, not just the party whose board of directors selected the member firm to render the fairness opinion; e.g., in the case of a takeover, a member issuing a fairness opinion to the target's board of directors would also have to disclose any material relationships it had with the acquiror. As noted above, the disclosure is not required to be quantified, but each of the material relationships should be identified in the fairness opinion.

      Independent Verification of Information

      A member firm is required to disclose if any information that formed a substantial basis for the fairness opinion that was supplied to the firm by the company requesting the opinion concerning the companies that are parties to the transaction has been independently verified by the firm, and if so, a description of the information or categories of information that were verified. When no information has been verified, a blanket statement to that effect is sufficient. On the other hand, if a member firm independently verifies some or all of the information supplied to it concerning the companies that are parties to the transaction, it must describe the information or the categories of information that were verified. In those instances, FINRA notes that a firm making such a representation may also wish to explain in the fairness opinion its process or standards for independent verification.

      Use of Fairness Committee

      A disclosure of whether or not the fairness opinion was approved or issued by a fairness committee is required. For purposes of the Rule, the term, "fairness committee" includes any committee or group that approves a fairness opinion in accordance with the requirements of paragraph (b) regardless of whether the member firm calls it a "fairness committee."

      Compensation to Insiders

      Finally, member firms are required to disclose whether or not the fairness opinion expresses an opinion about the fairness of the amount or nature of the compensation to any of the company's officers, directors or employees, or class of such persons, relative to the compensation to the public shareholders of the company. This disclosure highlights to the investor the potential conflict of interest between the member issuing the fairness opinion and the issuer receiving the opinion by requiring disclosure of whether the member did or did not take into account the amount and nature of compensation flowing to certain insiders relative to the benefits to shareholders in reaching a fairness determination.

      Procedures Required by NASD Rule 2290(b)

      NASD Rule 2290(b) requires that any member firm issuing a fairness opinion must have written procedures for approval of a fairness opinion. The firm must have procedures regarding the types of transactions and the circumstances in which the firm will use a fairness committee to approve or issue a fairness opinion, and in those transactions in which it uses a fairness committee:

      (A) the process for selecting personnel to be on the fairness committee;
      (B) the necessary qualifications of persons serving on the fairness committee; and
      (C) the process to promote a balanced review by the fairness committee, which shall include the review and approval by persons who do not serve on the deal team to the transaction.

      FINRA notes that paragraph (b)(1)(C) does not require that the fairness committee be comprised entirely of persons not serving on or advising the deal team. Rather, the provision requires that the firm have procedures to promote a balanced review by including on the fairness committee persons who are not serving on the deal team. Whether a person is considered to be part of the deal team requires an analysis of the particular facts and circumstances, and will not necessarily be determined by whether a person is included on all document distributions or participated in certain meetings. The determination of whether a person is part of a deal team will depend on the nature and substance of his or her contacts and the advice rendered to the firm.

      Firms are also required to have a process to determine whether the valuation analyses used in the fairness opinion are appropriate.

      The new rule becomes effective on December 8, 2007. An outline of the disclosure and procedural requirements under the Rule is included in Attachment B.


      1 See Securities Exchange Act Release No. 56645 (October 11, 2007), 72 FR 59317(October 19, 2007) (Approval Order of SR-NASD-2005-080).

      2 488 A.2d 858 (Del. 1985).


      ATTACHMENT A

      New language is underlined, deletions are in brackets.

      * * * * *

      2200. COMMUNICATIONS WITH CUSTOMERS AND THE PUBLIC

      * * * * *

      2290. Fairness Opinions

      (a) Disclosures

      If at the time a fairness opinion is issued to the board of directors of a company the member issuing the fairness opinion knows or has reason to know that the fairness opinion will be provided or described to the company's public shareholders, the member must disclose in the fairness opinion:
      (1) if the member has acted as a financial advisor to any party to the transaction that is the subject of the fairness opinion, and, if applicable, that it will receive compensation that is contingent upon the successful completion of the transaction, for rendering the fairness opinion and/or serving as an advisor;
      (2) if the member will receive any other significant payment or compensation contingent upon the successful completion of the transaction;
      (3) any material relationships that existed during the past two years or that are mutually understood to be contemplated in which any compensation was received or is intended to be received as a result of the relationship between the member and any party to the transaction that is the subject of the fairness opinion;
      (4) if any information that formed a substantial basis for the fairness opinion that was supplied to the member by the company requesting the opinion concerning the companies that are parties to the transaction has been independently verified by the member, and if so, a description of the information or categories of information that were verified;
      (5) whether or not the fairness opinion was approved or issued by a fairness committee; and
      (6) whether or not the fairness opinion expresses an opinion about the fairness of the amount or nature of the compensation to any of the company's officers, directors or employees, or class of such persons, relative to the compensation to the public shareholders of the company.
      (b) Procedures

      Any member issuing a fairness opinion must have written procedures for approval of a fairness opinion by the member, including:
      (1) the types of transactions and the circumstances in which the member will use a fairness committee to approve or issue a fairness opinion, and in those transactions in which it uses a fairness committee:
      (A) the process for selecting personnel to be on the fairness committee;
      (B) the necessary qualifications of persons serving on the fairness committee;
      (C) the process to promote a balanced review by the fairness committee, which shall include the review and approval by persons who do not serve on the deal team to the transaction; and
      (2) the process to determine whether the valuation analyses used in the fairness opinion are appropriate.

      * * * * *


      ATTACHMENT B

      Outline of Fairness Opinion Rule Requirements

      This outline highlights the disclosure and procedural requirements under NASD Rule 2290. Please be aware that, in the case of any misunderstanding, the rule language prevails. In addition, please note that your firm may have additional policies and procedures that must be followed.

      Disclosures

      A broker-dealer issuing a fairness opinion that will be disclosed to a company's public shareholders must make the following disclosures in the fairness opinion:

      •  If the broker-dealer will receive any compensation contingent on the successful completion of the transaction for acting as a financial adviser to any party to the transaction or otherwise;
      •  Any contemplated or existing material relationships involving the payment or receipt of compensation between the broker-dealer and any party to the transaction during the last two years;
      •  If the firm has independently verified any information supplied by the company requesting the fairness opinion, which is a substantial basis for the opinion and, if so, describe the information;
      •  Whether the fairness opinion was approved or issued by a fairness committee; and
      •  Whether the fairness opinion expresses an opinion about the fairness of the compensation to any of the company's insiders, relative to the compensation to the company's public shareholders.

      Procedures

      Any broker-dealer issuing a fairness opinion must have written procedures for approval of a fairness opinion including:

      •  When a member will use a fairness committee and where a fairness committee is used, the firm must specify:
      •  the process for selecting members of the fairness committee;
      •  the necessary qualifications for committee members; and
      •  the process to promote a balanced review by the fairness committee, which includes the review and approval of persons who are not on the transaction deal team.
      •  The firm must specify the process to determine that valuation analyses used are appropriate.

    • 07-53 SEC Approves New NASD Rule 2821 Governing Deferred Variable Annuity Transactions; Effective Date: May 5, 2008

      View PDF File

      Deferred Variable Annuities

      Regulatory Notice
      Notice Type

      New Rule
      Referenced Rules & Notices

      NASD Rule 2310
      NASD Rule 2330
      NASD Rule 2820
      NASD Rule 2821
      NASD Rule 3010
      NASD Rule 3012
      NTM 99-35
      NTM 01-23
      NTM 03-71
      NTM 05-50
      NYSE Information Memo 05-54
      SEC Rule 15c3-1
      SEC Rule 15c3-3
      Suggested Routing

      Compliance
      Continuing Education
      Internal Audit
      Legal
      Operations
      Registered Representatives
      Senior Management
      Systems
      Trading
      Training
      Variable Contracts
      Key Topics

      Deferred Variable Annuities
      Disclosure
      Principal Review
      Sales Practices
      Suitability
      Supervision
      Training

      Executive Summary

      On September 7, 2007, the SEC approved new NASD Rule 2821 regarding broker-dealers' compliance and supervisory responsibilities for deferred variable annuities.1 The rule text is set forth in Attachment A and is effective May 5, 2008.

      Questions regarding this Notice may be directed to James S. Wrona, Associate Vice President and Associate General Counsel, Office of General Counsel, at (202) 728-8270; or Lawrence N. Kosciulek, Director, Investment Companies Regulation, at (240) 386-4535.

      Discussion

      Deferred variable annuities are hybrid investments containing both securities and insurance features.2 They offer choices among a number of complex contract options, which can cause confusion for both the individuals who sell them and customers who buy them. FINRA developed Rule 2821 to enhance broker-dealers' compliance and supervisory systems and provide more comprehensive and targeted protection to investors regarding deferred variable annuities.

      The Rule's Application

      Rule 2821 applies to the purchase or exchange (not sale or surrender) of a deferred variable annuity and the initial subaccount allocations.3 Rule 2821 does not apply to reallocations of subaccounts made or to funds paid after the initial purchase or exchange of a deferred variable annuity. Other FINRA rules, however, are applicable to such transactions. For instance, FINRA's general suitability rule (NASD Rule 2310) continues to apply to any recommendations to reallocate subaccounts or to sell a deferred variable annuity.4 Rule 2821 applies to the use of deferred variable annuities to fund IRAs, but not to deferred variable annuities sold to certain tax-qualified, employer-sponsored retirement or benefit plans,5 unless a member firm makes a recommendation to an individual plan participant, in which case the rule would apply to that recommendation.6

      The Rule's Main Requirements

      Rule 2821 has four main requirements, which are discussed below. An outline of the general division of responsibility among registered representatives, registered principals and firms is included with this Notice (Attachment B). Firms and their associated persons should carefully review the actual rule language, however, to understand the breadth of the obligations that the rule imposes.

      Registered Representative Requirements for Recommended Transactions

      Under the "Recommendation Requirements" section of the rule,7 a registered representative must have a reasonable basis to believe that the customer has been informed, in general terms, of the material features of a deferred variable annuity, such as potential surrender period and surrender charge, potential tax penalty, mortality and expense fees, charges for and features of enhanced riders, insurance and investment components and market risk.8 Although the rule requires only generic disclosure, registered representatives and principals may not ignore product-specific features. For example, a firm and its brokers cannot adequately determine the suitability of a transaction without knowing the material features of the deferred variable annuity in question.9

      This section of the rule also requires that the registered representative have a reasonable basis to believe that the customer would benefit from certain features of deferred variable annuities, such as tax-deferred growth, annuitization or a death or living benefit.10 The rule does not require that a registered representative determine that the customer would benefit from all of these features or that the customer, in hindsight, actually took advantage of one or more of them.

      Further, this section states that a registered representative must have a reasonable basis to believe that "the particular deferred variable annuity as a whole, the underlying subaccounts to which funds are allocated at the time of the purchase or exchange of the deferred variable annuity, and riders and similar product enhancements, if any, are suitable...."11 Thus, the suitability determination must include careful consideration of the product in its entirety and its component parts, including initial subaccount allocations.

      If an "exchange" of one variable annuity for another is involved, the registered representative must have a reasonable basis to believe that "the transaction as a whole also is suitable for the particular customer" and must consider a number of additional factors.12 Those factors include "whether (i) the customer would incur a surrender charge, be subject to the commencement of a new surrender period, lose existing benefits, ... or be subject to increased fees or charges....; (ii) the customer would benefit from product enhancements and improvements; and (iii) the customer's account has had another deferred variable annuity exchange within the preceding 36 months."13 Regarding the last factor, a registered representative must determine whether the customer has effected another exchange at the broker-dealer at which he or she is performing the review and must make reasonable efforts to ascertain whether the customer has effected an exchange at any other broker-dealer(s) within the preceding 36 months.14

      The rule also requires a registered representative to make reasonable efforts to ascertain and consider various other types of customer-specific information when recommending that a customer purchase or exchange a deferred variable annuity. This information includes the customer's "age, annual income, financial situation and needs, investment experience, investment objectives, intended use of the deferred variable annuity, investment time horizon, existing assets (including investment and life insurance holdings), liquidity needs, liquid net worth, risk tolerance, tax status, and such other information used or considered to be reasonable by the member or person associated with the member in making recommendations to customers."15 Although not explicitly addressed in the rule, deferred variable annuities generally are considered to be long-term investments and are therefore typically not suitable for investors who have short-term investment horizons.

      Finally, a registered representative who recommends the purchase or exchange of a deferred variable annuity must document and sign the determinations discussed above. This signed document must provide reviewing principals with enough information to adequately assess whether the registered representative has complied with the requirements of Rule 2821.

      Principal Review and Approval Obligations for All Transactions

      The rule's "Principal Review and Approval" section includes both timing and substantive components. With regard to timing, the rule requires review and approval "[p]rior to transmitting a customer's application for a deferred variable annuity to the issuing insurance company for processing, but no later than seven business days after the customer signs the application...."16 FINRA recognizes that (in view of the variety of features and provisions of deferred variable annuity contracts) principal review of these investments often can require more time than reviews of many other types of securities transactions. To ensure that broker-dealers have sufficient time for a rigorous and thorough review prior to transmittal, FINRA has provided interpretive relief and the SEC has provided an exemption (as described below) regarding a number of rules that otherwise might have, as a practical matter, shortened the period within which broker-dealers could review the transactions.

      Broker-dealers often accept customer checks made payable to the issuing insurance company when customers sign applications for deferred variable annuities. The broker-dealers' receipt of the checks, however, could have triggered application of a number of other rules that might have required relatively quick principal reviews. NASD Rule 2330, for instance, generally prohibits improper use of customer funds, and NASD Rule 2820 specifically requires broker-dealers to "transmit promptly" the application and purchase payment for a variable annuity contract to the issuing insurance company. To alleviate the potential conflict between Rule 2821's review timing requirement and other FINRA rules, FINRA created an important exception: A broker-dealer may hold an application for a deferred variable annuity and a customer's non-negotiated check payable to an insurance company for up to seven business days without violating either Rule 2330 or Rule 2820 if the reason for the hold is to allow completion of principal review of the transaction pursuant to Rule 2821.

      An SEC exemption also was needed because "[m]any broker-dealers are subject to lower net capital requirements under [SEC] Rule 15c3-1 and are exempt from the requirement to establish and fund a customer reserve account under [SEC] Rule 15c3-3 because they do not carry customer funds or securities."17 Although some of these firms receive checks from customers made payable to third parties, the SEC does not deem a firm to be carrying customer funds if it "promptly transmits" the checks to third parties.18 The SEC has interpreted "promptly transmits" to mean that "such transmission or delivery is made no later than noon of the next business day after receipt of such funds or securities."19

      In conjunction with its approval of Rule 2821, the SEC provided an exemption to the "promptly transmits" requirement under the following conditions

      •  The transaction is subject to the principal review requirements of Rule 2821 and a registered principal has reviewed and determined whether he or she approves of the purchase or exchange of the deferred variable annuity within seven business days in accordance with the rule;
      •  The broker-dealer promptly transmits the check no later than noon of the business day following the date a registered principal reviews and determines whether he or she approves of the purchase or exchange of the deferred variable annuity; and
      •  The broker-dealer maintains a copy of each such check and creates a record of the date the check was received from the customer and the date the check was transmitted to the insurance company if approved or returned to the customer if rejected.

      If all three of these conditions are met, a firm is "exempt from any additional requirements of [SEC] Rules 15c3-1 or 15c3-3 due solely to a failure to promptly transmit a check made payable to an insurance company for the purchase of a deferred variable annuity product by noon of the business day following the date the broker-dealer receives the check from the customer...."20

      During the rulemaking process, some commenters asked whether principals must complete or simply begin their review prior to the transmittal of the application to the issuing insurance company. The principal review must be completed before transmittal of the application to the insurance company.

      A coalition of 32 life insurance companies asked whether the timing of principal review under Rule 2821 would be impacted by a firm's status as a "captive broker-dealer." The coalition explained that a number of insurance companies share personnel with affiliated broker-dealers and have centralized units that may share personnel who are responsible for both the broker-dealer's principal review of the variable annuity application and the insurance company's issuance process. The coalition sought clarification that receipt of customer applications by broker-dealer personnel for principal review, even if those personnel share office space with and/or also work for the insurer, would not be considered "transmitted to the issuing insurance company for processing" under Rule 2821.

      To respond to the coalition's request for clarification, it is necessary to emphasize that the main purpose of requiring pre-transmittal principal review is to have the principal review and determine whether to approve the application prior to the issuance of the contract. Ordinarily, FINRA would consider the application "transmitted" to theinsurance company when the broker-dealer sends the application to the insurance company for processing, whether it is sent via electronic means, facsimile transmission, regular or overnight mail, or courier. The dividing lines can become blurred, however, when a captive broker-dealer and insurance company share office space and/or employees who carry out both the principal review and the issuance process. In such situations, FINRA considers the application "transmitted" to the insurance company only when the broker-dealer's principal, acting as such, has approved the transaction, provided that the affiliated broker-dealer ensures that arrangements and safeguards exist to prevent the insurance company from issuing the contract prior to principal approval by the broker-dealer.21

      In addition to addressing the timing of principal review, this section of the rule states that a principal shall treat "all transactions as if they have been recommended for purposes of this principal review" and shall only approve the transaction if he or she determines "that there is a reasonable basis to believe that the transaction would be suitable based on the factors delineated in paragraph (b) of this Rule."22 A principal who determines that the transaction is unsuitable nonetheless may authorize the processing of the transaction if the principal determines that the transaction was not recommended and that the customer, after being informed of the reason why the principal found it to be unsuitable, affirms that he or she wants to proceed with the purchase or exchange of the deferred variable annuity. All of the determinations required by this part of the rule must be documented and signed by the principal.

      FINRA emphasizes, however, that the rule does not require broker-dealers to effect trades that they determine are not suitable; rather, the rule permits them to do so under the narrow circumstances discussed above. Thus, the rule has no effect on existing principles of law or contractual terms that allow a broker-dealer to decline the acceptance of an order.

      A few commenters asked whether principals have a more limited role under the rule if they are employed by a broker-dealer that does not have a sales force and does not make recommendations to customers.23 The rule requires that a broker-dealer have procedures in place designed to ensure that principals receive appropriate information about both the customer and the product(s) so that they can fulfill their review obligations under the rule and that principals review all purchase and exchange orders for suitability, irrespective of whether the orders were recommended.

      Firm Supervisory Procedures

      The rule specifically requires broker-dealers to establish and maintain written supervisory procedures reasonably designed to achieve compliance with the standards set forth in the rule.24 This part of the rule includes the requirements that the broker-dealer implement surveillance procedures to determine if any "associated persons have rates of effecting deferred variable annuity exchanges that raise for review whether such rates of exchanges evidence conduct inconsistent with the applicable provisions of this Rule, other applicable NASD rules, or the federal securities laws ('inappropriate exchanges') and have policies and procedures reasonably designed to implement corrective measures to address inappropriate exchanges...."25 The rule allows a firm to determine how to screen for and supervise such activity. Thus, a firm could perform this type of review on a periodic basis via exception reporting rather than as part of the principal review of each exchange transaction.

      Firm Training Program

      The fourth main requirement in the rule is a training component,26 which requires that firms create training programs for registered representatives who sell, and for registered principals who review transactions in, deferred variable annuities. Among other factors, firms must include training on the material aspects of deferred variable annuities.

      Use of Automated Supervisory Systems

      Rule 2821 does not preclude firms from using automated supervisory systems (or a mix of automated and manual supervisory systems) to facilitate compliance with the rule. Of course, firms that intend to rely on automated supervisory systems for compliance with Rule 2821 (or other rules) must remember that, at a minimum, a principal or principals would need to (1) approve the criteria that the automated supervisory system uses; (2) audit and update the automated supervisory system as necessary to ensure compliance with the rule; and (3) review exception reports that the automated supervisory system creates. As is always the case with the exercise of supervision under FINRA rules, the use of any automated supervisory system, aid or tool for the discharge of supervisory duties represents a direct exercise of supervision by the supervisor (a principal or principals under Rule 2821) and the supervisor remains responsible for the discharge of supervisory responsibilities in compliance with the rule. Consequently, a principal or principals relying on such an automated supervisory system is responsible for any deficiency in the system's criteria that would result in the system not being reasonably designed to comply with Rule 2821.

      A broker-dealer need not designate only one principal to perform these tasks. Consistent with NASD Rules 3010 and 3012, a broker-dealer generally is free to allocate supervisory responsibilities among its qualified registered principals as appropriate (whether in the context of automated or manual supervisory reviews). Thus, a broker-dealer may, for example, designate several principals to be responsible for various parts of an automated supervisory system.

      Finally, a broker-dealer must ensure that it provides training for (1) the firm's relevant associated persons on how to correctly input information into the automated supervisory system and (2) the firm's principals responsible for reviewing and approving deferred variable annuity transactions on how to use and interpret the reports generated by the firm's automated supervisory systems in order to properly review and monitor deferred variable annuity transactions.27


      1 See SEC Order Approving FINRA's NASD Rule 2821 Regarding Members' Responsibilities for Deferred Variable Annuities (Approval Order), Securities Exchange Act Release No. 56375 (Sept. 7, 2007), 72 FR 52403 (Sept. 13, 2007) (SR-NASD-2004-183); SEC Corrective Order, Securities Exchange Act Release No. 56375A (Sept. 14, 2007), 72 FR 53612 (Sept. 19, 2007) (SR-NASD-2004-183) (correcting the rule's effective date). Created on July 30, 2007, the Financial Industry Regulatory Authority (FINRA) comprises the former National Association of Securities Dealers, Inc. (NASD) and the member regulation, enforcement and arbitration functions of the New York Stock Exchange (NYSE). The FINRA rulebook consists of both NASD rules and certain NYSE rules until FINRA adopts a consolidated rulebook.

      2 In general, a variable annuity is a contract between an investor and an insurance company whereby the insurance company promises to make periodic payments to the contract owner or beneficiary, starting immediately (an immediate variable annuity) or at some future time (a deferred variable annuity). See Joint SEC and NASD Staff Report on Broker-Dealer Sales of Variable Insurance Products (June 2004) (Joint Report), available at www.sec.gov/news/studies/secnasdvip.pdf; see also NASD Notice to Members 99-35 (May 1999); NYSE Information Memo 05-54 (Aug. 11, 2005).

      3 Rule 2821(a)(1). The rule covers a stand-alone purchase of a deferred variable annuity and an exchange of one deferred variable annuity for another. For purposes of the rule, an "exchange" of a product other than a deferred variable annuity (such as a fixed annuity) for a deferred variable annuity would be covered by the rule as a "purchase." The rule does not cover customer sales or surrenders of deferred variable annuities, including the sale or surrender of a deferred variable annuity in connection with an "exchange" of a deferred variable annuity for another product (such as a fixed annuity).

      4 In a 2002 Regulatory & Compliance Alert entitled "Reminder—Suitability of Variable Annuity Sales," FINRA emphasized that Rule 2310 "applies to any recommendation to sell a variable annuity regardless of the use of the proceeds, including situations where the member recommends using the proceeds to purchase an unregistered product such as an equity-indexed annuity. Any recommendation to sell the variable annuity must be based upon the financial situation, objectives and needs of the particular investor." Regulatory & Compliance Alert (Spring 2002) at 13. See also NASD Notice to Members 05-50 (Aug. 2005) ("[R]recommendations to ... surrender a ... variable annuity ... must be suitable, including where such ... surrender[s] are for the purpose of funding the purchase of an unregistered EIA."). As part of the suitability analysis under Rule 2310 regarding a recommendation to sell a deferred variable annuity, a registered representative must consider, inter alia, tax consequences, surrender charges and loss of benefits (such as death, living or other contractual benefits).

      5 A deferred variable annuity purchased to fund an IRA (or other tax deferred account or vehicle) does not provide any additional tax deferred treatment of earnings beyond the treatment provided by the IRA (or other tax deferred account or vehicle) itself. Accordingly, where a customer is purchasing a deferred variable annuity to fund an IRA (or other tax deferred account or vehicle), firms must ensure that features other than tax deferral make the purchase of the deferred variable annuity for the IRA (or other tax deferred account or vehicle) appropriate.

      6 Another issue that arose during the rulemaking process is whether Rule 2821 would apply if a registered representative recommended a deferred variable annuity to an individual retirement plan participant and the annuity was the only funding vehicle for the employer's retirement plan. If the registered representative "recommends" the deferred variable annuity, then Rule 2821 would apply. However, not all communications about a deferred variable annuity would constitute a "recommendation" that triggers application of the rule. For instance, a firm's generic communication to plan participants indicating only that their employer has chosen a deferred variable annuity as the funding vehicle for its retirement plan generally would not constitute a "recommendation" triggering application of the rule. For a review of guidelines for determining whether a particular communication could be deemed a "recommendation," see NASD Notice to Members 01-23 (Apr. 2001).

      7 Rule 2821(b).

      8 Rule 2821(b)(1)(A)(i). While the rule does not specify the exact type or form of disclosure that is required, a registered representative who merely delivers a prospectus to an investor ordinarily would not have a reasonable basis to believe that the customer has been instructed or educated—"informed"—about the material features of a deferred variable annuity for purposes of the rule.

      9 A broker's understanding of the features of an investment product is an important component of both reasonable-basis suitability (i.e., the requirement that a broker determine, after appropriate due diligence, whether the product is suitable for at least some investors) and customer-specific suitability (i.e., the requirement that the broker determine whether the product is suitable for the particular customer at issue). See NASD Notice to Members 03-71 (Nov. 2003).

      10 In the past, it was apparent that some brokers and investors did not fully understand important aspects of these features. For instance, "although a benefit of a variable annuity investment is that earnings accrue on a tax-deferred basis, a minimum holding period is often necessary before the tax benefits are likely to outweigh the often higher fees imposed on variable annuities relative to alternative investments, such as mutual funds." NASD Notice to Members 99-35 (May 1999). See also NYSE Information Memo 05-54 (Aug. 11, 2005) ("A customer of advanced years might lack the actuarial expectations necessary for a deferred variable annuity to yield its benefit of income shelter versus costs, and his or her lower tax bracket might render such benefits marginal or negative.").

      11 Rule 2821(b)(1)(A)(iii).

      12 Id.

      13 Rule 2821(b)(1)(B).

      14 FINRA generally would view asking customers whether they had an exchange at another broker-dealer within 36 months to be a "reasonable effort" in this context.

      15 Rule 2821(b)(2).

      16 Rule 2821(c).

      17 SEC Order Granting Exemption to Broker-Dealers from Requirements in Rules 15c3-1 and 15c3-3 to Promptly Transmit Customer Checks (Exemption Order), Securities Exchange Act Release No. 56376 (Sept. 7, 2007), 72 FR 52400 (Sept. 13, 2007).

      18 See Securities Exchange Act Release No. 31511 (Nov. 24, 1992) (stating that a firm shall not be deemed to receive funds if checks are payable to an entity other than itself—such as to another broker-dealer or escrow agent—and the firm promptly forwards such funds to the third party).

      19 Id., note 11, and 17 CFR § 240.15c3-1(c)(9). The SEC has extended this definition to SEC Rule 15c3-3(k). See NYSE's SEC Rule Interpretations Handbook, at 15c3-3(k)(2)(ii)/015.

      20 Exemption Order, supra note 17.

      21 Several commenters have asked, in the case where a captive broker-dealer shares office space and/or employees with the insurance company, whether, in advance of the broker-dealer's principal approval of the transaction, the customer's funds could be deposited in an account at the insurance company and administration of the issuance processing could begin. The rule does not permit depositing the customer's funds in an account at the insurance company prior to completion of principal review. The rule, however, does not prohibit using the information required for principal review and approval in aid of the issuance process. For instance, the rule generally does not prohibit a broker-dealer from inputting information used as part of its suitability review into a shared database (irrespective of the media used for that database, i.e., paper or electronic) that the insurer uses for the issuance process, provided that no further steps are taken in the issuance process.

      22 Rule 2821(c).

      23 One commenter asked whether Rule 2821 applies to an issuer's direct sale of a deferred variable annuity to a customer without any involvement of a broker-dealer or persons associated with a broker-dealer. FINRA's rules apply only to member broker-dealers and their associated persons. FINRA notes, however, that the determination of whether an entity should be registered as a broker-dealer rests with the SEC.

      24 See Rule 2821(d).

      25 Id. (emphasis added). FINRA notes that Rule 2821(d)(1) focuses on whether an associated person has effected an inappropriate number of exchanges, while Rule 2821(b)(1)(B)(iii) focuses on whether a particular customer has had another exchange within a 36-month period.

      26 See Rule 2821(e).

      27 The firm also would need to comply with applicable requirements of NASD Rule 3110 and SEC Rules 17a-3 and 17a-4 and interpretations thereof.


      ATTACHMENT A

      New language is underlined.

      * * * * *

      2821. Members' Responsibilities Regarding Deferred Variable Annuities

      (a) General Considerations
      (1) Application

      This Rule applies to the purchase or exchange of a deferred variable annuity and the subaccount allocations. This Rule does not apply to reallocations of subaccounts made or to funds paid after the initial purchase or exchange of a deferred variable annuity. This Rule also does not apply to deferred variable annuity transactions made in connection with any tax-qualified, employer-sponsored retirement or benefit plan that either is defined as a "qualified plan" under Section 3(a)(12)(C) of the Securities Exchange Act of 1934 or meets the requirements of Internal Revenue Code Sections 403(b), 457(b), or 457(f), unless, in the case of any such plan, a member or person associated with a member makes recommendations to an individual plan participant regarding a deferred variable annuity, in which case the Rule would apply as to the individual plan participant to whom the member or person associated with the member makes such recommendations.
      (2) Creation, Storage, and Transmission of Documents

      For purposes of this Rule, documents may be created, stored, and transmitted in electronic or paper form, and signatures may be evidenced in electronic or other written form.
      (3) Definitions

      For purposes of this Rule, the term "registered principal" shall mean a person registered as a General Securities Sales Supervisor (Series 9/10), a General Securities Principal (Series 24), or an Investment Company Products/Variable Contracts Principal (Series 26), as applicable.
      (b) Recommendation Requirements
      (1) No member or person associated with a member shall recommend to any customer the purchase or exchange of a deferred variable annuity unless such member or person associated with a member has a reasonable basis to believe
      (A) that the transaction is suitable in accordance with Rule 2310 and, in particular, that there is a reasonable basis to believe that
      (i) the customer has been informed, in general terms, of various features of deferred variable annuities, such as the potential surrender period and surrender charge; potential tax penalty if customers sell or redeem deferred variable annuities before reaching the age of 591/2; mortality and expense fees; investment advisory fees; potential charges for and features of riders; the insurance and investment components of deferred variable annuities; and market risk;
      (ii) the customer would benefit from certain features of deferred variable annuities, such as tax-deferred growth, annuitization, or a death or living benefit; and
      (iii) the particular deferred variable annuity as a whole, the underlying subaccounts to which funds are allocated at the time of the purchase or exchange of the deferred variable annuity, and riders and similar product enhancements, if any, are suitable (and, in the case of an exchange, the transaction as a whole also is suitable) for the particular customer based on the information required by subparagraph (b)(2) of this Rule; and
      (B) in the case of an exchange of a deferred variable annuity, the exchange also is consistent with the suitability determination required by subparagraph (b)(1)(A) of this Rule, taking into consideration whether
      (i) the customer would incur a surrender charge, be subject to the commencement of a new surrender period, lose existing benefits (such as death, living, or other contractual benefits), or be subject to increased fees or charges (such as mortality and expense fees, investment advisory fees, or charges for riders and similar product enhancements);
      (ii) the customer would benefit from product enhancements and improvements; and>
      (iii) the customer's account has had another deferred variable annuity exchange within the preceding 36 months.
      The determinations required by this paragraph shall be documented and signed by the associated person recommending the transaction.
      (2) Prior to recommending the purchase or exchange of a deferred variable annuity, a member or person associated with a member shall make reasonable efforts to obtain, at a minimum, information concerning the customer's age, annual income, financial situation and needs, investment experience, investment objectives, intended use of the deferred variable annuity, investment time horizon, existing assets (including investment and life insurance holdings), liquidity needs, liquid net worth, risk tolerance, tax status, and such other information used or considered to be reasonable by the member or person associated with the member in making recommendations to customers.
      (c) Principal Review and Approval

      Prior to transmitting a customer's application for a deferred variable annuity to the issuing insurance company for processing, but no later than seven business days after the customer signs the application, a registered principal shall review and determine whether he or she approves of the purchase or exchange of the deferred variable annuity. Subject to the exception in this paragraph, and treating all transactions as if they have been recommended for purposes of this principal review, a registered principal shall approve the transaction only if the registered principal has determined that there is a reasonable basis to believe that the transaction would be suitable based on the factors delineated in paragraph (b) of this Rule. Notwithstanding the foregoing, a registered principal may authorize the processing of the transaction if the registered principal determines that the transaction was not recommended and that the customer, after being informed of the reason why the registered principal has not approved the transaction, affirms that he or she wants to proceed with the purchase or exchange of the deferred variable annuity. The determinations required by this paragraph shall be documented and signed by the registered principal who reviewed and approved, rejected, or authorized the transaction.
      (d) Supervisory Procedures

      In addition to the general supervisory and recordkeeping requirements of Rules 3010, 3012, 3013, and 3110, a member must establish and maintain specific written supervisory procedures reasonably designed to achieve compliance with the standards set forth in this Rule. The member also must (1) implement surveillance procedures to determine if any of the member's associated persons have rates of effecting deferred variable annuity exchanges that raise for review whether such rates of exchanges evidence conduct inconsistent with the applicable provisions of this Rule, other applicable NASD rules, or the federal securities laws ("inappropriate exchanges") and (2) have policies and procedures reasonably designed to implement corrective measures to address inappropriate exchanges and the conduct of associated persons who engage in inappropriate exchanges.
      (e) Training

      Members shall develop and document specific training policies or programs reasonably designed to ensure that associated persons who effect and registered principals who review transactions in deferred variable annuities comply with the requirements of this Rule and that they understand the material features of deferred variable annuities, including those described in subparagraph (b)(1)(A)(i) of this Rule.

      * * * * *


      ATTACHMENT B

      Division of Responsibilities Outline under Rule 2821 (Deferred Variable Annuities)

      This outline highlights the general division of responsibility among registered representatives, registered principals and firms under Rule 2821. Please be aware that, in the case of any misunderstanding, the rule language prevails. In addition, please note that your firm may have additional policies and procedures that registered representatives and principals must follow.

      Registered Representatives (RRs),

      •  when recommending either a purchase or an exchange of a deferred variable annuity, must
      1. reasonably try to obtain and consider information about the customer, including
      a. age
      b. annual income
      c. financial situation and needs
      d. investment experience
      e. investment objectives
      f. intended use of the deferred variable annuity
      g. investment time horizon
      h. existing assets (e.g., investment and life insurance holdings)
      i. liquidity needs
      j. liquid net worth
      k. risk tolerance
      l. tax status
      2. reasonably believe that the purchase or exchange is suitable, based on a variety of factors, including
      a. the customer has been informed, in general terms, of the material features of deferred variable annuities, such as
      •  potential surrender period and
      •  potential tax penalty components
      •  mortality and expense fees
      •  charges for and features of surrender charge enhanced riders, if any
      •  insurance and investment
      •  market risk
      b. the customer would benefit from one or more features of deferred variable annuities, such as
      •  tax-deferred growth
      •  annuitization
      •  a death or living benefit
      c. the particular deferred variable annuity as a whole, underlying subaccounts, and riders and similar product enhancements, if any, are suitable
      3. document and sign his or her determinations, providing the principal assigned to review the transaction with enough information to assess compliance with the rule
      •  when determining suitability for a recommended exchange of a deferred variable annuity, also must consider whether the customer
      1. would incur a surrender charge, be subject to a new surrender period, lose existing benefits or be subject to increased fees or charges
      2. would benefit from product enhancements and improvements
      3. has exchanged a deferred variable annuity within the last 36 months

      Registered Principals

      1. must review each purchase and exchange and determine whether to approve the transaction before sending the customer's application to the insurer for processing, but no later than seven business days after the customer has signed the application
      2. must treat all transactions as if they have been recommended for purposes of review
      3. can approve the transaction only if he or she reasonably believes that it is suitable based on the factors that RRs must consider for recommended transactions
      4. may authorize the processing of an unsuitable transaction if the principal determines both that
      a. the transaction was not recommended and
      b. the customer, after being told why the principal found it to be unsuitable, has stated that he or she wants to proceed with the purchase or exchange
      5. must document and sign all determinations

      Broker-Dealer Firms,

      •  with respect to supervisory procedures, must
      1. have written supervisory procedures reasonably designed to achieve compliance with the rule
      2. have surveillance procedures to identify which, if any, of their RRs have a rate of effecting exchanges that raises a question as to whether those exchanges comply with this or other rules
      3. have procedures to address and correct exchanges that do not comply with this or other rules
      •  with respect to training, must
      1. create training programs on deferred variable annuities for RRs who sell, and for principals who review transactions in, these products

    • 07-52 Approves FINRA Membership Waive-In Process for Certain NYSE Member Organizations; Effective Date: October 12, 2007

      View PDF File

      Regulatory Notice
      Notice Type

      Rule Amendment
      Referenced Rules & Notices

      NASD IM-1013-1
      NASD IM-Section 4(b)(1) and (e)
      NASD Rule 1017
      NASD Rule 1021
      NASD Rule 1031
      NASD Rule 8000 Series
      NASD Rule 9000 Series
      NYSE Rule 2
      Suggested Routing

      Compliance
      Legal
      Registration
      Senior Management
      Key Topic(s)

      Mandatory FINRA Membership for NYSE Member Organizations
      Member Application Process
      Membership Waive-In Application

      Mandatory FINRA Membership for NYSE Member Organizations

      Executive Summary

      The SEC has approved NASD IM-1013-1, which establishes a waive-in application process for FINRA membership for certain NYSE-only member organizations that must become FINRA members as a result of NYSE's new mandatory FINRA membership requirement. The SEC also approved a membership application fee waiver for firms that become FINRA members pursuant to NASD IM-1013-1.

      Questions concerning this Notice should be directed to:

      •  Gary L. Goldsholle, Vice President and Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8104;
      •  Philip A. Shaikun, Associate Vice President and Associate General Counsel, OGC, at (202) 728-8451;
      •  Jeffrey M. Pasquerella, Deputy District Director, District 10, at (212) 858-4163; or
      •  Erika L. Lazar, Senior Attorney, OGC, at (212) 656-4591.

      Background & Discussion

      As part of the consolidation of NASD and the member regulatory functions of NYSE Regulation, Inc. into FINRA (the Transaction),1 the SEC approved a rule change to the definition of "member organization" in NYSE Rule 2(b) to require all member organizations that are currently, or propose to become, NYSE member organizations to become members of FINRA.2

      In connection with the mandatory membership requirement, FINRA established a waive-in process to expedite the approval of membership applications of the approximately 86 NYSE member organizations that must now become FINRA members. That process is set forth in NASD IM-1013-1, approved by the SEC on October 12, 2007.3 FINRA also established new IM-Section 4(b)(1) and (e) to Schedule A of the By-Laws, which waives the membership application fees for those firms that become FINRA members pursuant to NASD IM-1013-1.

      Waive-In Process and Requirements

      NASD IM-1013-1 establishes a waive-in process for firms that, as of July 25, 2007: (1) are approved NYSE member organizations, or (2) have submitted an application to become an NYSE member organization and are subsequently approved for NYSE membership (together "NYSE-only member organizations"), provided that such firms were not also NASD members as of July 30, 2007, the closing date of the Transaction. The waive-in process makes these firms automatically eligible to become FINRA members and to register all associated persons whose registrations are approved with NYSE in registration categories recognized by FINRA upon submission to FINRA of a signed waive-in membership application (Waive-In Application) with certain specified information, as set forth below.

      The Waive-In Application requires NYSE-only member organizations to submit the following to FINRA:

      •  General company information, including Central Registration Depository (CRD®) Number and contact person;
      •  An attestation that all information on the applicant's CRD form, as of the date of submission of the Waive-In Application, is accurate and complete, and fully reflects all aspects of the applicant's current business, including, but not limited to, ownership structure, management, product lines and disclosures;
      •  The identity of the firm's Executive Representative;4
      •  Completed and signed Entitlement Forms;
      •  A signed FINRA membership agreement; and
      •  Representations that: (1) the applicant's Form BD will be amended as needed to remain current and accurate, (2) all individual and entity registrations with FINRA will be kept current, and (3) all information and statements contained in the Waive-In Application are current, true and complete.

      Once an NYSE-only member organization has completed and submitted a Waive-In Application, FINRA has three business days to review the application, and, if complete, to issue an application approval notification letter. The FINRA membership agreement would become effective on the date of such notification letter.

      FINRA has not recognized any new registration categories as a result of the Transaction. Thus, associated persons of the NYSE-only member organizations will be automatically registered with FINRA only for those registration categories that NASD and NYSE jointly recognized at the close of the Transaction (e.g., a General Securities Representative Series 7); provided, however, that the firm must, upon approval of FINRA membership, submit an amended Form U4 for each such associated person, denoting the corresponding FINRA (NASD) registration category (or categories) for such person.

      Membership Application Fee Waiver

      FINRA also added IM-Section 4(b)(1) and 4(e) to Schedule A of the By-Laws. This provision provides that NYSE member organizations that become members of FINRA pursuant to the waive-in process shall not be assessed the fee set forth in Section 4(b)(1) to Schedule A for the initial Form U4 filed by firms for the registration of any representative or principal associated with the member organization at the time a firm submits its application for FINRA membership. Also, such firms shall not be assessed the membership application fee set forth in Section 4(e) to Schedule A.

      Applicable Rules

      NYSE-only member organizations admitted pursuant to NASD IM-1013-1 are subject to: NYSE rules incorporated by FINRA; FINRA's By-Laws and Schedules to By-Laws, including Schedule A (Assessments and Fees); and NASD Rule 8000 (Investigations and Sanctions) and Rule 9000 (Code of Procedure) Series, provided that their securities business is limited to Floor brokerage on the NYSE, or routing away to other markets orders that are ancillary to their core Floor business under NYSE Rule 70.40 (permitted Floor activities).5

      If an NYSE-only member organization admitted pursuant to NASD IM-1013-1 seeks to expand its business operations to include any activities other than the permitted Floor activities, such firm must apply for and receive approval to engage in such business activity pursuant to NASD Rule 1017, which requires an application and prior FINRA approval of material changes in a firm's operations before those changes may occur. Upon approval of such business expansion, the firm would become subject to all FINRA rules.

      Additionally, associated persons of an NYSE-only member organization admitted to FINRA pursuant to NASD IM-1013-1 would be subject to the same set of rules as the firm with which they are associated, namely the NYSE rules incorporated by FINRA, FINRA's By-Laws and Schedules to By-Laws, and the NASD Rule 8000 and 9000 Series.

      Inasmuch as these associated persons would not be subject to NASD Rules 1021 or 1031, they would not be required to register in a registration category recognized by FINRA. To the extent that such persons continue to be associated solely with a firm whose business complies with the limitations imposed on those firms admitted to FINRA pursuant to the waive-in process, FINRA is not imposing any registration requirements beyond those that the NYSE requires, provided that their business is confined in scope as contemplated in NASD IM-1013-1. The licensing and other requirements applicable to the NYSE-only member organizations and their associated persons, however, are subject to change as part of the process of establishing a consolidated rulebook applicable to all FINRA members.


      1 On July 26, 2007, the SEC approved amendments to NASD's By-Laws to implement governance and related changes to accommodate the consolidation of the member firm regulatory functions of NASD and NYSE Regulation, Inc. See Exchange Act Release No. 56145 (July 26, 2007), 72 FR 42169 (August 1, 2007) (File No. SR-NASD-2007-023). The SEC also approved a plan by FINRA and NYSE Regulation to allocate regulatory responsibility relating to the NYSE member firm regulation rules to FINRA. See Exchange Act Release No. 56148 (July 26, 2007), 72 FR 42146 (August 1, 2007) (File No. 4-544).

      2 See Exchange Act Release No. 56654 (October 12, 2007), 72 FR 59129 (October 18, 2007) (File No. SR-NYSE-2007-67); see also File No. SR-FINRA-2007-019.

      3 See Exchange Act Release No. 56653 (October 12, 2007), 72 FR 59127 (October 18, 2007) (File No. SR-NASD-2007-056).

      4 As required by Article IV, Section 3 of the FINRA By-Laws.

      5 See Exchange Act Release No. 56653 (October 12, 2007), 72 FR 59127 (October 18, 2007), n. 9. Activities that are ancillary to a Floor broker's core business include: (1) routing orders in NYSE-traded securities to an away market for any reason relating to their ongoing Floor activity, including regulatory compliance or meeting best-execution obligations; or (2) provided that the majority of transactions effected by the firm are effected on the NYSE, sending to other markets orders in NYSE-traded or non-NYSE-traded securities and/or futures if such orders relate to hedging positions in NYSE-traded securities, or are part of arbitrage or program trade strategies that include NYSE-traded securities.


      Attachment A

      Below is the text of the rule change. New language is underlined; deletions are in brackets

      * * * * *

      NYSE Rule 2. "Member," "Membership," "Member Firm," etc.

      (a) No Change.
      (b)
      (i) The term "member organization" means a registered broker or dealer (unless exempt pursuant to the Securities Exchange Act of 1934) that is a member of the Financial Industry Regulatory Authority ("FINRA") and approved by the Exchange and authorized to designate an associated natural person to effect transactions on the floor of the Exchange or any facility thereof. This term shall include a natural person so registered, approved and licensed and who directly effects transactions on the floor of the Exchange or any facility thereof.
      (ii) The term "member organization" also includes [any] a registered broker or dealer that is a member of FINRA, which does not own a trading license and agrees to be regulated by the Exchange as a member organization and which the Exchange has agreed to regulate.
      (iii) No Change.
      (c) through (h) No Change.

      * * * * *

      SCHEDULE A TO NASD BY-LAWS

      * * * * *

      Section 1 through Section 4

      No Change.

      IM-Section 4(b)(1) and (e)—Exemption from Certain Registration and Membership Application Fees for Certain New York Stock Exchange Member Organizations

      NYSE member organizations that become members of FINRA pursuant to IM-1013-1 shall not be assessed the fee set forth in Section 4(b)(1) to Schedule A of the NASD By-Laws for the initial Form U-4 filed by firms for the registration of any representative or principal associated with the member organization at the time a firm submits its application for FINRA membership. Such firms also shall not be assessed the membership application fee set forth in Section 4(e) to Schedule A of the NASD By-Laws. However, those firms will otherwise remain subject to FINRA's By-Laws and Schedules to By-Laws, including Schedule A.

      Section 5 through Section 13

      No Change.

      * * * * *

      1000. MEMBERSHIP, REGISTRATION AND QUALIFICATION REQUIREMENTS

      * * * * *

      1013. New Member Application and Interview

      * * * * *

      IM-1013-1. Membership Waive-In Process for Certain New York Stock Exchange Member Organizations

      This Interpretive Material sets forth a membership waive-in process for certain New York Stock Exchange ("NYSE") member organizations to become members of FINRA as part of the consolidation of the member firm regulatory functions of NASD and NYSE Regulation, Inc. ("NYSE Regulation"). It applies to firms that, as of July 25, 2007, (1) are approved NYSE member organizations or (2) have submitted an application to become an NYSE member organization and are subsequently approved for NYSE membership (together "NYSE-only member organizations"), provided that such firms were not also NASD members as of July 30, 2007. Such firms are eligible to automatically become FINRA members and to automatically register all associated persons whose registrations are approved with NYSE in registration categories recognized by FINRA upon submission to FINRA's Member Regulation Department ("the Department") of a signed waive-in membership application ("Waive-In Application") with the following information:

      (1) General company information, including Central Registration Depository (CRD®) Number and contact person.
      (2) An attestation that all information on the applicant's CRD form, as of the date of submission of the Waive-In Application is accurate and complete and fully reflects all aspects of the applicant's current business, including, but not limited to, ownership structure, management, product lines and disclosures.
      (3) The identity of the firm's Executive Representative.
      (4) Completed and signed Entitlement Forms.
      (5) A signed FINRA Membership Agreement.
      (6) Representations that the NYSE applicant's Uniform Application for Broker-Dealer Registration (Form BD) will be amended as needed to keep current and accurate; that all individual and entity registrations with FINRA will be kept current; and that all information and statements contained in the Waive-In Application are current, true and complete.

      The Department shall review the Waive-In Application within three (3) business days of receipt and, if complete, issue a letter notifying the applicant that it has been approved for membership. The Membership Agreement shall become effective on the date of such notification letter.

      Firms admitted pursuant to this Interpretive Material shall be subject to the NYSE rules incorporated by FINRA, FINRA's By-Laws and Schedules to By-Laws, including Schedule A, and the NASD Rule 8000 and Rule 9000 Series, provided that their securities business is limited to floor brokerage on the NYSE, or routing away to other markets orders that are ancillary to their core floor business under NYSE Rule 70.40 ("permitted floor activities"). If an NYSE-only member organization admitted pursuant to this Interpretive Material seeks to expand its business operations to include any activities other than the permitted floor activities, such firm must apply for and receive approval to engage in such business activity pursuant to NASD Rule 1017. Upon approval of such business expansion, the firm shall be subject to all NASD rules, in addition to those NYSE rules incorporated by FINRA.

      Pursuant to IM-Section 4(b)(1) and (e) to Schedule A of the NASD By-Laws, a firm applying to waive in for membership pursuant to this Interpretive Material shall not be assessed certain registration and application fees set forth in Sections 4(b)(1) and (e) to Schedule A of the NASD By-Laws.

    • 07-51 Amendments to NASD IM-9216 to include certain NYSE Rules under the Minor Rule Violation Plan Effective Date: September 24, 2007

      View PDF File

      Minor Rule Violation Plan

      Regulatory Notice

      Notice Type



      Rule Amendment
      Referenced Rules & Notices

      NASD IM-9216
      NASD Rule 9216
      NYSE Rule 476A
      SEC Rule 19d-1(c)(2)
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Senior Management
      Key Topic(s)

      Minor Rule Violation Plan (MRVP)

      Executive Summary

      Effective September 24, 2007, the list of violations eligible for disposition under the MRVP includes certain NYSE rules that pertain to the regulation of member firm conduct and that were incorporated into the FINRA rulebook.1 FINRA's NYSE rules apply solely to FINRA members that also are members of the NYSE on or after July 30, 2007, referred to as "dual members." The amendments to NASD IM-9216 allow FINRA to impose a fine—rather than commence disciplinary proceedings—for minor violations by dual members of the NYSE rules (in addition to the other rules) contained in the MRVP.

      IM-9216, as amended, is set forth in Attachment A of this Notice.

      Questions concerning this Notice may be directed to Kathryn M. Moore, Assistant General Counsel, Office of General Counsel, at (202) 974-2974.

      Background and Discussion

      The FINRA rulebook currently consists of both NASD Rules and certain incorporated NYSE Rules. The incorporated NYSE Rules apply solely to members of FINRA that are also members of the NYSE on or after July 30, 2007, referred to as "dual members."2

      FINRA did not incorporate, among other rules, the NYSE disciplinary rules or related interpretations, including NYSE's Minor Rule Violation Plan (MRVP), as set forth in NYSE Rule 476A.3 As a result, FINRA has amended its MRVP (as set forth in NASD IM-9216) to include those incorporated NYSE Rules currently listed in NYSE's MRVP.

      The purpose of the MRVP is to provide for a meaningful sanction for a minor or technical violation of a rule when the initiation of a disciplinary proceeding through the formal complaint process would be more costly and time-consuming than would be warranted. Inclusion of a rule in the MRVP does not mean it is an unimportant rule; rather, it means that a minor or technical violation of the rule may be more appropriately handled with a fine rather than through disciplinary proceedings. FINRA retains the discretion to bring full disciplinary proceedings for the violation of any rule listed in the MRVP.

      Currently, NASD IM-9216 lists certain rules from the following categories of rules, the minor violation of which may result in a fine:

      •  NASD Rules
      •  Provisions of the NASD (now FINRA) By-Laws and Schedules to By-Laws
      •  Incorporated NYSE Rules
      •  Exchange Act Rules
      •  MSRB Rules

      The amendments to IM-9216 also specify the applicability of the rules listed based on whether the firm is a dual member or a FINRA-only member.

      •  Any dual member (including any persons affiliated with such member) may be subject to a fine for minor violations of any rule listed in NASD IM-9216 that applies to such member or person. However, any dual member that was not also a member of NASD as of July 30, 2007 (i.e., was an NYSE-only member prior to the effective date of the consolidation) and that does not engage in any activities that would have required it to be a FINRA member (and its affiliated persons that are not otherwise subject to NASD rules) may be subject to a fine for minor violations only of the following rules listed in NASD IM-9216: any incorporated NYSE Rule, Exchange Act Rule, FINRA By-Law or Schedule to By-Laws, or the NASD Rule 8000 Series.4
      •  Any FINRA member firm that is not also a member of the NYSE (and its associated persons that are not otherwise subject to NYSE rules) may be subject to a fine for minor violations of any rule listed in NASD IM-9216, with the exception of the incorporated NYSE rules.

      FINRA will continue to apply the $2,500 maximum fine level under NASD IM-9216 in determining fine levels for minor violations of any rule included in the plan, including the incorporated NYSE Rules.

      The amendments also delete from NASD IM-9216 references to NASD rules that have been rescinded.5


      1 See Securities Exchange Act Release No. 56504 (September 24, 2007), 72 FR 55850 (October 1, 2007) (Approval Order of File No. SR-NASD-2007-055).

      2 See Securities Exchange Act Release No. 56147 (July 26, 2007), 72 FR 42166 (August 1, 2007) (Notice of Filing and Order Granting Accelerated Approval of File No. SR-NASD-2007-054).

      3 The NYSE's MRVP (NYSE Rule 476A) was not incorporated because NYSE Rule 476A contains procedures that would conflict with the finding of a minor rule violation by FINRA. For example, NYSE Rule 476A permits a person against whom a fine is imposed to contest the NYSE's fine determination by, among other things, appealing to the NYSE board of directors.

      4 FINRA has established a membership waive-in process for certain NYSE member organizations that were not also NASD members as of July 30, 2007. See Securities Exchange Act Release No. 56653 (October 12, 2007), 72 FR 59127 (October 18, 2007) (Order Approving SR-NASD-2007-056). Firms admitted pursuant to this process are subject only to the incorporated NYSE Rules, FINRA's By-Laws and Schedules to By-Laws, the NASD Rule 8000 Series (Investigations and Sanctions) and the NASD Rule 9000 Series (Code of Procedure), provided their securities business is limited to certain permitted floor activities. Accordingly, such firms are not subject to a fine for the minor violation of NASD Rules that do not apply to such firms.

      5 On June 30, 2006, the SEC approved SR-NASD-2005-087, which, among other things, deleted NASD Rules 4619, 4642, 4652, 5430, 6720 and 8212 from the NASD Manual. See Securities Exchange Act Release No. 54084 (June 30, 2006), 71 FR 38935 (July 10, 2006) (Order Approving SR-NASD-2005-087). On September 28, 2006, the SEC approved SR-NASD-2006-091, which, among other things, deleted NASD Rule 6420 from the NASD manual. See Securities Exchange Act Release No. 54537 (September 28, 2006), 71 FR 59173 (October 6, 2006) (Order Approving SR-NASD-2006-091).


      Attachment A

      Below is the text of the rule change. New language is underlined; deletions are in brackets

      * * * * *

      9200. DISCIPLINARY PROCEEDINGS

      * * * * *

      IM-9216. Violations Appropriate for Disposition Under Plan Pursuant to SEC Rule 19d-1(c)(2)

      Any member of FINRA that is also a member of the New York Stock Exchange LLC ("NYSE") ("Dual Member") (including any persons affiliated with such member) may be subject to a fine under NASD Rule 9216(b) with respect to any rule listed in this IM-9216 that applies to such member or person. However, any Dual Member that was not also a member of NASD as of July 30, 2007 and that does not engage in any activities that would have required it to be an NASD member (and its affiliated persons that are not otherwise subject to NASD rules) shall only be subject to a fine under NASD Rule 9216(b) with respect to the following rules listed in this IM-9216: any NYSE rule, SEC Exchange Act rule, NASD By-Law or Schedule to the By-Laws, or the NASD Rule 8000 Series.

      Any member of FINRA that is not also a member of the NYSE (and its associated persons that are not otherwise subject to NYSE rules) may be subject to a fine under NASD Rule 9216(b) with respect to any rule listed in this IM-9216, with the exception of the NYSE rules.

      • NASD Rules 2210, 2211, and 2220, and IM-2210-1, -2210-2, -2210-3, -2210-4, -2210-5, -2210-7, and -2210-8—Communications with the public.
      • NASD Rule 3360—Failure to timely file reports of short positions on Form NS-1.
      • NASD Rule 3110—Failure to keep and preserve books, accounts, records, memoranda, and correspondence in conformance with all applicable laws, rules, regulations and statements of policy promulgated thereunder, and with NASD Rules.
      • NASD Rules 8211[, Rule 8212,] and [Rule] 8213—Failure to submit trading data as requested.
      • Article IV of the NASD By-Laws—Failure to timely submit amendments to Form BD.
      • Article V of the NASD By-Laws—Failure to timely submit amendments to Form U4.
      • Article V of the NASD By-Laws—Failure to timely submit amendments to Form U5.
      • NASD Rule 1120—Failure to comply with the Firm Element of the continuing education requirements.
      • NASD Rule 3010(b)—Failure to timely file reports pursuant to the Taping Rule.
      • NASD Rule 3070—Failure to timely file reports.
      • [—Rule 4619(d)—Failure to timely file notifications pursuant to SEC Regulation M.]
      • NASD Rules 4632, [4642, 4652,]4632A, [5430,]6130, 6170, 6130A, 6170A, 6230, [6420,]6550, and 6620[, and 6720]—Transaction reporting in equity and debt securities.
      • NASD Rules 6954 and 6955—Failure to submit data in accordance with the Order Audit Trail System ("OATS").
      • NASD Rule 11870—Failure to abide by Customer Account Transfer Contracts.
      • Failure to provide or update contact information as required by NASD Rules.
      • SEC Exchange Act Rule 604—Failure to properly display limit orders.
      • SEC Exchange Act Rule 602(b)(5)—Failure to properly update published quotations in certain Electronic Communication Networks ("ECNs").
      • SEC Exchange Act Rule 17a-5—Failure to timely file FOCUS reports and annual audit reports.
      • SEC Exchange Act Rule 17a-10—Failure to timely file Schedule I.
      • MSRB Rule A-14—Failure to timely pay annual fee.
      • MSRB Rule G-12—Failure to abide by uniform practice rules.
      • MSRB Rule G-14—Failure to submit reports.
      • MSRB Rule G-36—Failure to timely submit reports.
      • MSRB Rule G-37—Failure to timely submit reports for political contributions.
      • MSRB Rule G-38—Failure to timely submit reports detailing consultant activities.
      • NYSE Rule 134(c) and (e)—Failure to comply with specified QT procedures and time periods.
      • NYSE Rules 312(a), (b) & (c), 313, 345.12, 345.17, 346(c), 351, 421, and 440F & G—Reporting rule violations.
      • NYSE Rules 345.11, 410, 432(a), 440, 440I, and 472(c)—Record retention rule violations.
      • NYSE Rules 312(h) & (i), 342(c), 342.10, 346(e) and (f), 382(a), and 791(c)—Failure to obtain approval rule violations.
      • NYSE Rules 342(b), (d) & 342.13, 311(b)(5), and 344—Failure of a member organization to have individuals responsible and qualified for the positions of Financial Principal, Operations Principal, Compliance Official, Branch Office Manager and Supervisory Analyst.
      • NYSE Rule 343—Requirements relating to member organization office sharing arrangements.
      • NYSE Rule 345(a)—Failure of a member organization to have individuals responsible and qualified for the positions of Securities Lending Supervisor and Securities Trader Supervisor.
      • NYSE Rule 346(b)—Failure to obtain employer's prior written consent for engaging in an outside activity.
      • NYSE Rule 352(b) and (c)—Guaranteeing a customer's account against loss or sharing in profits or losses.
      • NYSE Rule 387—Requirements for customer COD/POD transactions.
      • NYSE Rule 392—Notification requirements.
      • NYSE Rule 401A—Failure to acknowledge customer complaint within 15 business days.
      • NYSE Rule 407—Requirements for transactions of employees of the Exchange, members or member organizations.
      • NYSE Rule 407A—Reporting and notification requirements for members.
      • NYSE Rule 408(a)—Requirement that written authorization be obtained for discretionary power in a customer's account.
      • NYSE Rule 411(b)—Requirements to bundle multiple odd-lot orders in the same stock, which aggregate to 100 shares or more, to aggregate the orders into round-lot orders.
      • NYSE Rule 412 and the interpretations thereunder—Failure to transfer a customer securities account in accordance with requirements.
      • NYSE Rule 416A—Failure to promptly provide or promptly update required membership profile information through the Electronic Filing Platform ("EFP"), or failure to electronically certify that required membership profile information is complete and accurate.
      • NYSE Rule 445(4)—Failure to designate and identify an Anti-Money Laundering contact person or persons.
      • NYSE Rules 704 and 705—Options position limits and exercise limits.
      • NYSE Rules 720 and 722(b)—Failure of a member organization to have individuals responsible and qualified for the positions of Registered Options Principal, Senior Registered Options Principal and Compliance Registered Options Principal.
      • NYSE Rule 726—Options disclosure document and prospectus delivery requirement violations.
      • NYSE Rule 780(b)(i)—Requirement for members and member organizations to indicate final decisions of holders of equity options either to exercise or not to exercise expiring equity options by a specific time.
      • NYSE Rule 780(f)—Requirement for members and member organizations to make, keep and file with the Exchange records concerning final exercise decisions made with respect to options in certain circumstances.
      • NYSE Rule 780.10(b)—Requirement to deliver "exercise advice".
      • NYSE Rule 781—Allocation of exercise assignment notice violations.

      * * * * *

    • 07-50 SEC Approves Amendments to NASD Rule 11870 and NYSE Rule 412 to Conform with NSCC's ACATS Transfer Cycle Time Frames; Effective Date: October 22, 2007

      View PDF File

      ACATS Transfer Cycle

      Regulatory Notice

      Notice Type



      Rule Amendment
      Referenced Rules & Notices

      NASD Rule 11870
      NSCC Important Notice A#6515 (P&S#6085)
      NYSE Rule 412
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Key Topic(s)

      Automated Customer Account Transfer Service (ACATS)
      Customer Account Transfer Contracts
      National Securities Clearing Corporation (NSCC)

      Executive Summary

      The SEC approved amendments to NASD Rule 11870 and NYSE Rule 412 to make the time frames in the rules for validating or taking exception to an instruction to transfer a customer's securities account assets and for completing the transfer of the assets consistent with the time frames in the NSCC Automated Customer Account Transfer Service (ACATS) transfer cycle.1

      As further discussed in this Notice, effective October 22, 2007, NSCC modified its rules to shorten the account transfer time frame with respect to certain types of transfers.2

      NASD Rule 11870 and NYSE Rule 412, as amended, are set forth in Attachment A. The amendments became effective on October 22, 2007.

      Questions concerning this Notice should be directed to:

      •  Rachael Grad, Counsel, Office of General Counsel, at (202) 728-8290 (with respect to NASD Rule 11870).
      •  Stephen Kasprzak, Principal Counsel, Risk Oversight and Operational Regulation, at (212) 656-5226 (with respect to NYSE Rule 412).

      Background and Discussion

      NASD Rule 11870 and NYSE Rule 412 regulate the transfer of customer accounts from one member (the carrying firm) to another (the receiving firm). Such transfers generally occur through ACATS, an electronic transfer system the National Securities Clearing Corporation (NSCC) developed to automate and standardize account transfers. The rule amendments make the time frames in NASD Rule 11870 and NYSE Rule 412 consistent with the time frames that NSCC established in ACATS.

      Members are advised that, effective October 22, 2007, NSCC modified its rules to shorten the account transfer time frame with respect to certain types of ACATS transfers. The current NSCC time frames are addressed in NSCC Important Notice A#6515 (P&S#6085) (October 18, 2007) http://www.dtcc.com/downloads/legal/imp_notices/2007/nscc/a6515.pdf, and NSCC Important Notices cited therein. NASD Rule 11870 and NYSE Rule 412, as amended, reflect NSCC's recent changes by eliminating two of the three business days previously allowed for validating or taking exception to transfer requests.

      NASD Rule 11870 and NYSE Rule 412 will change if and when NSCC further modifies the account transfer time frames in the future. FINRA will announce any such changes in those time frames to its members in a Regulatory Notice and other appropriate communications.


      1 See Securities Exchange Act Release No. 56677 (October 19, 2007), 72 FR 60699 (October 25, 2007) (Order Granting Approval of a Proposed Rule Change Relating to NASD Rule 11870 (Customer Account Transfer Contracts) and NYSE Rule 412 (Customer Account Transfer Contracts) to Make the Time Frames in the Rules for Validating or Taking Exception to an Instruction to Transfer a Customer's Securities Account Consistent with the Time Frames in the Automated Customer Account Transfer Service; File No. SR-FINRA-2007-005).

      2 See Securities Exchange Act Release No. 56678 (October 19, 2007) 72 FR 60701 (October 25, 2007) (Order Granting Approval of a Proposed Rule Change to Amend its Rules and Procedures with Regard to the Automated Customer Account Transfer Service (ACATS) and ACATS Fund/SERV Processing; File No. SR-NSCC-2007-13).


      Attachment A

      Below is the text of the rule change. New language is underlined; deletions are in brackets.

      * * * * *

      11000. UNIFORM PRACTICE CODE

      * * * * *

      11870. Customer Account Transfer Contracts

      (a) No Change
      (b) Transfer Procedures
      (1) Upon receipt from the customer of an authorized broker-to-broker transfer instruction form ("TIF") to receive such customer's securities account assets in whole or in specifically designated part, from the carrying member, the receiving member must immediately submit such instruction to the carrying member. The carrying member must, within [three] one business day[s] following receipt of such instruction, or receipt of a TIF received directly from the customer authorizing the transfer of assets in specifically designated part: (A) validate the transfer instruction to the receiving member (with an attachment reflecting all positions and money balances to be transferred as shown on its books); or (B) take exception to the transfer instruction for reasons other than securities positions or money balance discrepancies and advise the receiving member of the exception taken. The time frame(s) set forth in this paragraph will change, as determined from time-to-time in any publication, relating to the ACATS facility, by the National Securities Clearing Corporation (NSCC).
      (2) No Change.
      (c) and (d) No Change.
      (e) Completion of the Transfer

      Within three business days following the validation of a transfer instruction, the carrying member must complete the transfer of the customer's security account assets to the receiving member. The receiving member and the carrying member must immediately establish fail-to-receive and fail-to-deliver contracts at then-current market values upon their respective books of account against the long/short positions that have not been delivered/received and the receiving/carrying member must debit/credit the related money amount. The customer's security account assets shall thereupon be deemed transferred. The time frame(s) set forth in this paragraph will change, as determined from time-to-time in any publication, relating to the ACATS facility, by the NSCC.
      (f) through (n) No Change.

      * * * * *

      Rule 412. Customer Account Transfer Contracts

      (a) No Change.
      (b)
      (1) Upon receipt from the customer of an authorized broker-to-broker transfer instruction form ("TIF") to receive such customer's securities account assets in whole or in specifically designated part, the receiving organization will immediately submit such instruction to the carrying organization. The carrying organization must, within [three (3)] one business day[s] following receipt of such instruction, or receipt of a TIF received directly from the customer authorizing the transfer of assets in specifically designated part: (i) validate the transfer instruction (with an attachment reflecting all positions and money balances to be transferred as shown on its books) to the receiving organization or (ii) take exception to the transfer instruction for reasons other than securities positions or money balance discrepancies and advise the receiving organization of the exception taken. The time frame(s) set forth in this paragraph will change, as determined from time-to-time in any publication, relating to the ACATS facility, by the National Securities Clearing Corporation (NSCC).
      (2) No Change.
      (3) Within three [(3)] business days following the validation of a transfer instruction, the carrying organization must complete the transfer of the customer's securities account assets to the receiving organization. The carrying organization and the receiving organization must establish fail to receive and fail to deliver contracts at then current market values upon their respective books of account against the long/short positions (including options) that have not been delivered/received and the receiving/carrying organization must debit/credit the related money amount. The customer's securities account assets shall thereupon be deemed transferred. The time frame(s) set forth in this paragraph will change, as determined from time-to-time in any publication, relating to the ACATS facility, by the NSCC.
      (c) through (f) No Change.

      Supplementary Material .10 through .30 No Change.

      * * * * *

    • 07-49 Guidance for Firms Affected by the California Wildfires

      View PDF File

      Regulatory Relief

      PLEASE NOTE: The FINRA rulebook currently consists of both NASD Rules and certain NYSE Rules that FINRA has incorporated, including the NYSE rules referenced in this Notice. The incorporated NYSE Rules apply solely to members of FINRA that are also members of NYSE on or after July 30, 2007, referred to as "Dual Members." Dual Members also must comply with NASD Rules. Until the adoption of a consolidated rulebook, FINRA's Regulatory Notices will address both NASD and the incorporated NYSE Rules.

      Regulatory Notices

      Notice Type



      Guidance
      Referenced Rules & Notices

      NASD IM-1000-2
      NASD Rule 3010
      NASD Rule 3012
      NASD Rule 3110
      NYSE Rule 342 and Rule 342.23
      NYSE Rule 342.10
      NYSE Rule 343
      NYSE Rule 345(a), Interpretation /03
      NYSE Rule 401(b)
      NYSE Rule 440
      Suggested Routing

      Compliance
      Executive Representative
      Senior Management
      Institutional
      Internal Audit
      Legal
      Operations
      Registration
      Systems
      Key Topic(s)

      Books and Records
      Business Continuity
      Continuing Education
      Customer Communication
      Customer Funds and Securities
      Credit Regulation
      Disaster Recovery
      Emergency Office Relocation
      Form U4
      Military Personnel & National Guard
      Margin Extension Process

      Executive Summary

      In light of the tragic situation resulting from the recent California wildfires, FINRA wants to assure those firms with offices in the affected areas that we will work closely with you as you recover. While we recognize your first priority is the well being of your family, employees and customers, we also understand that some firms are concerned with a number of regulatory and compliance issues. In this regard, FINRA is providing guidance on a variety of topics, including emergency office relocations, continuing education requirements for registered personnel, registered personnel engaged in military duty, books and records, the handling of customers' funds and securities and customer communication.

      Questions or comments concerning this Notice may be directed to:

      •  William Jannace, Managing Director, Risk Oversight and Operational Regulation, at (212) 656-2744;
      •  Patricia Albrecht, Assistant General Counsel, Office of General Counsel, at (202) 728-8026; or
      •  Daniel M. Sibears, Executive Vice President, Member Regulation Programs, at (202) 728-6911.

      Discussion

      Emergency Office Relocations

      To relocate displaced personnel, member firms not impacted by the California wildfires are encouraged to make office space available and to otherwise assist those who have been recently displaced. If a firm relocates displaced personnel to a location not currently registered as a branch office or identified as a regular nonbranch location, firms should use their best efforts to provide written notification to FINRA as soon as possible after establishing a new temporary office or space-sharing arrangement that includes, at minimum:

      •  the office address,
      •  the entities involved,
      •  the names of registered personnel,
      •  a contact phone number,
      •  the expected duration,1 if possible, and
      •  whether any space-sharing arrangements are with an organization in a securities or related business.

      FINRA also will not require Dual Members to obtain prior approval pursuant to Rule 343 (Offices-Sole Tenancy, Hours, Display of Membership Certificates) for a temporary office or space-sharing arrangement (i.e., arrangements with an expected duration of 90 calendar days or less).

      All firms making temporary office arrangements, however, should remain mindful of the need for proper supervision of these locations.2

      Form U4

      The requirement to maintain updated Form U4 information (e.g., office of employment address) for registered employees affected by relocations resulting from this event are temporarily suspended. In addition, it is not necessary to submit branch office applications for any newly opened temporary office locations or space-sharing arrangements established as a result of recent events.

      Books and Records Maintained at the Affected Locations

      Firms that maintained books and records at the affected locations should make every effort to retrieve or back up such records. If any such records were permanently destroyed, a list of the types of books and records required to be maintained pursuant to NASD Rule 3110 (Books and Records) and Exchange Act Rules 17a-33 and 17a-44—and, for Dual Members only, NYSE Rule 440 (Books and Records)—must be prepared. The list should include the time periods affected, but need not include records that can be recreated from an electronic database or that can be retrieved otherwise from a service bureau, back-up records storage facility, etc. All such lists must be submitted to the firm's Liaison or Finance Coordinator as soon as possible, but no later than December 31, 2007. Firms unable to meet this time frame must contact their Liaison or Finance Coordinator, as appropriate.

      Customer Funds and Securities

      As soon as possible, firms should determine the dollar amount of any customer checks or securities held at affected business offices that cannot be located or accounted for. This information should be provided, in writing, to your Liaison or Finance Coordinator. In areas where postal service has been suspended or the firm is concerned about a customers' ability to receive mail, FINRA will not object to interim solutions for dealing with customer dividend, interest and similar cash payments. See the U.S. Postal Service Web site for further information on areas with disrupted or suspended mail service at: www.usps.com/communications/news/serviceupdates.htm#ca.

      In instances where a branch office or nonbranch location has been relocated or customer calls are being rerouted to another office, FINRA understands that firms may need to deviate from standard operating procedures to accommodate customers who need to access their funds. Procedures that generally require written letters of authorization to move funds or direct a check to a third-party address may, at the firm's discretion, be waived, but firms should exercise as much due diligence as possible in validating the identity of the customer and providing heightened overall supervision of these accounts. Validating the identity of customers remains each firm's responsibility.

      Where changes to normal operations are needed, those should be taken into account by firms in fulfilling their obligations to review their supervisory control policies and procedures. When conducting that review, members should ensure that the policies and procedures relating to the transmittal of customer funds, customer changes of address and increased requests for hand delivery of checks are adequate after considering changes to normal operations. Supervisory control policies and procedures also should be considered that will mitigate risk that may arise due to reduced ability to communicate with customers, inability to rely on mail or other disruptions to the existing controls. Please consult NASD Rule 3012 (Supervisory Control System) for further guidance. Dual Members should also consult NYSE Rule 342.23 (Approval, Supervision and Control) and NYSE Rule 401(b) (Business Conduct).

      Firms that clear for introducing firms unable to conduct business are encouraged to accept liquidating orders from customers so that customers' access to funds is not restricted. Additionally, member firms that participate in FINRA's recently developed Small Firm Emergency Partner Program (SFEPP) may wish to invoke those arrangements. If they do, those firms should remember to contact their pre-established partner firm during this significant business disruption to assist customers in accessing their funds and other assets through liquidating transactions, and if previously agreed to by the two firms, effecting certain types of purchases, such as purchasing money market funds. Member firms with general questions regarding the SFEPP can access information on FINRA's Web site at www.finra.org/sfepp.

      Continuing Education and Qualification Examinations

      FINRA is extending continuing education requirements and qualifications examination windows for candidates who reside in any county in California declared a "major disaster" by the federal government. Registered representatives who have a qualifications examination or continuing education window due to expire any time from the date of this Notice to the end of November will have their windows extended to December 31, 2007. As more information becomes available, additional extensions may be provided. Please contact FINRA Field Support Services at (800) 999-6647 if you have any questions or require additional information on test center status in these areas.

      Credit Regulation

      FINRA will be accepting margin extensions on a case-by-case basis for reason code "Acts of God" for customers located in regions affected by the wildfires. Please contact Financial Operations at (202) 728-8411 prior to transmission. Dual Members should contact the Credit Regulation Department at (212) 656-8572 prior to transmission.

      Confirmations and Customer Statements

      FINRA will not object to member firms holding confirmations, statements and other communications or notices on behalf of those customers located in the affected areas for a period not to exceed 90 calendar days or until further notice. Firms must exercise appropriate supervisory review of the accounts affected, maintain a log of those accounts for which mail is being held and notify the customer holding those accounts that those communications are being held on their behalf as soon as possible. If additional time is required beyond 90 calendar days, please contact your Liaison or Finance Coordinator.

      Customer Communication

      Firms are encouraged to promptly place a notice on their Web sites that indicates to affected customers whom they may contact concerning their accounts, access to funds or securities, etc. If feasible, firms should consider the activation of toll-free numbers dedicated to responding to these customers.

      Business Continuity and Contingency Plans

      Firms affected by the California wildfires should contact their Liaison or Finance Coordinator to discuss those business continuity and contingency plan actions implemented to address any problems that have resulted.

      Military Personnel and National Guard

      FINRA By-Laws, as well as NASD Interpretive Material 1000-2 (Status of Persons Serving in the Armed Forces of the United States) and NYSE Rule 345(a), Interpretation /03 (Registered Persons Who Volunteer or Are Called to Active Military Duty) (Dual Members only), provide specific relief to FINRA-registered persons engaged in the investment banking and securities business who volunteer or are called into active military duty. Such persons will be placed in a specially designated "inactive" status once FINRA is notified of their military call-up, but will remain registered for FINRA purposes. Such persons will remain eligible to receive transaction-related compensation, including continuing commissions, because they remain registered with a firm while on inactive status.

      Also, an employing firm may allow a registered person on inactive status to enter into an arrangement with another person registered with the employing firm to service his or her accounts and to share in commissions generated by those accounts. However, such a person on inactive status may not perform any duties of a registered person. In addition, dues and assessments identified in Article VI of the FINRA By-Laws will be waived for such persons. Member firms should notify FINRA of such events by mailing or faxing to the Registration and Disclosure Department a letter (on firm letterhead) identifying the name and CRD number of the person called into active duty, the name and CRD number of the firm (or firms) with whom the person is associated, the date the firm received notification from the individual and a copy of the official call-up notification. Member firms should mail letters notifying FINRA of military call-ups to FINRA Registration and Disclosure Department, P.O. Box 9495, Gaithersburg, MD 20898-9495 or fax them to (240) 386-4751.

      If you have questions about this process, please call the Gateway Call Center at (301) 590-6500. For more information, view FINRA's Active Military Leave Guidance Web page at www.finra.org/RegulatorySystems/CRD/FilingGuidance/p005228.


      1 A temporary location established in response to the implementation of a business continuity plan is not considered to be a branch office, as that term is defined in NASD Rule 3010(g)(2(A)(vii) and NYSE Rule 342.10(G) (Definition of Branch Office) unless the location supervises one or more non-branch locations. See NASD Rule 3010(g)(2)(B); NYSE Rule 342.10.

      2 See generally NASD Rule 3010; NYSE Rules 342.

      3 See 17 C.F.R. 240.17a-3.

      4 See 17 C.F.R. 240.17a-4.

    • 07-48 Broker-Dealer, Investment Adviser Firm, Agent and Investment Adviser Representative, and Branch Renewals for 2008; Payment Deadline: December 10, 2007

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      B-D and IA Renewals for 2008

      Payment Deadline: December 10, 2007

      Regulatory Notice
      Notice Type

      Renewals
      Referenced Rules & Notices

      NTM 02-48
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Registration
      Senior Management
      Key Topics

      CRD®
      Renewals
      Registration
      IARDSM

      Executive Summary

      The 2008 registration renewal process begins on November 5, 2007 when online Preliminary Renewal Statements are made available to all firms on Web CRD/IARD.

      Firms should note the following key dates in the 2008 renewal process:

      October 22, 2007 Firms may start submitting post-dated Forms U5 and BR Closing/Withdrawal filings via Web CRD.
      November 1, 2007 Firms may start submitting post-dated Forms BDW via Web CRD, as well as Forms ADV-W via IARD.

      Post-dated filings that are submitted by 11 p.m., Eastern Time (ET) November 2, 2007 will not appear on the firm's Preliminary Renewal Statement. December 31, 2007 is the only date that can be used for a post-dated termination filing.
      November 5, 2007 Preliminary Renewal Statements are available on Web CRD.
      December 10, 2007 Full payment of Preliminary Renewal Statements is due.
      January 2, 2008 Final Renewal Statements are available on Web CRD.

      Member firms are advised that failure to return full payment of their Preliminary Renewal Statement to FINRA by December 10, 2007 could cause the firm to become ineligible to do business in the jurisdictions where they are registered effective January 1, 2008.

      In addition to this Notice, firms should review the instructions posted at www.finra.org/renewals, especially the 2008 Renewal Program Bulletin, the 2008 IARD Renewal Program Bulletin (if applicable) on the Investment Adviser Web site at www.iard.com/renewals.asp, and any mailed information to ensure continued eligibility to do business as of January 1, 2008.

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

      Background & Discussion

      Preliminary Renewal Statements

      Beginning November 5, 2007, Preliminary Renewal Statements will be available for viewing and printing on Web CRD. The statements will include the following fees:

      •  Web CRD system processing fees;
      •  FINRA branch office fees;
      •  FINRA branch renewal processing fees;
      •  American Stock Exchange (AMEX), Boston Stock Exchange (BSE), Chicago Board Options Exchange (CBOE), International Securities Exchange (ISE), NASDAQ Stock Exchange (NQX), New York Stock Exchange (NYSE), NYSE Arca, Inc. (ARCA) and Philadelphia Stock Exchange (PHLX) maintenance fees;
      •  state agent renewal fees;
      •  state BD renewal fees;
      •  state BD branch fees
      •  investment adviser firm and representative renewal fees, if applicable; and
      •  broker-dealer and/or investment adviser branch renewal fees.

      FINRA must receive full payment of the Preliminary Renewal Statement fees no later than December 10, 2007.

      If payment is not received by the December 10, 2007 payment due date, firms will be assessed a Renewal Payment Late Fee. This late fee will be included as part of the firm's Final Renewal Statement and will be calculated as follows: 10 percent of a member firm's cumulative final renewal assessment or $100, whichever is greater, with a cap of $5,000. Please see NTM 02-48 for details. Firms also risk failing to renew if fees are not received in time.

      Fees

      A fee of $30 will be assessed for each person who renews his/her registration with any regulator through Web CRD. Firms can access a listing of agents for whom their firm will be assessed by requesting the Renewals—Firm Renewal Roster.

      For 2008, any investment adviser fees that are assessed for state-registered investment adviser firms and investment adviser representatives (RA) by the North American Securities Administrators Association (NASAA) that renew through the IARD Program will be also be included on the Preliminary Renewal Statement.

      The FINRA branch office assessment fee of $75 per branch, based on the number of active FINRA branches as of December 31, 2007, will be assessed. One branch office assessment fee will be waived per firm.

      The FINRA branch renewal processing fee of $20 per branch, based on the number of active FINRA branches as of December 31, 2007, will be assessed. One branch renewal processing fee will be waived per firm.

      FINRA personnel assessment fees are not assessed through the FINRA Renewal Program. FINRA will mail all FINRA member firms a separate billing for this fee. Firms can access a listing of agents for whom the firm will be assessed the personnel assessment fee by requesting the Renewals—Firm Renewal Roster.

      Renewal fees for AMEX, ARCA, BSE, CBOE, ISE, NQX, NYSE, PHLX and state registrations are also assessed on the Preliminary Renewal Statement. These fees are based on the number of registered personnel employed in each SRO/jurisdiction by the member firm.

      Branch office renewal fees will also be collected for those regulators who choose to renew branches registered with them via Web CRD/IARD.

      Some participating jurisdictions may require steps beyond the payment of renewal fees to FINRA to complete the broker-dealer or investment adviser renewal process. Firms should contact each jurisdiction directly for further information on state renewal requirements. A Regulator Directory can be found at www.nasaa.org/QuickLinks/ContactYourRegulator.cfm.

      For detailed information regarding 2008 investment adviser renewals, you may also visit the investment adviser Web site, www.iard.com. A matrix of investment adviser renewal fees for states that participate in the 2008 IARD Renewal Program is posted at www.iard.com/pdf/rep_fee_sch.pdf.

      Renewal Payment

      Firms have four payment methods available to pay 2008 renewal fees:

      •  New for 2008: Automatic Daily-to-Renewal Account Transfer
      •  Web CRD/IARD E-Pay
      •  Check
      •  Wire transfer

      Automatic Daily-to-Renewal Account Transfer

      To facilitate Renewal payment processing for all firms, FINRA will automatically transfer funds from a firm's Daily Account to its Renewal Account on December 10, 2007, the Preliminary Renewal Statement payment deadline. FINRA will transfer funds only if a firm has sufficient funds available in its Daily Account on December 10 to cover the amount. Please Note: If a firm does not want funds automatically transferred from its Daily Account to its Renewal Account, the firm should ensure that its payment is received in its Renewal Account by the December 10 deadline. Separately, if a firm wishes to transfer funds between affiliated firms, the firm should contact the Gateway Call Center at (301) 869-6699 for further instructions prior to the renewal deadline.

      Web CRD/IARD E-Pay

      The Web CRD/IARD E-Pay application is accessible from both the Preliminary and Final Renewal Statements and the FINRA (www.finra.org/crd) or IARD (www.iard.com) Web sites and allows firms to make an ACH payment from a designated bank account to their Web CRD/IARD Renewal Account. Please note that in order for funds to be posted to your firm's Renewal Account by December 10, 2007, payment must be submitted electronically no later than 8:30 p.m. ET on December 6, 2007.

      Check

      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 "Renewal" in the memo line. Firms should mail their renewal payment, along with a print-out of the first page of their online renewal statement, directly to:

      U.S. Mail or Express/Overnight Delivery
      FINRA
      P.O. Box 7777-8705
      Philadelphia, PA 19175-8705
      (Note: This box will not accept courier or overnight deliveries.)
      FINRA
      8705
      Mellon Bank Room 3490
      701 Market Street
      Philadelphia, PA 19106
      Telephone: (301) 869-6699

      Member firms should use the blue, pre-addressed renewal payment envelope that they are scheduled to receive in early November, or should use the full address, as noted above, to ensure prompt processing.

      Please note: The addresses for renewal payments are different than the addresses for funding firms' 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 "Renewal" on the check memo line.
      •  Be sure to send your payment either in the pre-addressed renewal payment envelope that will be mailed to you or write the address on the envelope exactly as noted above.

      Wire Payment

      Firms may wire full payment of the Preliminary Renewal Statement by requesting their bank to initiate the wire transfer to: "Mellon Financial, Philadelphia, PA." Firms should provide their bank the following information:

      Transfer funds to: Mellon Financial, Philadelphia, PA
      ABA Number: 031 000 037
      Beneficiary: FINRA
      FINRA Account Number: 8-234-353
      Reference Number: Firm CRD number and "Renewal"

      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 FINRA bank account.
      •  Provide the firm's CRD number and "Renewal" as reference only.
      •  Record the confirmation number of the wire transfer provided by the bank.

      Renewal Reports

      Beginning November 5, 2007, the renewal reports will be available to request, print and/or download via Web CRD. Three reports/downloads are available for reconciliation with the Preliminary Renewal Statement:

      •  Firm Renewal Report—applicable to broker-dealer and investment adviser firms.This report lists individuals included in the 2008 Renewal Program processing and includes billing codes (if they have been supplied by the firm).
      •  Branches Renewal Report—applicable to broker-dealer and investment adviser firms. This report lists each branch registered with FINRA, and/or with any other regulator that renews branches registered with the regulator through Web CRD/IARD and 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 FINRA Approval Report—applicable to FINRA member firms. This report contains all individuals who are not registered with FINRA 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 as soon as possible to determine if any FINRA registrations need to be requested or jurisdictions terminated prior to renewal processing for the Preliminary Renewal Statement available on November 5. Note that any post-dated termination filings submitted by 11 p.m. ET on November 2, 2007, will not appear on the firm's Preliminary Renewal Statement.

      Post-Dated Form Filings

      This functionality allows firms to file a termination form with a termination date of December 31, 2007. If a Form U5, BDW, BR Closing/Withdrawal or ADV-W indicates a termination date of December 31, 2007, an agent (AG), broker-dealer and/or investment adviser (firm) and investment adviser representative (RA) may continue doing business in the jurisdiction until the end of the calendar year without being assessed 2008 renewal fees. December 31, 2007 is the only date that can be used for a post-dated form filing.

      Firms can begin electronically filing post-dated Forms U5 and BR Closing/Withdrawal via Web CRD on October 22, 2007. Firms can begin electronically filing post-dated Forms BDW and ADV-W via Web CRD/IARD on November 1, 2007. Firms that submit post-dated termination filings by 11 p.m. ET, on November 2, 2007 will not be assessed renewal fees for the terminated registrations on their Preliminary Renewal Statement. Firms that submit post-dated termination filings on, or after, November 5, 2007, will not be assessed renewal fees for the terminated jurisdictions on the Final Renewal Statement in January 2008. Those firms should see a credit balance on their Final Renewal Statement if the firm has not requested additional registrations during that time period to offset the credit balance.

      Firms should query individual, branch and/or firm registrations after a termination filing has been submitted to ensure that electronic Forms U5, BDW, BR Closing/ Withdrawal and ADV-W are reflected on the system by the renewal filing deadline date of 6 p.m. ET on December 21, 2007.

      Firms should exercise care when submitting post-dated Forms U5, BDW, BR Closing/ Withdrawal and ADV-W. FINRA will systematically process these forms as they are submitted and cannot withdraw a post-dated termination once submitted and processed. A firm that files a post-dated termination in error will have to file a new Form U4, BD Amendment, Form BR or Form ADV when Web CRD/IARD resumes filing processing on January 2, 2008. New registration fees would be assessed as a result.

      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 p.m. ET November 2, 2007 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 only four regulators that participate in Web CRD renewals for agent fees, but do not participate in CRD Phase II:

      •  American Stock Exchange
      •  Chicago Stock Exchange
      •  National Stock Exchange
      •   NYSE Arca, Inc.
      •  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 2007 is 6 p.m. ET December 21, 2007. This same date appliesto the filing of Forms BDW with regulators that are not Phase II participants.

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

      Firms that file either a Form ADV Amendment, unmarking a state (generating the status of "Removal Requested at End of Year") or a full or partial Form ADV-W by 11 p.m. ET November 2, 2007 will avoid the assessment of the applicable renewal fees on their Preliminary Renewal Statement.

      The deadline for electronic filing of Form ADV Amendments or Forms ADV-W for firms that want to cancel a notice filing or terminate a state registration before year-end 2007 is 6 p.m. ET December 21, 2007.

      Removing Open Registrations

      Throughout the year, firms have access to the "Approved AG Reg Without FINRA Approval" Report via Web CRD. This report identifies agents whose FINRA 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 still 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 reinstate the FINRA 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 as soon as possible. Requesting this report will enable firms to identify individuals who can be terminated by November 2, 2007 to avoid being charged for those individuals on their Preliminary Renewal Statement. The Approved AG Reg Without FINRA Approval Report will also advise a firm if there are no agents at the firm within this category.

      Final Renewal Statements

      Beginning January 2, 2008, FINRA 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, 2007. 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/IARD.

      •  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. Please note that overpayments will be systemically transferred to firms' Daily Accounts as of January 2, 2008. Firms that have a credit (sufficient) balance in their Daily Account may request a refund by mailing or faxing a written request signed by the designated signatory to the Finance Department, 9509 Key West Avenue, Rockville, MD 20850, (301) 869-6699, fax number: (240) 386-5344. The request should include a printout of the firm's credit balance as reflected on Web CRD.

      On or after January 2, 2008, FINRA member firms and joint BD/IA firms should access the Web CRD Reports functionality for the Firm Renewal Report, which will list all renewed personnel with FINRA, AMEX, ARCA, BSE, CBOE, ISE, NQX, NYSE, PHLX, and each jurisdiction. Agents and RAs whose registrations are "approved" in any of these jurisdictions during November and December will be included in this roster. Registrations that are "pending approval" or are "deficient" at year's end will not be included in the 2008 Renewal Program. Firms will also be able to request the Branches Renewal Report that lists all branches for which they have been assessed renewal fees. Versions of these reports will also be available for download.

      Firms have until February 4, 2008 to report any discrepancies on the renewal reports. This is also the deadline for receipt of final payment. Specific information and instructions concerning the Final Renewal Statement and renewal reports will be available in a January 2008 Regulatory Notice.

    • 07-47 Amendments to NASD IM-2210-4: Web Site References to FINRA Membership and Limitations on the Use of FINRA's Name and Other Corporate Names Owned by FINRA; Effective Date: November 17, 2007

      View PDF File

      FINRA Web Site References

      Regulatory Notice

      Notice Type



      Rule Amendment
      Referenced Rules & Notices

      NTM 07-02
      NASD IM-2210-4
      NASD Rule 2210
      Suggested Routing

      Advertising
      Compliance
      Legal
      Operations
      SeniorManagement
      Key Topics

      Hyperlink Requirement
      Use of FINRA name and FINRA-owned corporate names
      Web site reference to FINRA membership

      Executive Summary

      Effective November 17, 2007, member firms and persons associated with a member firm that refer to their FINRA membership on a Web site are required to provide a hyperlink to www.finra.org. Certain limits to the use of FINRA's name and any other corporate name owned by FINRA (including NASD) also become effective on this date.

      IM-2210-4, as amended, is set forth in Attachment A. The amendments become effective on November 17, 2007.

      Questions concerning this Notice should be directed to Gary L. Goldsholle, Vice President and Associate General Counsel, Office of General Counsel, at (202) 728-8104; or Rachael Grad, Counsel, Office of General Counsel, at (202) 728-8290.

      Background & Discussion

      "Hyperlink Requirement"

      Previously, FINRA amended IM-2210-4 to establish a requirement for member firms and persons associated with a member that refer to their membership in NASD on a Web site to hyperlink to NASD's home page, www.nasd.com ("the hyperlink requirement").1 The rule change was scheduled to take effect on July 7, 2007.2 In view of the fact that NASD was changing its corporate name, NASD delayed the implementation of the hyperlink requirement until its new corporate name and Internet domain could be established.3

      On July 30, 2007, NASD changed its name to FINRA and changed its Internet domain from www.nasd.com to www.finra.org. On September 17, 2007, FINRA submitted proposed rule change SR-FINRA-2007-14 to amend IM-2210-4 to reflect the new corporate identity.

      The amendments to IM-2210-4 replace references to NASD with FINRA. Thus, member firms, or persons associated with a member firm, that refer to their FINRA membership on a Web site must provide a hyperlink to www.finra.org, instead of www.nasd.com.4 As discussed in NASD Notice to Members 07-02, firms are not required to refer to their FINRA membership on their Web sites. The hyperlink requirement applies only to the extent that a member firm or a person associated with a member firm chooses to represent on a Web site that the firm is a member of FINRA.

      A hyperlink to www.finra.org must be located in close proximity to any reference reasonably designed to draw the public's attention to FINRA membership. Since only one hyperlink to www.finra.org is required, member firms have the flexibility to place the hyperlink in close proximity to any FINRA reference, as long as it is reasonably designed to draw the public's attention to FINRA membership. Firms should note that IM-2210-4 also applies to a Web site relating to a firm's investment banking or securities business that is maintained by or on behalf of any person associated with the firm.5

      Use of FINRA-Owned Corporate Names

      The amendments to IM-2210-4 also limit the use of any other corporate name owned by FINRA, including NASD, the Trade Reporting and Compliance Engine (TRACE) and the Alternative Display Facility (ADF). Members can neither state nor imply in any communications with the public that FINRA (or any other corporate name or facility owned by FINRA) endorses, indemnifies or guarantees the member's business practices, selling methods, the class or type of securities offered, or any specific security.

      Finally, firms should note that the reference to the NASD By-Laws in IM-2210-4 has been updated to refer to the FINRA By-Laws, which were adopted on July 30, 2007.6


      1 See Securities Exchange Act Release No. 54740 (November 9, 2006); 71 FR 67184 (November 20, 2006); File No. SR-NASD-2006-073.

      2 See NASD Notice to Members 07-02 (January 2007).

      3 FINRA previously announced that it would file a separate rule change to amend IM-2210-4 to reflect its new corporate name. See Securities Exchange Act Release No. 56124 (July 24, 2007); 72 FR 42165 (August 1, 2007); File No. SR-NASD-2007-042 (Notice of Filing and Immediate Effectiveness of Proposed Rule Change to Delay the Implementation of NASD Interpretative Material 2210-4, which Requires Certain Member Firms to Provide a Hyperlink to http://www.nasd.com) (File No. SR-NASD-042).

      4 See File No. SR-NASD-2007-042.

      5 See NASD Notice to Members 07-02 (January 2007).

      6 Specifically, Article XV, Section 2 of the FINRA By-Laws now states: "No member shall use the name of the Corporation except to the extent that may be permitted by the Rules of the Corporation." The name of the Corporation is Financial Industry Regulatory Authority, Inc. See Securities Exchange Act Release No. 56146 (July 26, 2007); 72 FR 42190 (August 1, 2007); File No. SR-NASD-2007-053 (Notice of Filing and Order Granting Accelerated Approval of Proposed Rule Change Relating to the Restated Certificate of Incorporation of National Association of Securities Dealers, Inc.).


      ATTACHMENT A

      Below is the text of the rule change. New language is underlined; deletions are in brackets.

      * * * * *

      2210. COMMUNICATIONS WITH THE PUBLIC

      * * * * *

      IM-2210-4. Limitations on Use of FINRA's [NASD's] Name and Any Other Corporate Name Owned by FINRA

      Members may indicate [NASD] FINRA membership in conformity with Article XV, Section 2 of the [NASD] FINRA By-Laws in one or more of 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 FINRA, or any other corporate name or facility owned by FINRA, [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) No Change.
      (3) on a member's internet Web site provided that the member provides a hyperlink to [NASD's] FINRA's internet home page, [www.nasd.com] www.finra.org, in close proximity to the member's indication of [NASD] FINRA membership. A member is not required to provide more than one such hyperlink on its Web site. If the member's Web site contains more than one indication of [NASD] FINRA membership, the member may elect to provide any one hyperlink in close proximity to any reference reasonably designed to draw the public's attention to [NASD] FINRA membership. This provision also shall apply to an internet Web site relating to the member's investment banking or securities business maintained by or on behalf of any person associated with a member.

      * * * * *

    • 07-46 FINRA Requests Comment on Proposed Amendments to OTC Trade Reporting Requirements for Equity Securities; Comment Period Expires November 12, 2007

      View PDF File

      OTC Trade Reporting

      Regulatory Notice
      Notice Type

      Request for Comment
      Referenced Rules & Notices

      Compliance
      Legal
      Operations
      Senior Management
      Systems
      Trading
      Suggested Routing

      NASD Rules 4632, 4632A, 4632C and 4632E
      NASD Rule 6620
      Regulatory Notice 07-38
      Key topics

      Agency
      Alternative Display Facility
      OTC Reporting Facility
      Riskless Principal
      Trade Reporting
      Trade Reporting Facilities

      Comment Period Expires November 12, 2007

      Executive Summary

      FINRA is issuing this Notice to solicit comments from member firms and other interested parties on two proposals relating to OTC trade reporting requirements applicable to listed and unlisted equity securities.

      •  Trade Reporting Structure Proposal. FINRA is proposing to simplify and update the current market maker-based trade reporting structure and is seeking comment on alternative structures, such as, e.g., requiring the sell-side or executing party to report a trade in all cases, except where a trade is with a customer or non-member firm.
      •  Linking Proposal. FINRA is proposing to require firms to provide information sufficient to link tape and non-tape reports that are submitted to FINRA for the same overall transaction (e.g., riskless principal or agency where a firm is acting as agent on behalf of another member firm).

      These proposals are discussed in greater detail on the following pages.

      Action Requested

      FINRA encourages all interested parties to comment on the proposal. Comments must be received by November 12, 2007. Member firms and other interested parties can submit their comments using the following methods:

      •  Mailing comments in hard copy to the address below; or
      •  Emailing comments to pubcom@finra.org.

      To help FINRA process and review comments more efficiently, you should only use one method to comment on this proposal; however, if you wish to submit comments using more than one of the methods listed above, you should indicate that in the submissions.

      Comments sent by hard copy should be mailed to:

      Barbara Z. Sweeney
      Office of the Corporate Secretary
      FINRA
      1735 K Street, NW
      Washington, DC 20006-1506

      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 FINRA Web site. Generally, comments will be posted on the FINRA Web site one week after the end of the comment period.1

      Before becoming effective, a proposed rule change must be authorized for filing with the Securities and Exchange Commission (SEC) by the FINRA Board, and then must be approved by the SEC, following publication for public comment in the Federal Register.2

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

      Background & Discussion

      FINRA is soliciting comment on two proposals to amend over-the-counter (OTC) trade reporting requirements for equity securities transactions. For purposes of this Notice, the term "OTC trade reporting requirements" refers to the trade reporting rules relating to:

      (1) trades in NMS stocks, as defined in SEC Rule 600(b)(47) of Regulation NMS, effected otherwise than on an exchange that are reported to FINRA through the Alternative Display Facility (ADF) or a Trade Reporting Facility (TRF); and
      (2) trades in non-exchange-listed securities (e.g., OTCBB and Pink Sheet securities) that are reported to FINRA through the OTC Reporting Facility (ORF).

      Trade Reporting Structure Proposal

      Under current rules, the following trade reporting structure is in place: (1) in transactions between two market makers, the sell-side reports; (2) in transactions between a market maker and a non-market maker, the market maker reports; (3) in transactions between two non-market makers, the sell-side reports; and (4) in transactions between a member firm and either a non-member or customer, the member firm reports.3

      FINRA understands that this reporting structure can result in confusion, delays and double-reporting, as the parties to a trade attempt to determine which party has the trade reporting obligation. Today, a firm's status as a market maker may not always be apparent to the contra-party to a trade and, increasingly, firms' proprietary desks (other than their market making desks) are handling and executing transactions in equity securities.

      FINRA is soliciting comment on a proposal to create a simpler, more uniform trade reporting structure. FINRA's goal is to adopt an approach that will result in more accurate and timely trade reporting and make the trade reporting process less cumbersome for firms.

      One approach FINRA is considering is a sell-side reporting structure, whereby the sell-side to a transaction between member firms would always have the trade reporting obligation. In trades between a member firm and a customer (the term "customer" does not include a broker-dealer) or between a member firm and a non-member, the member firm would report the trade.

      A second approach FINRA is considering is an executing broker reporting structure, whereby the broker executing a trade between member firms would always have the trade reporting obligation. In trades between a member firm and a non-member or customer, the member firm would report the trade. Proponents of an executing broker reporting structure contend that such an approach better aligns the trade reporting responsibility with the party responsible for compliance with SEC Rule 611 of Regulation NMS (the Order Protection Rule). By aligning these requirements, the firm with the trade reporting obligation will also be the party that is aware of and can properly report whether an exception or exemption from the Order Protection Rule applied to the transaction.

      FINRA is soliciting comments on the following issues:

      •  What are the advantages and disadvantages (if any) of the current reporting structure and the two structures described above?
      •  Is there another reporting structure or variation on the two structures described above that should be considered?
      •  With respect to the proposed executing broker reporting structure, how would firms define "executing broker"? Are there any instances where it may be difficult to identify the executing broker to a transaction? For example, where two member firms agree to a trade over the telephone or where a member firm electronically delivers an order against another member firm's quote, which member firm is considered the executing broker? If there are situations in which the executing broker is not easily determined or the two parties disagree as to which party has the reporting obligation, how would firms propose handling trade reporting in such instances?
      •  What are the technological implications and burdens associated with each of the reporting structures described above?
      •  How much time would firms need to make the necessary systems changes to implement each of the reporting structures described above?

      Linking Proposal

      Under the existing trade reporting rules, firms are not required to input a unique identifier that allows FINRA to easily link multiple trade report submissions related to the same overall transaction.4 Thus, for example, if a tape report (i.e., the transaction is reported to the tape for publication) and a non-tape report (i.e., a report for purposes other than for tape publication and generally for clearing or regulatory purposes) are submitted to FINRA for a riskless principal transaction,5 there currently is no specific information on either report to indicate that it relates to another trade report that has also been submitted. Similarly, if a firm is acting in an agency capacity on behalf of another member firm in an OTC trade and submits a non-tape report to FINRA to reflect the offsetting portion of the agency trade,6 there is no specific information to link the related tape and non-tape reports for this transaction.

      FINRA is soliciting comment on a proposal to require that firms provide information to link related reports when both a tape and non-tape report are submitted to FINRA for the same overall transaction.7 FINRA is considering as a possible approach requiring firms to include the same unique identifier on both the tape and non-tape report. Such linking information would allow FINRA staff to recreate more accurately a firm's market activity. Additionally, it would enable FINRA staff to validate that there is, in fact, a tape report associated with a non-tape report and ensure that firms are not using non-tape transactions to circumvent other rules (e.g., the Limit and Market Order Protection Rules).8

      Specifically, FINRA is soliciting comments on the following issues:

      •  If FINRA mandated the use of a unique identifier on trade reports so that tape and non-tape reports could be linked, should the identifier be:
      (1) a unique identifier that is generated and submitted by the firm (e.g., as a new field on both the tape and non-tape reports) (Option 1); or
      (2) a control number assigned by the trade reporting facility on the confirmation of receipt of the tape report that would then be entered by the firm submitting the non-tape report (Option 2)?
      •  What are the advantages and disadvantages (if any) of each of the options described above?
      •  Is there another linkage mechanism that firms believe should be considered?
      •  With respect to Option 1, would a firm that is not the reporting party on the tape report be in a position to ensure that a unique identifier is generated and submitted by the reporting party in that tape report? If this is problematic in certain situations, should the firm submitting the non-tape report be required to use the control number set forth in Option 2?
      •  Should submission of linkage information be required on a "real-time" basis at the time the trade report is submitted, or is there an alternative that would facilitate linking of reports through end-of-day submissions?
      •  How would situations where multiple tape reports need to be linked to a single non-tape report, or vice versa, be addressed under any approach? If firms were to generate the unique identifier under Option 1, FINRA believes this may facilitate use of that same unique identifier on multiple related reports. If firms were required to use a control number assigned by a trade reporting facility under Option 2, each tape report would be assigned a different control number. Would firms be able to input multiple assigned control numbers into a single report?
      •  If linking multiple reports to a single report is problematic, FINRA also is considering whether mandating a one-to-one ratio, such that a single non-tape report must be submitted for each tape report (i.e., aggregation of reports for linkage purposes would not be permitted), is appropriate. What problems or issues, technological or otherwise, would that raise?
      •  Rather than require that linkage information be provided, would the use of three-party trade reports, which would embed linkage information within a single three-party trade report submission, provide a more workable option?9 Could such an approach be under-or over-inclusive?
      •  How should FINRA handle non-tape reports that need to be linked to reports of trades executed on and reported to the tape through an exchange?10
      •  In addition to riskless principal transactions and agency transactions where a firm acts as agent on behalf of another member firm, there are other types of transactions that require the submission of related tape reports and non-tape reports (e.g., cross transactions by Alternative Trading Systems involving multiple member firms and step-outs and reversals of previously executed trades). Are there any specific issues or problems with extending the proposed linking requirement to these and any other types of related transactions? Are there other types of transactions for which firms submit related tape and non-tape reports?
      •  What are the technological implications and burdens associated with FINRA's proposal to require firms to link tape and non-tape reports submitted to FINRA?
      •  How much time would firms need to make the necessary systems changes to implement this proposal?

      1 See Notice to Members 03-73 (November 2003) (NASD Announces Online Availability of Comments). Personal identifying information, such as names or email addresses, will not be edited from submissions. Submit only information that you wish to make publicly available.

      2 Section 19 of the Securities Exchange Act of 1934 (Exchange Act) permits certain limited types of proposed rule changes to take effect upon filing with the SEC. The SEC has the authority to summarily abrogate these types of rule changes within 60 days of filing. See Exchange Act Section 19 and rules thereunder.

      3 See NASD Rules 4632(b) (relating to the FINRA/NASDAQ TRF); 4632A(b) (relating to the ADF); 4632C(b) (relating to the FINRA/NSX TRF); 4632E(b) (relating to the FINRA/NYSE TRF); 6620(b) (relating to the ORF).

      4 FINRA recently filed with the SEC a proposed rule change to require that on any non-tape (or clearing-only) report submitted to a FINRA facility associated with a previously executed trade that was not reported to that same FINRA facility, firms identify the facility or market where the associated trade was reported. See SR-FINRA-2007-012, available at www.finra.org/RulesRegulation/RuleFilings/2007RuleFilings/P036903. Thus, for example, if the initial leg of a riskless principal (or agency) transaction is an over-the-counter trade reported to the FINRA/NYSE TRF, a firm submitting a non-tape (or clearing-only) report for the offsetting leg to the FINRA/NASDAQ TRF would be required to use a special indicator on that report to designate that the initial leg was reported to the FINRA/NYSE TRF. However, there would be no information to directly link the non-tape report submitted to the FINRA/NASDAQ TRF to the tape report submitted to the FINRA/NYSE TRF for this transaction.

      5 For purposes of OTC trade reporting requirements, a "riskless principal" transaction is a transaction in which a firm, after having received an order to buy (sell) a security, purchases (sells) the security as principal (the initial leg) and satisfies the original order by selling (buying) as principal at the same price (the offsetting "riskless" leg). Firms may report a riskless principal transaction in one of two ways. One alternative is to report the transaction in a single tape report that is marked with a "riskless principal" capacity indicator. The other alternative is to submit two (or more, as necessary) reports: a tape report to reflect the initial leg of the transaction and a non-tape report that is marked as riskless principal to reflect the offsetting "riskless" leg. See NASD Rules 4632(d)(3)(B) (relating to the FINRA/NASDAQ TRF); 4632A(e)(1)(C)(ii) (relating to the ADF); 4632C(d)(3)(B) (relating to the FINRA/NSX TRF); 4632E(e)(3)(B) (relating to the FINRA/ NYSE TRF); 6620(d)(3)(B) (relating to the ORF).

      6 See FINRA Regulatory Notice 07-38 (August 2007).

      7 At this time, FINRA is not proposing to require that firms provide specific linking information for trades executed on and reported through exchanges, but is soliciting comment on this concept generally, as indicated below.

      8 The New York Stock Exchange and the Boston Stock Exchange have addressed issues associated with linking trade reports for multiple legs of a riskless principal transaction. See Securities Exchange Act Release No. 56017 (July 5, 2007), 72 FR 38110 (July 12, 2007) (order approving SR-NYSE-2007-21); Securities Exchange Act Release No. 51251 (February 24, 2005), 70 FR 10439 (March 3, 2005) (order approving SR-BSE-2004-27).

      9 A three party trade report is a single last sale trade report that denotes one reporting member and two contra parties. See, e.g., NASD Rule 4632A(d).

      10 Pursuant to proposed rule change SR-FINRA-2007-012 (see note 4), if, for example, the initial leg of a riskless principal (or agency) transaction is executed on and reported through the NASDAQ Exchange, a firm submitting a non-tape (or clearing-only) report for the offsetting leg of the transaction to FINRA would be required to use a special indicator on that report to designate that the initial leg was reported through the NASDAQ Exchange. However, there would be no information to directly link the non-tape report to the related tape report.

    • 07-45 Amendments to NASD Rule 3210 to Conform with Amendments to the SEC's Regulation SHO Delivery Requirements; Effective Date: October 15, 2007

      View PDF File

      Regulatory Notice

      Notice Type

      Rule Amendment

      Referenced Rules & Notices

      NASD Rule 3210
      NTM 06-28
      SEC Regulation SHO
      SEC Rule 144
      Suggested Routing

      Compliance
      Executive Representatives
      Internal Audit
      Legal
      Operations
      SeniorManagement
      Systems
      Trading
      Training
      Key Topic(s)

      Non-Reporting Threshold Securities
      Short Sales
      Short Sale Delivery Requirements

      Short Sale Delivery Requirements

      Executive Summary

      FINRA is issuing this Notice to advise firms and other interested parties of changes to NASD Rule 3210 (Short Sale Delivery Requirements) to conform with amendments to the SEC's Regulation SHO delivery requirements.

      Beginning on October 15, 2007, firms are required to close out within 35 consecutive settlement days any previously "grandfathered" fail-to-deliver positions in a non-reporting threshold security1 that is on the Rule 3210 threshold list on that date. Any new fails in a non-reporting threshold security after October 15, 2007 will be subject to Rule 3210's 13 consecutive settlement day close-out requirements. There is, however, one exception; as of October 15, 2007, firms will have 35, rather than 13, consecutive settlement days to close out fails to deliver resulting from sales of non-reporting threshold securities pursuant to SEC Rule 144.

      The text of NASD Rule 3210, as amended, is set forth in Attachment A of this Notice. The compliance date of the amendments is October 15, 2007, to coincide with the compliance date of the amendments to the Regulation SHO delivery requirements.

      Questions regarding this Notice may be directed to the Legal Section, Market Regulation, at (240) 386-5126, or the Office of General Counsel at (202) 728-8071. For questions regarding the NASD Rule 3210 Threshold Securities List, contact FINRA Operations at (866) 776-0800.

      Background and Discussion

      On August 7, 2007, the Securities and Exchange Commission (SEC) adopted amendments to the mandatory close-out requirement in Rule 203 of Regulation SHO, which applies to reporting securities.2 The amendments, among other things, eliminate the "grandfather"3 provision contained in Rule 203(b)(3)(i) of Regulation SHO and extend the close-out requirement from 13 to 35 consecutive settlement days for fails to deliver resulting fromsales of threshold securities4 pursuant to SEC Rule 144. The compliance date of the amendments to Rule 203 of Regulation SHO is October 15, 2007.5

      Rule 3210 applies substantially similar delivery requirements to non-reporting threshold equity securities.6 FINRA has applied and interpreted the Rule 3210 delivery requirements consistent with the SEC's application and interpretation of the Regulation SHO delivery requirements. Moreover, in the adopting release relating to the amendments to Regulation SHO delivery requirements, the SEC indicated that it anticipates that Rule 3210 would be similarly amended.7 Therefore, to maintain consistency with the SEC's amendments to Rule 203 of Regulation SHO, FINRA filed for immediate effectiveness a proposed rule change to make conforming amendments to Rule 3210.8

      As amended, Rule 3210 requires that any previously grandfathered fail-to-deliver position in a non-reporting security that is on the Rule 3210 list on October 15, 2007 be closed out within 35 settlement days of that date. If the fail-to-deliver position has persisted for 35 consecutive settlement days from October 15, 2007, a clearing agency participant and any broker-dealer for which it clears transactions, including market makers, are prohibited from accepting any short-sale orders or effecting further short sales in the particular non-reporting threshold security without borrowing, or entering into a bona-fide arrangement to borrow, the security until the participant closes out the entire fail-to-deliver position by purchasing securities of like kind and quantity. If a security becomes a non-reporting threshold security after October 15, 2007, any fails to deliver in that security that occurred prior to the security becoming a non-reporting threshold security will be subject to Rule 3210's mandatory 13 settlement day close-out requirement, similar to any other fail-to-deliver position in a non-reporting threshold security. These positions will no longer be "grandfathered" from the Rule 3210 delivery requirements.

      Additionally, as amended, firms have 35, rather than 13, consecutive settlement days to close-out fail-to-deliver positions in SEC Rule 144 restricted securities. If the fail-to-deliver position persists for 35 consecutive settlement days in a non-reporting threshold security sold pursuant to SEC Rule 144, a participant of a registered clearing agency and any broker-dealer for which it clears transactions, including market makers, are prohibited from effecting further short sales in the particular non-reporting threshold security without borrowing, or entering into a bona-fide arrangement to borrow, the security until the participant closes out the entire fail-to-deliver position by purchasing securities of like kind and quantity.

      Consistent with the compliance date of the amendments to Rule 203 of Regulation SHO, the compliance date of the amendments to Rule 3210 is October 15, 2007.


      1 The term "non-reporting threshold security" means any equity security of an issuer that is not registered pursuant to Section 12 of the Exchange Act and for which the issuer is not required to file reports pursuant to Section 15(d) of the Exchange Act and, for five consecutive settlement days, has: (1) aggregate fails to deliver at a registered clearing agency of 10,000 shares or more; and (2) a reported last sale during normal market hours (9:30 a.m. to 4 p.m., Eastern Time (ET)) for the security on that settlement day that would value the aggregate fail to deliver position at $50,000 or more. In the event there is no reported last sale on any settlement day during such five-day period, the value of the aggregate fail position would be based on the previously reported last sale.

      2 The term "reporting security" means any equity security of an issuer that is registered under Section 12 of the Exchange Act or that is required to file reports under Section 15(d) of the Exchange Act.

      3 The "grandfather" provision excludes from the Regulation SHO close-out requirement fail-to-deliver positions that were established prior to the security becoming a threshold security or prior to the Regulation SHO effective date. Specifically, the grandfather provision applies in two situations: (1) to fail-to-deliver positions occurring before the January 3, 2005 Regulation SHO effective date; and (2) to fail-to- deliver positions that were established on or after January 3, 2005, but prior to the security appearing on the Regulation SHO threshold securities list. See Securities Exchange Act Release No. 54154 (July 14, 2006), 71 FR 41710 (July 21, 2006). See also SEC Division of Market Regulation: Key Points About Regulation SHO, dated April 11, 2005.

      4 The term "threshold security" means any reporting security that (1) for five consecutive settlement days had aggregate fails to deliver at a registered clearing agency of 10,000 shares or more, and the level of fails is equal to a least one-half of one percent of the issue's total shares outstanding; and (2) is included on a list published by a self-regulatory organization.

      5 See Securities Exchange Act Release No. 56212 (August 7, 2007), 72 FR 45543 (August 14, 2007).

      6 See Securities Exchange Act Release No. 53596 (April 4, 2006), 71 FR 18392 (April 11, 2006) (order approving SR-NASD-2004-044). See also Notice to Members 06-28 (June 2006).

      7 See endnote 5 at 45544, note 7.

      8 See File No. SR-FINRA-2007-013.


      ATTACHMENT A

      Below is the text of the rule change. New language is underlined; deletions are in brackets.

      3210. Short Sale Delivery Requirements

      (a) If a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency in a non-reporting threshold security for 13 consecutive settlement days, the participant shall immediately thereafter close out the fail to deliver position by purchasing securities of like kind and quantity.
      (1) Provided, however, a participant of a registered clearing agency that has a fail to deliver position at a registered clearing agency in a non-reporting threshold security on October 15, 2007, and which, prior to October 15, 2007, had been previously grandfathered from the close-out requirement in paragraph (a) (i.e., because the participant of a registered clearing agency had the fail to deliver position at a registered clearing agency on the settlement day preceding the day that the security became a non-reporting threshold security), shall close out that fail to deliver position within thirty-five settlement days of October 15, 2007 by purchasing securities of like kind and quantity. The requirements in paragraph (b) shall apply to all such fails to deliver that are not closed out in conformance with this paragraph (a)(1).
      (2) Provided, however, if a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency for thirty-five consecutive settlement days in a non-reporting threshold security that was sold pursuant to SEC Rule 144, the participant shall immediately thereafter close out the fail to deliver position in the security by purchasing securities of like kind and quantity. The requirements in paragraph (b) shall apply to all such fails to deliver that are not closed out in conformance with this paragraph (a)(2).
      [(b) The provisions of this rule shall not apply to the amount of the fail to deliver position that the participant of a registered clearing agency had at a registered clearing agency on the settlement day immediately preceding the day that the security became a non-reporting threshold security; provided, however, that if the fail to deliver position at the clearing agency is subsequently reduced below the fail to deliver position on the settlement day immediately preceding the day that the security became a non-reporting threshold security, then the fail to deliver position excepted by this paragraph (b) shall be the lesser amount.]
      (b)[(c)] If a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency in a non-reporting threshold security for 13 consecutive settlement days (or 35 consecutive settlement days if entitled to rely on paragraphs (a)(1) or (a)(2) of this rule), the participant and any broker or dealer for which it clears transactions, including any market maker that would otherwise be entitled to rely on the exception provided in paragraph (b)(2)(iii) of SEC Rule 203 of Regulation SHO, may not accept a short sale order in the non-reporting threshold security from another person, or effect a short sale in the non-reporting threshold security for its own account, without borrowing the security or entering into a bonafide arrangement to borrow the security, until the participant closes out the fail to deliver position by purchasing securities of like kind and quantity.
      (c)[(d)] If a participant of a registered clearing agency reasonably allocates a portion of a fail to deliver position to another registered broker or dealer for which it clears trades or for which it is responsible for settlement, based on such broker or dealer's short position, then the provisions of this rule relating to such fail to deliver position shall apply to the portion of such registered broker or dealer that was allocated the fail to deliver position, and not to the participant.
      (d)[(e)] A participant of a registered clearing agency shall not be deemed to have fulfilled the requirements of this rule where the participant enters into an arrangement with another person to purchase securities as required by this rule, and the participant knows or has reason to know that the other person will not deliver securities in settlement of the purchase.
      (e)[(f)] For the purposes of this rule, the following terms shall have the meanings below:
      (1) the term "market maker" has the same meaning as in section 3(a)(38) of the Exchange Act.
      (2) the term "non-reporting threshold security" means any equity security of an issuer that is not registered pursuant to section 12 of the Exchange Act and for which the issuer is not required to file reports pursuant to section 15(d) of the Exchange Act:
      (A) for which there is an aggregate fail to deliver position for five consecutive settlement days at a registered clearing agency of 10,000 shares or more and for which on each settlement day during the five consecutive settlement day period, the reported last sale during normal market hours for the security on that settlement day that would value the aggregate fail to deliver position at $50,000 or more, provided that if there is no reported last sale on a particular settlement day, then the price used to value the position on such settlement day would be the previously reported last sale; and
      (B) is included on a list published by NASD.
      A security shall cease to be a non-reporting threshold security if the aggregate fail to deliver position at a registered clearing agency does not meet or exceed either of the threshold tests specified in paragraph (e)[(f)](2)(A) of this rule for five consecutive settlement days.
      (3) the term "participant" means a participant as defined in section 3(a)(24) of the Exchange Act, that is an NASD member.
      (4) the term "registered clearing agency" means a clearing agency, as defined in section 3(a)(23)(A) of the Exchange Act, that is registered with the Commission pursuant to section 17A of the Exchange Act.
      (5) the term "settlement day" means any business day on which deliveries of securities and payments of money may be made through the facilities of a registered clearing agency.
      (f)[(g)] Pursuant to the Rule 9600 Series, the staff, for good cause shown after taking into consideration all relevant factors, may grant an exemption from the provisions of this rule, either unconditionally or on specified terms and conditions, to any transaction or class of transactions, or to any security or class of securities, or to any person or class of persons, if such exemption is consistent with the protection of investors and the public interest.

      * * * * *

      9610. Application

      (a) Where to File

      A member seeking exemptive relief as permitted under Rules 1021, 1050, 1070, 2210, 2315, 2320, 2340, 2520, 2710, 2720, 2790, 2810, 2850, 2851, 2860, Interpretive Material 2860-1, 3010(b)(2), 3020, 3150, 3210, 3230, 5150, 6958, 8211, 8213, 11870, or 11900, or Municipal Securities Rulemaking Board Rule G-37 shall file a written application with the appropriate department or staff of NASD and provide a copy of the application to the Office of General Counsel of NASD.
      (b) through (c) No change.

    • 07-44 SEC Approves New Interpretive Material That Authorizes FINRA to Establish a Temporary Program to Allow Firms to Voluntarily Remit Accumulated Funds; Reminder Concerning Proper Disclosure of the Section 3 Fee; Effective Date: December 11, 2007 Sunset Date: June 11, 2008

      View PDF File

      Regulatory Notice

      Notice Type

      Guidance

      Referenced Rules & Notices

      IM-Section 3
      SEC Rule 31
      Suggested Routing

      Finance
      Compliance
      Legal
      Operations
      Senior Management
      Key Topic(s)

      Accumulated Funds
      Section 3 of Schedule A to the By-Laws
      Section 31 of the Securities Exchange Act of 1934

      Accumulated Funds

      Executive Summary

      FINRA is establishing a temporary program that will allow member firms to remit to FINRA funds previously collected, but not remitted, in connection with assessments used by NASD to pay the SEC's Section 31 fees, otherwise known as "accumulated funds." Firms may, on a one-time only, voluntary basis, remit all or part of historically accumulated funds that were collected and are in surplus of the assessment under Section 3 of Schedule A to the By-Laws in accordance with the terms of this interpretive material. This Program is effective December 11, 2007 and will automatically sunset effective June 11, 2008, and thereafter may not be used by member firms.

      FINRA also is reminding firms of proper disclosure for transaction fees assessed under Section 3.

      Questions concerning this Notice may be directed to Finance, at (240) 386-5397; or the Office of General Counsel, at (202) 728-8071.

      Background and Discussion

      On June 8, 2007, the Securities and Exchange Commission (SEC or Commission) approved new interpretive material (IM-Section 3) to Section 3 of Schedule A to the By-Laws.1 IM-Section 3 establishes a temporary program to allow member firms to voluntarily remit funds originally collected for purposes of paying Section 31 fees to the SEC to be used to pay such fees.

      Pursuant to Section 31 of the of the Securities Exchange Act of 19342 and SEC Rule 31, FINRA and the national securities exchanges are required to pay transaction fees to the SEC that are designed to recover the costs related to the government's supervision and regulation of the securities markets and securities professionals. To offset this obligation, FINRA assesses its clearing and self-clearing members a regulatory fee in accordance with Section 3 of Schedule A of the By-Laws, which mirrors the SEC Section 31 fee in scope and amount. Clearing firms may, in turn, seek to charge a fee to their customers or correspondent firms.

      Precisely reconciling the amounts billed previously by NASD and the amounts collected from customers and correspondent firms historically has been difficult for some member firms, causing surpluses to accumulate at these firms. These accumulated funds were not remitted, although they may have been previously identified as "Section 31 Fees" or "SEC Fees" by certain firms.3

      Consequently, to address the issue of accumulated funds, NASD proposed, and the SEC approved, a temporary program to allow firms, on a one-time-only basis, to voluntarily remit historically accumulated funds. These funds will be used to pay FINRA's current Section 31 fees in conformity with prior representations made by member firms. To the extent the payment of these historically accumulated funds is in excess of the fees due to the SEC from FINRA under Section 31 of the Act, such surplus shall be used by FINRA to offset other regulatory costs.

      It should be noted that member firms are not required to remit such funds to FINRA. This program is completely voluntary. Accordingly, this temporary program imposes no obligation on any FINRA member firm that believes that accumulated funds should be retained or disposed of in another manner. Firms wishing to remit such accumulated funds to FINRA may submit a check or wire such funds to FINRA specifying on the check or in the wire transfer that such funds are "FINRA Accumulated Funds."

      •  Checks can be sent to:

      FINRA
      P.O. Box 7777-W8555
      Philadelphia, PA 19175-8555
      •  NASD wire information:

      Bank Address: Philadelphia, PA
      Account Name: FINRA
      ABA Number: 031000037
      Account Number: 8-234-353

      Disclosure of Section 3 Fees

      FINRA also would like to take this opportunity to reiterate its prior statements4 that member firms that pass on to their customers transaction fees collected under Section 3 of Schedule A to the By-Laws are not permitted to refer to the fees assessed by FINRA as "Section 31 Fees" or "SEC Fees." Further, FINRA reminds firms that they should not mislabel this fee on customer confirmations, or in any representations or communications with customers. Adhering to this guidance should ensure that issues related to accumulated funds will not recur.


      1 See Securities Exchange Act Release No. 55886 (June 8, 2007), 72 FR 32935 (June 14, 2007) (order approving SR-NASD-2007-027). The Commission found that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities association. In particular, the Commission found that the proposed rule change is consistent with Section 15A(b)(6) of the Act, which requires, among other things, that NASD rules must be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade and, in general, to protect investors and the public interest. In addition, the Commission stated in its approval order that it believes that this program "will provide a reasonable means for member firms to dispose of any accumulated funds they may have in their possession."

      2 15 U.S.C. 78ee.

      3 NASD's rule also previously referred to this fee as an "SEC Transaction Fee." The SEC stated in its release adopting new Rule 31 and Rule 31T that "it is misleading to suggest that a customer or [self-regulatory organization] member incurs an obligation to the Commission under Section 31." See Securities Exchange Act Release No. 49928 (June 28, 2004), 69 FR 41060, 41072 (July 7, 2004). In response to this statement, NASD amended its rule to refer to this fee as a "Regulatory Transaction Fee." See Securities Exchange Act Release No. 50274 (August 26, 2004), 69 FR 53757 (September 2, 2004) (SR-NASD-2004-129). Further, NASD issued guidance to ensure there is no confusion in the marketplace regarding NASD's "Regulatory Transaction Fee" and the "SEC's Section 31 Fee." See NASD Member Alert issued on June 27, 2007, Notice to Members 05-11 (February 2005) and NTM 04-63 (August 2004).

      4 See NASD Member Alert issued on June 27, 2007, NTM 05-11 (February 2005) and NTM 04-63 (August 2004).

    • 07-43 FINRA Reminds Firms of Their Obligations Relating to Senior Investors and Highlights Industry Practices to Serve these Customers

      View PDF File

      Regulatory Notice

      Notice Type

      Guidance

      Referenced Rules & Notices

      NASD IM-2310-3
      NASD Rule 2110
      NASD Rule 2210
      NASD Rule 2310
      NTM 96-86
      NTM 99-35
      NTM 03-71
      NTM 04-30
      NTM 04-89
      NTM 05-26
      NTM 05-59
      NTM 06-38
      NYSE Information Memo 05-54
      NYSE Rule 472
      Suggested Routing

      Advertising
      Compliance
      Continuing Education
      Legal
      Registered Representatives
      Senior Management
      Key Topic(s)

      Baby Boomers
      Communications with the Public
      Designations and Credentials
      Diminished Capacity
      Fraud
      Retirement
      Sales Practices
      Seniors
      Suitability

      Senior Investors

      Executive Summary

      One of FINRA's priorities is the protection of senior investors, as well as Baby Boomers who are at or approaching retirement.1 FINRA's efforts in this area include investor education, member education and outreach, examinations and enforcement. The purpose of this Notice is to urge firms to review and, where warranted, enhance their policies and procedures for complying with FINRA sales practice rules, as well as other applicable laws, regulations and ethical principles, in light of the special issues that are common to many senior investors. The Notice also highlights, for the consideration of FINRA's member firms, a number of practices that some firms have adopted to better serve these customers.

      Questions concerning this Notice may be directed to:

      •  Laura Gansler, Associate Vice President, Office of Emerging Regulatory Issues, at (202) 728-8275;
      •  James Wrona, Associate Vice President and Associate General Counsel, Office of General Counsel, at (202) 728-8270; and
      •  John Komoroske, Vice President, Office of Investor Education, at (202) 728-8475.

      Discussion

      The number of Americans who are at or nearing retirement age is growing at an unprecedented pace. The United States population aged 65 years and older is expected to double in size within the next 25 years.2 By 2030, almost 1 out of every 5 Americans—approximately 72 million people—will be 65 years old or older.3 Those who are 85 years old and older are now in the fastest-growing segment of the U.S. population.4 At the same time, Americans are living longer than ever, meaning that retirement assets have to last longer than ever, too. Moreover, fewer and fewer retirees and pre-retirees can rely on traditional corporate pension plans to provide for a meaningful portion of retirement needs. Therefore, the financial decisions made by those who are at or nearing retirement are more important than ever before.

      FINRA understands that, as with other investors, levels of wealth, income and financial sophistication vary among older investors. FINRA does not have special rules for senior customers. Firms owe all their customers the same obligations and duties. However, in executing those duties, age and life stage (whether pre-retired, semi-retired or retired) can be important factors, and firms should make sure that the procedures they have in place take these considerations into account where appropriate. Two areas of particular concern to FINRA are the suitability of recommendations to, and communications aimed at, older investors.

      Suitability

      NASD Rule 2310 requires that in recommending "the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable" for that customer, based on "the facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs." The rule also requires that, before executing a recommended transaction, a firm must make reasonable efforts to obtain information concerning the customer's financial status, tax status, investment objectives and "such other information used or considered to be reasonable by such member or registered representative in making recommendations to the customer."

      Although the rule does not explicitly refer to a customer's age or life stage, both are important factors to consider in performing a suitability analysis. As investors age, their investment time horizons, goals, risk tolerance and tax status may change. Liquidity often takes on added importance. And, depending on their particular circumstances, seniors and retirees may have less tolerance for certain types of risk than other investors. For example, retirees living solely on fixed incomes may be more vulnerable to inflation risk than those who are still in the workforce, depending on the number of years those retirees are likely to rely on fixed incomes. Likewise, investors whose investment time horizons afford less time or opportunity to recover investment losses may be disproportionately affected by market fluctuations.

      Therefore, firms cannot adequately assess the suitability of a product or transaction for a particular customer without making reasonable efforts to obtain information about the customer's age, life stage and liquidity needs. Other questions to consider include:

      •  Is the customer currently employed? If so, how much longer does he or she plan to work?
      •  What are the customer's primary expenses? For example, does the customer still have a mortgage?
      •  What are the customer's sources of income? Is the customer living on a fixed income or anticipate doing so in the future?
      •  How much income does the customer need to meet fixed or anticipated expenses?
      •  How much has the customer saved for retirement? How are those assets invested?
      •  How important is the liquidity of income-generating assets to the customer?
      •  What are the customer's financial and investment goals? For example, how important is generating income, preserving capital or accumulating assets for heirs?
      •  What health care insurance does the customer have? Will the customer be relying on investment assets for anticipated and unanticipated health costs?

      Firms should carefully consider the risk of a product with the age and retirement status of the customer in mind, including its market, inflation and issuer credit risk. Investment involves varying degrees of risk and reward. For many investors who are at or nearing retirement, there can be a temptation to reach for yield to maximize retirement income without the appreciation of the concomitant risk. Moreover, it can be difficult for some investors to fully appreciate the risks of certain products or strategies, particularly if they are concerned about running out of money. Yet, especially when investments involve retirement accounts or lump-sum pension plan payments, taking undue risks with funds needed to last a lifetime can be financially disastrous.

      Firms do not have an obligation to shield their customers from risks that customers want to take, but they are required to fully understand the products recommended by their registered representatives, to give their customers a fair and balanced picture of the risks, costs and benefits associated with the products or transactions they recommend and recommend only those products that are suitable in light of the customer's financial goals and needs.5

      This does not mean that all seniors are, or should be, risk-adverse, or that any particular product, per se, is unsuitable for older investors. However, certain products or strategies pose risks that may be unsuitable for many seniors, because of time horizon considerations, liquidity, volatility or inflation risk. Therefore, FINRA's examiners are focusing on recommendations to seniors, particularly those that involve the following:

      •  Products that have withdrawal penalties or otherwise lack liquidity, such as deferred variable annuities, equity indexed annuities, some real estate investments and limited partnerships;
      •  Variable life settlements;
      •  Complex structured products, such as collateralized debt obligations (CDOs);
      •  Mortgaging home equity for investment purposes; and
      •  Using retirement savings, including early withdrawals from IRAs, to invest in high-risk investments.

      Many of these have been the subject of separate rulemaking or other guidance from FINRA in the past. For example, FINRA has repeatedly stated that variable annuities are generally considered to be long-term investments and are therefore typically not suitable for investors who have short-term investment horizons. This is true even of some variable annuities that offer riders specifically designed for seniors, including those offering guaranteed life benefits.6 We also have issued guidance on the suitability of variable life settlements, which are generally aimed at investors over the age of 70;7 and the use of home equity for investment purposes.8 FINRA also is concerned about recommendations that investors use retirement savings, in some cases by making early withdrawals from IRAs pursuant to Section 72(t) of the Internal Revenue Code, to make unsuitable alternative investments.9

      As we have in the past, we also caution firms that a customer's net worth alone is not determinative of whether a particular product is suitable for that investor, even when the investor qualifies as an accredited investor under Regulation D of the Securities Act of 1933. Over-reliance on net worth is particularly problematic where an investor meets the accredited investor standard based largely on home values, which may represent the largest asset of many senior investors.10 Simply put, eligibility does not equal suitability.11

      Firms also are reminded that their suitability obligation applies to institutional customers, as well as retail customers, although the scope of that obligation varies depending on whether the institution is able to independently assess the risk associated with a particular recommendation and is in fact exercising independent judgment.12 FINRA is concerned about the suitability of recommendations to some pension plans, particularly recommendations involving relatively new, complicated or high-risk asset classes, such as leveraged exchange-traded funds (ETFs) or the equity tranches of some collateralized mortgage obligations (CMOs). As NASD IM-2310-3 points out, even institutional customers that have the general capability to assess risk may not be able to understand a particular instrument, particularly a product that is new or that has significantly different risk and volatility characteristics than other investments made by the institution. Therefore, in making recommendations to institutional customers, including pension plans, firms should consider both the general ability of the institution to independently assess investment risk, and whether the customer understands the particular product well enough to exercise that ability with respect to the recommendation.

      Communications with the Public

      Senior Designations and Credentials

      FINRA also is concerned about the proliferation of professional designations, particularly those that suggest an expertise in retirement planning or financial services for seniors, such as "certified senior adviser," "senior specialist," "retirement specialist" or "certified financial gerontologist." The criteria used by organizations that grant professional designations for investment professionals vary greatly. Some designations require formal certification, with procedures that include completion of a detailed and rigorous curriculum focused on financial issues, culminating with one or more examinations, as well as mandatory continuing professional education. On the other end of the spectrum, some designations can be obtained simply by paying membership dues. Nonetheless, seniors may be led to believe that these individuals are particularly qualified to assist them based on such designations. A recent FINRA Investor Education Foundation-sponsored survey found that a quarter of senior investors surveyed were told by an investment professional that the investment professional was specially accredited to advise them on senior financial issues, and a half of those investors were more likely to listen to the professional's advice because of it.

      Firms that allow the use of any title or designation that conveys an expertise in senior investments or retirement planning where such expertise does not exist may violate NASD Rules 2110 and 2210, NYSE Rule 472, and possibly the antifraud provisions of the federal securities laws. In addition, some states prohibit or restrict the use of senior designations.13

      NASD Rule 2210 and NYSE 472 prohibit firms and registered representatives from making false, exaggerated, unwarranted or misleading statements or claims in communications with the public. This prohibition includes referencing nonexistent or self-conferred degrees or designations or referencing legitimate degrees or designations in a misleading manner. Firms therefore must have adequate supervisory procedures in place to ensure that their registered representatives do not violate this requirement. As with all supervisory procedures, these procedures should be written, clearly communicated to employees, and effectively enforced. And, they should cover how approved designations may be used.

      Some firms FINRA surveyed in connection with the preparation of this Notice ban the use of any designation that includes the word "senior" or "retirement." Others maintain a list of approved designations, and a registered representative wishing to use a designation not on the list must submit it for review by a committee consisting of principals, compliance officers and/or legal department personnel. Criteria used by committees to review proposed designations include the curriculum, examinations and continuing education components. To help investors and firms understand professional designations, FINRA maintains a database of such designations and the qualifications, if any, that are needed to obtain them at http://apps.finra.org/DataDirectory/1/prodesignations.aspx. Please note, however, that FINRA does not approve or endorse any professional designation, and it maintains the list solely to assist in the evaluation of the listed designations.14

      In addition to senior designations, FINRA notes that some third-party vendors are marketing ghostwritten books on senior investing to registered representatives as tools to establish credibility. Holding oneself out as the author of a book on senior investing, and therefore an expert, could violate a number of rules, including NASD Rules 2110, 2120 and 2210, and NYSE Rule 472.

      High-Pressure Sales Seminars Aimed at Seniors

      Another area of concern to FINRA and other regulators is the use of aggressive or misleading sales tactics aimed at seniors, particularly the use of "free lunch" seminars that use high-pressure sales tactics to promote products that may not be suitable for all persons in attendance. Such high-pressure tactics include attempts to create an artificial or inappropriate sense of urgency around major decisions or commitments (e.g., the use of phases such as "limited time offer" or "you have to sign up today") or that heighten or exaggerate typical fears of older investors (e.g., the return of double-digit inflation or becoming financially dependent on family members). In response to these concerns, in May 2006, FINRA conducted a series of on-site examinations of broker-dealers that offer so-called "free lunch" sales seminars aimed at seniors. Other regulators simultaneously conducted similar examinations of investment advisers and other firms that offer such seminars.

      In the course of the coordinated examinations, regulators found troubling sales practices, including the use of false or misleading sales materials used in connection with high-pressure sales seminars aimed exclusively or primarily at seniors or those at or nearing retirement. Among the most common practices were inaccurate or exaggerated claims regarding the safety, liquidity or expected returns of the investment or strategy being touted; scare tactics; misrepresentations or material omissions about the product or strategy; conflicts of interest; or misleading credentials used by persons sponsoring or participating in the seminar. The examinations also detected instances in which advertisements failed to include the firm's name, or made improper use of testimonials, in violation of NASD Rule 2210(d). The full discussion of the regulators' findings is presented in Protecting Senior Investors: Report of Examinations of Securities Firms Providing "Free Lunch" Sales Seminars (Report), available at www.finra.org/reports.

      FINRA will continue to follow up on the examination findings that relate to its members and will bring disciplinary actions where warranted. We also will continue to pay particular attention to the conduct of firms and their registered representatives in connection with sales seminars that are aimed primarily at seniors. We therefore urge firms to review their policies and procedures relating to sales seminars to make sure they are adequate. In doing so, firms should consult Appendix A of the Report, which contains detailed best practices for supervising sales seminar activities. These practices were identified by regulators in the course of the examinations as elements of effective supervisory procedures.

      Diminished Capacity and Suspected Financial Abuse of Seniors

      In addition to the regulatory concerns discussed above, there are other issues that firms sometimes encounter when dealing with senior investors. One of the most troubling to the firms we surveyed is that of investors who exhibit signs of diminished mental capacity. Unfortunately, this difficult and sensitive issue is likely to become more common as the ranks of older seniors grow: a recent study published by the National Institute on Aging reveals that impaired cognition affects approximately 20 percent of people aged 85 years or older.

      Another troubling issue is suspected financial—and sometimes mental or physical—abuse of senior customers by their family members or caregivers. Financial abuse is difficult to define, and therefore, difficult to recognize. In general terms, it is the misuse of an older adult's money or belongings by a relative or a person in a position of trust. Red flags can include sudden, atypical or unexplained withdrawals; drastic shifts in investment style; inability to contact the senior customer; signs of intimidation or reluctance to speak in the presence of a caregiver; and isolation from friends and family.

      These sensitive issues were raised repeatedly by the firms we surveyed for this Notice, and we include in this Notice, for the consideration of other FINRA members, some of the steps that firms, as a matter of sound business practice and as a way of serving their senior customers, are taking to address them. In doing so, we are not suggesting that firms are required to take these steps, including developing special written supervisory procedures for servicing senior customers. Firms and clients differ, and policies and procedures that work well for one firm may not be appropriate for another. The steps include:

      •  Designating a specific individual or department, such as the compliance or legal department, to serve as a central advisory contact for questions about senior issues, as well as a repository of available resources.
      •  Providing written guidance to employees on senior-related issues, such as how to identify and/or what to do if they suspect their customer is experiencing diminished capacity or is being abused, financially or otherwise, by a family member, caregiver or other third party.

      For example, one firm FINRA surveyed has very detailed procedures requiring its employees to immediately notify their branch manager, supervisor or another designated firm employee if they suspect abuse. Under the firm's procedures, that person in turn must notify the firm's legal department, which may decide to report the suspected abuse to the appropriate state agency; restrict activity in the account and/or take any action necessary to comply with appropriate court orders. In addition, the firm requires that the contact with the legal department be documented in the customer's file in accordance with the firm's record retention schedule. The supervisor or branch manager also is instructed to contact local emergency services if immediate physical abuse of a senior investor is suspected.
      •  Asking, either at account opening or at a later point, whether the customer has executed a durable power of attorney. (Some firms report that it is easier to have conversations with their customers about such sensitive issues as a matter of routine.)
      •  Asking, either at account opening or at a later time, whether the customer would like to designate a secondary or emergency contact for the account whom the firm could contact if it could not contact the customer or had concerns about the customer's whereabouts or health. (To avoid violating Regulation S-P, firms would have to clearly disclose to the customer the conditions under which the information would be used, and the customer would have the right to withdraw consent at any time.)
      •  Asking the customer if he or she would like to invite a friend or family member to accompany the customer to appointments at the firm.
      •  Informing the customer (where appropriate) that, in the firm's view, a particular unsolicited trade is not suitable for the customer.
      •  Reminding registered representatives that it is important when dealing with customers, particularly seniors, to base recommendations on current information.
      •  Offering training to help registered representatives understand and meet the needs of older investors, including proper asset allocation, liquidity demand and longevity needs, as well as the possible changes in their suitability profiles. Some relevant materials are available at www.finra.org and www.saveandinvest.org. Further, some firms have invited representatives from senior-related advocacy groups, the Alzheimer's Association, and state and local agencies that serve seniors to speak to their employees. Organizations that can help firms locate local experts on senior issues include the National Association of State Units on Aging (www.nasua.org), the National Association of Area Agencies on Aging (www.n4a.org) and AARP (www.aarp.org).

      Investor Education

      Finally, we urge firms to be proactive in helping to educate customers about how to avoid being victims of financial fraud, including making investor education materials, prepared by FINRA, the SEC, state regulators, the firm or another source, available to senior investors.15 Registered representatives are often in a unique position to help customers learn about how to avoid fraudulent solicitations. We encourage our member firms and associated persons to talk with all of their customers, particularly seniors and others at high risk of being targeted, about how to spot scams and protect themselves and their families from financial fraud.16

      Conclusion

      Given the unprecedented number of investors who are at or nearing retirement age, protecting older investors is a priority for FINRA, and we urge firms to make it a priority, as well. We recognize that seniors are not all alike, and we stress that all investors are entitled to honesty and integrity from their broker-dealers. We remind firms to make sure that the policies and procedures that they do have, as well as relevant training materials, adequately take into account the special needs and concerns that are common to many investors as they age.


      1 For ease of reference, this Notice refers to both categories as seniors unless the context requires a more specific reference.

      2 See Wan He et al., U.S. Census Bureau, Current Population Reports, P23-209, 65+ in the United States: 2005, U.S. Government Printing Office, Washington, D.C. (2005), available at www.census.gov/prod/2006pubs/p23-209.pdf.

      3 Id.

      4 See Wan He et al., U.S. Census Bureau, Current Population Reports, P23-209, 65+ in the United States: 2005, U.S. Government Printing Office, Washington, D.C. (2005), available at www.census.gov/prod/2006pubs/p23-209.pdf. See also Frank B. Hobbs, U.S. Census Bureau, The Elderly Population, U.S. Government Printing Office, Washington, D.C. (2001), available at www.census.gov/population/www/pop-profile/elderpop.html.

      5 A broker must refrain from making an unsuitable recommendation even if the customer expressed an interest in engaging in the inappropriate trade or asked the broker to make the recommendation. See, e.g., Dane S. Faber, Exchange Act Release No. 49216, 2004 SEC LEXIS 277, at *23–24 (Feb. 10, 2004).

      6 See NASD Notice to Members (NTM) 96-86 (December 1996) and NTM 99-35 (May 1999). In NTM 99-35 and in NYSE Information Memo 05-54 (August 11, 2005), we outlined a series of "best practices" and critical criteria relating to sales of variable annuities. While some members have voluntarily adopted many of those practices, others have not. Because some firms continue to engage in problematic sales practices in this area, and some investors continue to be confused by certain features of these products, we have adopted a rule (Rule 2821) that establishes suitability, disclosure, principal review, and supervisory and training requirements, all tailored specifically to transactions in deferred variable annuities. See Exchange Act Release No. 56375 (Sept. 7, 2007) (SR-NASD-2004-183). See also www.finra.org/RulesRegulation/RuleFilings/2004RuleFilings/P012781.

      7 See NTM 06-38 (August 2006).

      8 See NTM 04-89 (December 2004). Other relevant Notices include NTM 03-71 (November 2003) (relating to non-conventional instruments); NTM 04-30 (April 2004) (relating to bonds and bond funds); NTM 05-26 (April 2005) (relating to vetting new products); and NTM 05-59 (September 2005) (relating to structured products).

      9 IRS Section 72(t) permits penalty-free withdrawals from IRAs before the age of 591/2 pursuant to a series of substantially equal periodic payments. Some registered representatives tout Section 72(t) as a "loophole" that allows investors to retire early by withdrawing assets and investing them in products or strategies that offer higher rates of return. In some cases, the registered representative may promise that the investments will generate returns high enough to allow the investor to maintain a standard of living that is equal to or even higher than they did while working. However, the promised rate of return may be unrealistically high, and investors may not fully appreciate the potential downside to such strategies, including the potential loss of their home, or the depletion of their retirement assets.

      10 On December 27, 2006, the SEC published for comment proposed changes to Regulation D that would establish a new "accredited natural person" requirement for investments in "private investment vehicles." The new standard would exclude the equity in a primary residence from the calculation of an accredited natural person's investment assets. The Commission has not yet adopted the proposal. See Securities Act Release No. 8766 (December 27, 2006) (SEC File No. S7-25-06).

      11 See Securities Act Release No. 8766 (December 27, 2006) (SEC File No. S7-25-06). See also Securities Act Release No. 8828 (August 3, 2007) (SEC File No. S7-18-07).

      12 See NASD IM-2310-3, which outlines certain factors that may be relevant when considering compliance with Rule 2310(a) in connection with recommendations to institutional customers. Two important considerations in determining the scope of a firm's suitability obligations to institutional customers are the customer's ability to evaluate investment risk independently, and the extent to which the customer is exercising that ability in connection with the recommendation.

      13 For example, Nebraska prohibits the use of senior designations, while Massachusetts permits the use of designations only if they have been approved by an independent accreditation agency. See Interpretative Opinion No. 26: Use of Certifications and Designations in Advertising by Investment Adviser Representatives and Broker-Dealer Agents, Special Notice of the Nebraska Department of Banking and Finance (November 13, 2006), available at www.ndbf.org/forms/bd-ia-special-notice.pdf. The Massachusetts regulations became effective June 1, 2007. See 950 Mass. Code Regs. 12.204(2)(i) (2007) (Registration of Broker-Dealer, Agents, Investment Adviser, Investment Adviser Representatives and Notice Filing Procedures), and the Notice of Final Regulations, available at www.sec.state.ma.us/sct/sctpropreg/propreg.htm. Further, as of the date of this Notice, the North American Securities Administrators Association, Inc. (NASAA) is developing a model rule that would "mak[e] it a separate violation of law to use a designation or certification to mislead investors. Once the model rule has been released for public comment and ultimately approved by the NASAA membership, [NASAA] will urge its adoption in every jurisdiction." Testimony of Joseph P. Borg, Director, Alabama Securities Commission and NASAA President, Before the Special Committee on Aging, United States Senate (September 5, 2007).

      14 Firms that are aware of designations that are not included in FINRA's database are invited to provide us with the relevant information so that we may include them.

      15 For relevant materials, visit the FINRA Investor Education Foundation's Web site, www.saveandinvest.org.

      16 To better understand why older investors fall prey to investment fraud, the FINRA Investor Education Foundation funded researchers that analyzed undercover tapes of fraud pitches and surveyed victims and non-victims to determine how they differ. Some of the key research findings include:

      •  Investment fraud victims are more financially literate than non-victims;
      •  Investment fraud criminals use a wide array of different influence tactics—from friendship to fear and intimidation tactics—to defraud the victim;
      •  Fraud pitches are tailored to match the psychological needs of the victim;
      •  Investment fraud victims are more likely to listen to sales pitches;
      •  Investment fraud victims are more likely to rely on their own experience and knowledge when making investment decisions;
      •  Investment fraud victims experience more difficulties from negative life events than non-victims;
      •  Investment fraud victims are more optimistic about the future; and
      •  Investment fraud victims dramatically under-report fraud.

      See Off the Hook Again: Understanding Why the Elderly Are Victimized by Economic Fraud Crimes, survey results and analysis prepared for WISE Senior Services by The Consumer Fraud Research Group (2006), available at www.finrafoundation.org/WISE_Investor_Fraud_Study_Final_Report.pdf.

    • 07-42 SEC Approves NASD Rule 1160 Regarding Firm Contact Information; Effective Date: December 31, 2007

      View PDF File

      Regulatory Notice

      Notice Type

      Rule Amendment

      Referenced Rules & Notices

      NASD Rule 1120
      NASD Rule 1150
      NASD Rule 1160
      NASD IM-3011-2
      NASD Rule 3520
      Suggested Routing

      Compliance
      Executive Representatives
      Legal
      Operations
      Senior Management
      Key Topic(s)

      AML Compliance Officer
      Contact Information
      Emergency Contact Information
      Executive Representative
      FINRA Contact System
      Regulatory Element Contact Person

      Contact Information

      Executive Summary

      Effective December 31, 2007, new NASD Rule 1160 (Contact Information Requirements) streamlines the review and verification of contact information and eliminates the requirement that member firms review and update certain designated contact information on a quarterly basis. The new rule requires firms to update designated contact information promptly upon any material change, verify such information annually and comply promptly with any request for such information.1

      NASD Rule 1160, approved by the SEC on August 1, 2007, and the related rule amendments are set forth in Attachment A of this Notice.

      Questions concerning this Notice should be directed to Patricia Albrecht, Assistant General Counsel, Office of General Counsel, at (202) 728-8026. Questions concerning the FINRA Contact System should be directed to Susanne Henke, Office of Member Relations, at (240) 386-6231.

      Background and Discussion

      Currently, there are several rules that require firms to identify and report to FINRA certain designated contact persons:

      •  NASD Rule 1120 (Continuing Education Requirements)
      •  NASD Rule 1150 (Executive Representative)
      •  NASD IM-3011-2 (Review of Anti-Money Laundering Compliance Person Information) and
      •  NASD Rule 3520 (Emergency Contact Information).

      These rules also require firms to review the contact information at the end of each calendar quarter, and if necessary, update such information within 17 business days after the end of each quarter.2 Member firms review this information and provide any updates online via the FINRA Contact System (FCS).

      Based on recommendations made by its Small Firm Rules Impact Task Force,3 FINRA has decided to eliminate these quarterly review requirements and replace them with NASD Rule 1160, which provides for a more comprehensive approach for verifying and updating all contact information required to be reported. Specifically, NASD Rule 1160 requires firms to provide the required contact information via FCS or such other means as FINRA may specify.4

      NASD Rule 1160 also requires firms to update the contact information promptly, but in any event not later than 30 days following any change in such information, as well as to review and, if necessary, update the information within 17 business days after the end of each calendar year.5 In addition, the rule requires firms to comply with any FINRA request for such information promptly, but in any event not later than 15 days following the request, or such longer period that may be agreed to by FINRA staff.6 NASD Rule 1160, however, does not relieve firms from any separate requirements to update such information.7

      NASD Rule 1160 has several advantages over current FINRA requirements applicable to firm contact information. Since the persons who occupy the designated positions at some firms seldom change, NASD Rule 1160 eliminates any unnecessary burden that firms may incur in conducting quarterly reviews of the contact information. At the same time, NASD Rule 1160 helps to ensure that the contact information required by FINRA is kept current and provided to FINRA promptly upon request. This will assure FINRA's ability to contact its member firms in the event of an emergency, as well as support firms' compliance with certain FINRA rules.

      To assist firms in complying with NASD Rule 1160, FINRA intends to continue the practice by reminding firms at the time they file their fourth quarter FOCUS report of the need to verify annually the required contact information on FCS.

      Finally, the approved rule change also amends NASD Rule 3520 to eliminate the requirement that only a firm's Executive Representative, or his or her written designee, be permitted to review and update the firm's emergency contact information.8 FINRA believes that eliminating this restriction will assist firms in complying with their obligation to keep current their emergency contact information by giving firms the flexibility to have others perform this duty as necessary or appropriate.

      NASD Rule 1160 and the related rule amendments become effective on December 31, 2007. In this regard, firms are reminded that, for the third quarter of 2007, the quarterly verification requirements set forth in NASD Rule 1120 (Continuing Education Requirements), NASD Rule 1150 (Executive Representative). NASD IM-3011-2 (Review of Anti-Money Laundering Compliance Person Information), and NASD Rule 3520 (Emergency Contact Information) remain in effect.


      1 See Securities Exchange Act Release No. 56179 (August 1, 2007), 72 FR 44203 (August 7, 2007) (Order Approving Proposed Rule Change Creating Rule 1160 Regarding the Reporting and Annual Review of Designated Contact Information; File No. SR-NASD-2007-034).

      2 Firms currently are required to promptly update such information in the event of a change, in addition to being required to review, and if necessary, update the designated contact information on a quarterly basis. See Rule 1120(a)(7) (Regulatory Element Contact Person); Rule 3011(d) (Anti-Money Laundering Compliance Program), and Rule 3520(b) (Emergency Contact Information). See also Article IV, Section 3 of the FINRA By-Laws, addressing procedures for members to change their Executive Representatives.

      3 In September 2006, FINRA (then NASD) established the Small Firm Rules Impact Task Force to examine how existing NASD rules impact smaller firms. In particular, the Task Force focuses on possible opportunities to amend or modernize certain conduct rules that may be particularly burdensome for small firms, where such changes are consistent with investor protection and market integrity.

      4 See NASD Rule 1160(a).

      5 See NASD Rule 1160(b).

      6 See NASD Rule 1160(c).

      7 For example, a firm must identify, among others, its Chief Executive Officer and Chief Compliance Officer on Form BD, and promptly update such information by submitting an amendment whenever the information becomes inaccurate or incomplete for any reason. See also Article IV, Section 1(c) of the FINRA By-Laws, requiring each member to ensure that its membership application is kept current at all times by supplementary amendments, and to file any such amendment no later than 30 days after learning of the facts or circumstances giving rise to the amendment.

      8 See Rule 3520(b).


      Attachment A

      Below is the text of the approved rule change. New language is underlined; deletions are in brackets.

      * * * * *

      1120. Continuing Education Requirements

      This Rule prescribes requirements regarding the continuing education of certain registered persons subsequent to their initial qualification and registration with NASD. The requirements shall consist of a Regulatory Element and a Firm Element as set forth below.

      (a) Regulatory Element
      (1) through (6) No Change.
      (7) Regulatory Element Contact Person

      Each member shall designate and identify to NASD (by name and e-mail address) an individual or individuals responsible for receiving e-mail notifications provided via the Central Registration Depository regarding when a registered person is approaching the end of his or her Regulatory Element time frame and when a registered person is deemed inactive due to failure to complete the requirements of the Regulatory Element program[, and provide prompt notification to NASD regarding any change in such designation(s). Each member must review and, if necessary, update the information regarding its Regulatory Element contact person(s) within 17 business days after the end of each calendar quarter to ensure the information's accuracy]. Each member shall identify, review, and, if necessary, update the information regarding its Regulatory Element contact person(s) in the manner prescribed by Rule 1160.
      (b) No Change.

      * * * * *

      1150. Executive Representative

      Each member must identify, review, and, if necessary, update its executive representative designation and contact information as required by Article IV, Section 3 of the NASD By-Laws in the manner prescribed by Rule 1160 [within 17 business days after the end of each calendar quarter].

      * * * * *

      1160. Contact Information Requirements

      (a) Each member shall report to NASD all contact information required by NASD via the NASD Contact System or such other means as NASD may specify.
      (b) Each member shall update its required contact information promptly, but in any event not later than 30 days following any change in such information. In addition, each member shall review and, if necessary, update its required contact information, via the NASD Contact System or such other means as NASD may specify, within 17 business days after the end of each calendar year.
      (c) Each member shall comply with any NASD request for such information promptly, but in any event not later than 15 days following the request, or such longer period that may be agreed to by NASD staff.

      * * * * *

      IM-3011-2. Review of Anti-Money Laundering Compliance Person Information

      Each member must identify, review, and, if necessary, update the information regarding its anti-money laundering compliance person designated pursuant to Rule 3011(d) in the manner prescribed by Rule 1160 [within 17 business days after the end of each calendar quarter to ensure the information's accuracy].

      * * * * *

      3520. Emergency Contact Information

      (a) Each member shall report to NASD, via such electronic or other means as NASD may [require] specify, prescribed emergency contact information for the member. The emergency contact information for the member includes designation of two emergency contact persons. Each emergency contact person shall be a member of senior management and a registered principal of the member.
      (b) Each member must promptly update its emergency contact information, via such electronic or other means as NASD may [require] specify, in the event of any material change. With respect to the designated emergency contact persons, [E]each member must identify, review, and, if necessary, update [its emergency contact information, including] such designations in the manner prescribed by Rule 1160. [of two emergency contact persons, within 17 business days after the end of each calendar quarter to ensure the information's accuracy. The member's Executive Representative, or his or her designee, which designation must be in writing, must conduct such review and any update. Furthermore, members must have adequate controls and procedures to ensure that only the Executive Representative, or his or her written designee, may perform the review and update.]

      * * * * *

    • 07-41 Member Firms are Reminded to Register with FINRA Associated Persons Who Also are Registered with Another SRO in a FINRA-Recognized Registration Category

      View PDF File

      Regulatory Notice

      Notice Type

      Guidance

      Key Topic(s)

      Form U4
      Registration
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Registration
      Senior Management

      FINRA Registration via Form U4

      Executive Summary

      FINRA reminds member firms that when an associated person of a member is registered with another SRO in a registration category recognized by FINRA, the member must register such person in that category with FINRA.

      Questions concerning this Notice may be directed to:

      •  Gary L. Goldsholle, Vice President and Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8104;
      •  Philip A. Shaikun, Associate Vice President and Associate General Counsel, OGC, at (202) 728-8451; or
      •  Richard E. Pullano, Associate Vice President and Chief Counsel, Registration and Disclosure, at (240) 386-4821.

      Discussion

      When an associated person of a FINRA member firm is registered with another self-regulatory organization (SRO) in a registration category recognized by FINRA, the firm must register such person in that category with FINRA. Thus, for example, if a person associated with a FINRA member firm is registered as a General Securities Representative (Series 7) with another SRO, the member must ensure that such person is also registered with FINRA as a General Securities Representative (Series 7). A list of registration categories recognized by FINRA is set forth in Attachment A.

      Registration with FINRA is accomplished by checking the appropriate FINRA registration category on that individual's Form U4.1

      A recent review of Form U4 data has revealed that certain firms have registered their associated persons with another SRO as, for example, a general securities representative, investment company and variable contracts products representative, supervisory analyst or registered options principal, without a corresponding registration with FINRA in those categories. FINRA has contacted the firms involved and instructed them to amend the Forms U4 for those individuals.

      Firms are reminded to ensure that when registering an associated person with another SRO in a category recognized by FINRA, they must denote the corresponding FINRA registration category for that person in the Form U4.


      1 FINRA intends to file a separate rule change to the Forms U4 and U5 to reflect NASD's corporate name change to FINRA. In addition, FINRA plans to implement an automated completeness check in the Central Registration Depository (CRD®) that will automatically flag the corresponding FINRA registration categories that must be checked when an associated person is registered in a FINRA-recognized category with another SRO.


      Attachment A

      FINRA currently recognizes the following categories of SRO registrations:

      OP Registered Options Principal (S4)
      IR Investment Company and Variable Contracts Products Rep. (S6)
      GS Full Registration/General Securities Representative (S7)
      SU General Securities Sales Supervisor (S9 and S10)
      AR Assistant Representative/Order Processing (S11)
      IE United Kingdom—Limited General Securities Registered Representative (S17)
      DR Direct Participation Program Representative (S22)
      GP General Securities Principal (S24)
      IP Investment Company and Variable Contracts Products Principal (S26)
      FA Foreign Associate
      FN Financial and Operations Principal (S27)
      FI Introducing Broker-Dealer/Financial and Operations Principal (S28)
      RS Research Analyst (S86, S87)
      RP Research Principal
      DP Direct Participation Program Principal (S39)
      OR Options Representative (S42)
      MR Municipal Securities Representative (S52)
      MP Municipal Securities Principal (S53)
      CS Corporate Securities Representative (S62)
      RG Government Securities Representative (S72)
      PG Government Securities Principal (S73)
      SA Supervisory Analyst (S16)
      PR Limited Representative—Private Securities Offerings (S82)
      CD Canada-Limited General Securities Registered Representative (S37)
      CN Canada—Limited General Securities Registered Representative (S38)
      ET Equity Trader (S55)
      FP Municipal Fund (S51)
      IF In-Firm Delivery Proctor

    • 07-40 SEC Approves Exception to Three Quote Rule and Related Recordkeeping Requirements for Certain Foreign Securities; Effective Date: September 28, 2007

      View PDF File

      Regulatory Notice

      Notice Type

      Rule Amendment

      Referenced Rules & Notices

      NASD Rule 2320
      NASD Rule 2310
      NASD Rule 3110
      NASD Rule 6610
      Suggested Routing

      Compliance
      Executive Representatives
      Legal
      Operations
      Senior Management
      Systems
      Trading
      Training
      Key Topic(s)

      Books and Records
      Foreign Securities
      Three Quote Rule

      Three Quote Rule

      Executive Summary

      Effective September 28, 2007, transactions in non-exchange-listed securities of a foreign issuer that is part of the FTSE All-World Index will be excluded from the application of Rule 2320(g) (Three Quote Rule) and Rule 3110(b) (Marking of Customer Order Tickets).1 Also as of September 28, 2007, customer transactions in non-exchange-listed securities listed on a Canadian exchange will be excluded from the application of Rules 2320(g) and 3110(b), subject to certain conditions. NASD Rules 2320(g) and 3110(b), as amended, are set forth in Attachment A of this Notice.

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

      Discussion

      The Three Quote Rule originally was adopted on May 2, 1988,2 as an amendment to FINRA's best execution rule and generally requires that firms that execute transactions in non-exchange-listed securities3 on behalf of customers contact a minimum of three dealers (or all dealers if three or less) and obtain quotations, if there are fewer than two quotations displayed on an inter-dealer quotation system that permits quotation updates on a real-time basis. The Three Quote Rule further defined a firm's best execution obligation to customers by setting forth additional requirements for transactions in non-exchange-listed securities, particularly transactions involving relatively illiquid securities with non-transparent prices.

      Since the adoption of the Three Quote Rule, the market for non-exchange-listed securities has changed significantly. FINRA has found that under certain circumstances, the Three Quote Rule can hinder, rather than further, compliance with the duty of best execution by causing significant delays in obtaining executions of customer orders, particularly orders in securities of foreign issuers. Accordingly, FINRA proposed, and the SEC approved, amendments that exclude from the application of the Three Quote Rule transactions effected in non-exchange-listed securities of foreign issuers that are part of the FTSE All-World Index.4

      As amended, a firm is not subject to the Three Quote Rule in connection with transactions in non-exchange-listed securities of a foreign issuer that are part of the FTSE All-World Index. To qualify for the exception, the transaction must be executed during regular business hours of the foreign market for the security and no trading halt or other similar trading or quotation restriction may be in effect in any foreign market on which such foreign security is listed.

      The amendments also codify existing exemptive relief relating to the application of the Three Quote Rule for customer transactions in Canadian securities executed on a Canadian exchange. As amended, a member firm is not subject to the Three Quote Rule in connection with any transaction for or with a customer in a non-exchange-listed security executed on a Canadian exchange, provided that (i) the firm or person associated with the firm conducts, pursuant to Rule 2320(a) and the duty of best execution, regular and rigorous reviews of the quality of the execution of such orders in such securities, and (ii) the orders are executed either in an agency or riskless principal capacity.

      The amendments also provide a corresponding exclusion to the recordkeeping requirements set forth in Rule 3110(b) if the member can establish and document its reliance on the exclusions to the Three Quote Rule.5 Firms continue to be required to comply with, among other rules, their best execution obligations under Rule 2320(a), and to the extent applicable, their suitability obligations under Rule 2310 (Recommendations to Customers).

      The amendments to Rules 2320(g) and 3110(b) become effective on September 28, 2007.


      1 See Securities Exchange Act Release No. 56004 (July 2, 2007), 72 FR 37285 (July 9, 2007) (order approving SR-NASD-2004-130).

      2 See Securities Exchange Act Release No. 25637 (May 2, 1988), 53 FR 16488 (May 9, 1988).

      3 A non-exchange-listed security is defined in Rule 6610 as generally any equity security that is not traded on any national securities exchange.

      4 The Financial Times and the London Stock Exchange operate the FTSE All-World Index. The FTSE All-World Index includes 48 different countries and approximately 3,000 securities. Securities included in the FTSE All-World Index can be obtained from the monthly FTSE All-World Review under the "Country Details" section of the review. The FTSE All-World Review is available for free on the on FTSE's Web site at http://www.ftse.com by registering to access the data. Daily updated constituent lists are also available to paying subscribers from FTSE and other data vendors. See Exhibit 2 to Amendment No. 2 to SR-NASD-2004-130 for a detailed description. Additional information also is available on FTSE's Web site at http://www.ftse.com.

      5 Rule 3110(b) requires that members indicate on the order ticket for each transaction in a non-exchange-listed security the name of each dealer contacted and the quotations received to determine the best inter-dealer market as required by the Three Quote Rule.


      ATTACHMENT A

      Below is the text of the rule change. New language is underlined; deletions are in brackets.

      2320. Best Execution and Interpositioning

      (a) through (f) No Change.
      (g)
      (1) Except as provided in subparagraph (3) below, [Unless two or more priced quotations for a non-exchange-listed security (as defined in the Rule 6600 Series) are displayed in an inter-dealer quotation system that permits quotation updates on a real-time basis,] in any transaction for or with a customer pertaining to the execution of an order in a non-exchange-listed security (as defined in the Rule 6600 Series), a member or person associated with a member shall contact and obtain quotations from three dealers (or all dealers if three or less) to determine the best inter-dealer market for the subject security.
      (2) No Change.
      (3) The requirements described in subparagraph (1) above shall not apply:
      (A) when two or more priced quotations for a non-exchange-listed security are displayed in an inter-dealer quotation system that permits quotation updates on a real-time basis; or
      (B) to any transaction for or with a customer pertaining to the execution of an order in a non-exchange-listed security of a foreign issuer that is part of the FTSE All-World Index if such transaction is executed during the regular business hours of the foreign market for the foreign security and no trading halt or other similar trading or quoting restriction is in effect in any foreign market on which such foreign security is listed; or
      (C) to any transaction for or with a customer pertaining to the execution of an order in a non-exchange-listed security that is listed on a Canadian exchange, provided that (i) such order is executed by the member or a person associated with the member on a Canadian exchange in an agency or riskless principal capacity; and (ii) the member or a person associated with the member conducts, pursuant to NASD Rule 2320(a) and the duty of best execution, regular and rigorous reviews of the quality of the execution of such orders in such securities.
      (4) Definitions

      For purposes of this paragraph (g):[,]
      (A) T[t]he term "inter-dealer quotation system" means any system of general circulation to brokers or dealers that regularly disseminates quotations of identified brokers or dealers.
      (B) [(4) For purposes of this paragraph,] T[t]he term "quotation medium" means any inter-dealer quotation system or any publication or electronic communications network or other device that is used by brokers or dealers to make known to others their interest in transactions in any security, including offers to buy or sell at a stated price or otherwise, or invitations of offers to buy or sell.
      (5) No Change.

      * * * * *

      3110. Books and Records

      (a) No Change.
      (b) Marking of Customer Order Tickets

      A person associated with a member shall indicate on the memorandum for each transaction in a non-exchange-listed security, as that term is defined in the Rule 6600 Series, the name of each dealer contacted and the quotations received to determine the best inter-dealer market; however, the requirements of this subparagraph shall not apply if the member can establish and has documented that:
      (1) two or more priced quotations for the security are displayed in an inter-dealer quotation system, as defined in Rule 2320(g), that permits quotation updates on a real-time basis for which NASD [Regulation] has access to historical quotation information; or
      (2) the transaction is effected in compliance with Rule 2320(g)(3)(B) or (C).
      (c) through (j) No Change.

    • 07-39 SEC Approves Amendments Regarding OATS Routing Method Code for Intermarket Sweep Orders Effective Date: February 4, 2008

      View PDF File

      Regulatory Notice

      Notice Type

      Guidance

      Referenced Rules & Notices

      NASD Rules 6950 through 6958 (OATS Rules)
      NTM 06-70
      SEC Rule 611 (Order Protection Rule)
      Suggested Routing

      Compliance
      Internal Audit
      Legal
      Operations
      Registered Representatives
      Senior Management
      Systems
      Trading
      Key Topic(s)

      Intermarket Sweep Orders
      OATS
      Regulation NMS

      Order Audit Trail System (OATS)

      Executive Summary

      Effective February 4, 2008, firms that transmit an intermarket sweep order (ISO), as defined in Regulation NMS, in an OATS-eligible security to another member firm, electronic communications network, non-member or exchange, must record and report the fact that the order was an ISO in their OATS reports.1 The amendments to the OATS rules are attached to this Notice as Exhibit A.

      Questions concerning this Notice may be directed to the Legal Section, Market Regulation, at (240) 386-5126, or to the Office of General Counsel at (202) 728-8071.

      Discussion

      NASD Rules 6950 through 6958 (OATS Rules) impose obligations on member firms to record in electronic form and report to OATS on a daily basis certain information regarding orders in NASDAQ-listed securities originated, received, transmitted, modified, canceled or executed by FINRA member firms.2 FINRA integrates the OATS information with quote and transaction information to create a time-sequenced record of orders, quotes and transactions. This information is used by FINRA in conducting surveillance and investigations of firms for violations of NASD rules and the federal securities laws.

      On June 9, 2005, the SEC adopted Regulation NMS, which established new substantive rules designed to modernize and strengthen the regulatory structure of the U.S. equities markets.3 Among other things, Regulation NMS adopted an Order Protection Rule (SEC Rule 611) that requires trading centers to establish, maintain and enforce written policies and procedures reasonably designed to prevent the execution of trades at prices inferior to protected quotations displayed by automated trading centers, subject to applicable exceptions. One of the exceptions from the Order Protection Rule is when the transaction that constitutes a trade-through4 is "effected by a trading center that simultaneously routed an intermarket sweep order to execute against the full displayed size of any protected quotation in the NMS stock that was traded through."5

      The purpose of the new amendments to the OATS rules is to require firms to record the fact that an order in an OATS-eligible security is an ISO when the firm routes an ISO to another member or non-member firm. Firms will be required to include this information in the Route Report that it submits to OATS by designating ISOs with a routing method code of "I."6 This requirement will ensure that FINRA knows that the order was an ISO and can utilize that information when reviewing audit trails to ensure compliance with Regulation NMS.

      The new ISO routing method code applies only to those orders required to be recorded and reported to FINRA pursuant to the OATS Rules. The new requirements do not require firms to submit Route Reports for all ISOs.

      Firms are required to use the ISO routing method code of "I" on Route Reports beginning February 4, 2008. However, the routing method code is already currently available for use by firms, and firms are encouraged to use the code on their Route Reports as soon as possible to facilitate FINRA's ability to determine whether a trade is made in reliance on an ISO exception from the Order Protection Rule.7

      In addition, FINRA is reminding firms of the current requirement to identify ISOs in OATS New Order Reports. Specifically, NASD Rule 6954(b)(15) requires firms to include in New Order Reports any "special handling requests, specified by [FINRA] for purposes of this Rule." Pursuant to that provision, the OATS Reporting Technical Specifications now include a new special handling code ("ISO") for ISOs in New Order Reports, which must be used when a firm relies on the exception from the Order Protection Rule for a transaction that "was the execution of an order identified as an intermarket sweep order."


      1 Securities Exchange Act Release No. 56003 (July 2, 2007), 72 FR 37287 (July 9, 2007) (SR-NASD-2007-028).

      2 Beginning on February 4, 2008, member firms also will be required to record and report order information regarding all OTC equity securities, as defined in NASD Rule 6951. See Securities Exchange Act Release No. 54585 (October 10, 2006); 71 FR 61112 (October 17, 2006) (SR-NASD-2005-101); NASD Notice to Members 06-70 (December 2006); see also Securities Exchange Act Release No. 55440 (March 9, 2007), 72 FR 12852 (March 19, 2007) (SR-NASD-2007-019).

      3 Securities Exchange Act Release No. 51808 (June 9, 2005), 70 FR 37496 (June 29, 2005).

      4 A "trade-through" is "the purchase or sale of an NMS stock during regular trading hours, either as principal or agent, at a price that is lower than a protected bid or higher than a protected offer." See 17 CFR 242.600(b)(77).

      5 See 17 CFR 242.611(b)(6). The phrase "intermarket sweep order" is defined in SEC Rule 600(b)(30) as "a limit order for an NMS stock that meets the following requirements: (i) When routed to a trading center, the limit order is identified as an intermarket sweep order; and (ii) Simultaneously with the routing of the limit order identified as an intermarket sweep order, one or more additional limit orders, as necessary, are routed to execute against the full displayed size of any protected bid, in the case of a limit order to sell, or the full displayed size of any protected offer, in the case of a limit order to buy, for the NMS stock with a price that is superior to the limit price of the limit order identified as an intermarket sweep order. These additional routed orders must also be marked as intermarket sweep orders." The amendments to the OATS Rules adopt this same definition of intermarket sweep order.

      6 When a member firm transmits an order in an OATS-eligible security to another member, electronic communications network, non-member, or exchange for handling or execution, the routing member is required to submit a Route Report to FINRA. The categories of information that a firm must include in a Route Report are set forth in NASD Rule 6954(c) and in the OATS Reporting Technical Specifications published by FINRA.

      7 For further guidance on the use of the "I" routing method code and the "ISO" special handling code, see "Additional Guidance Regarding the OATS Routing Method Code of 'I' and Special Handling Code of 'ISO,'" which is available on FINRA's OATS Web page at www.finra.org/RegulatorySystems/OATS/OATSReportIndex/p019397. Firms may also wish to consult the OATS Reporting Technical Specifications for further information.


      EXHIBIT A

      Below is the text of the rule change. New language is underlined; deletions are in brackets.

      6950. ORDER AUDIT TRAIL SYSTEM

      6951. Definitions

      For purposes of the Rule 6950 Series:

      (a) through (g) No change.
      (h) "Intermarket sweep order" shall have the same meaning as contained in SEC Rule 600(b)(30) adopted pursuant to the Act.
      (h) through (n) are designated as (i) through (o).

      * * * * *

      6954. Recording of Order Information

      (a) through (b) No change.
      (c) Order Transmittal

      Order information required to be recorded under this Rule when an order is transmitted includes the following.
      (1) No change.
      (2) When a member electronically transmits an order to another member, other than an order transmitted electronically for execution on an Electronic Communications Network:
      (A) the transmitting Reporting Member shall record:
      (i) through (iv) No change.
      (v) the date and time the order is transmitted, [and]
      (vi) the number of shares to which the transmission applies,[;] and
      (vii) whether the order is an intermarket sweep order; and
      (B) No change.
      (3) When a member electronically transmits an order for execution on an Electronic Communications Network:
      (A) the transmitting Reporting Member shall record:
      (i) through (v) No change.
      (vi) the date and time the order is transmitted, [and] (vii) the number of shares to which the transmission applies,[;] and
      (viii) whether the order is an intermarket sweep order; and
      (B) No change.
      (4) When a member manually transmits an order to another member, other than to an Electronic Communications Network:
      (A) the transmitting Reporting Member shall record:
      (i) through (vi) No change.
      (vii) the number of shares to which the transmission applies, [and]
      (viii) for each order to be included in a bunched order, the bunched order route indicator assigned to the bunched order by the Reporting Member,[;] and
      (ix) whether the order is an intermarket sweep order; and
      (B) No change.
      (5) When a member manually transmits an order to an Electronic Communications Network:
      (A) the transmitting Reporting Member shall record:
      (i) through (vi) No change.
      (vii) the number of shares to which the transmission applies, [and]
      (viii) for each order to be included in a bunched order, the bunched order route indicator assigned to the bunched order by the Reporting Member,[;] and
      (ix) whether the order is an intermarket sweep order; and
      (B) No change.
      (6) When a member transmits an order to a non-member, including but not limited to a national securities exchange, the Reporting Member shall record:
      (A) through (G) No change.
      (H) the routed order identifier or other unique identifier required by the non-member receiving the order, as applicable, [and]
      (I) identification of the non-member where the trade was transmitted, and[.]
      (J) whether the order is an intermarket sweep order.

    • 07-38 FINRA Extends Implementation of Rule Amendments Relating to Non-Tape (Or Clearing-Only) Reports for Previously Executed Trades Revised Effective Date: November 5, 2007

      View PDF File

      Regulatory Notice

      Notice Type

      Rule Amendment

      Referenced Rules & Notices

      NASD Rules 6130, 6130A, 6130C, 6130D and 6130E
      NASD Rules 4632, 4632A, 4632C, 4632D and 4632E
      NASD Rule 5000
      Regulatory Notice 07-33
      NTM 05-11
      NTM 98-40
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Senior Management
      Systems
      Trading
      Key Topic(s)

      Agency
      Alternative Display Facility
      OTC Reporting Facility
      Riskless Principal
      Step-Outs
      Reversals
      Trade Reporting
      Trade Reporting Facilities

      Non-Tape (Or Clearing-Only) Reports

      Executive Summary

      FINRA is issuing this Notice to extend the effective date of the new trade reporting requirements relating to non-tape (or clearing-only) reports. This Notice supersedes Regulatory Notice 07-33 (August 2007) and replaces the guidance provided in that Notice.

      As revised, on November 5, 2007, member firms will be prohibited from submitting to a FINRA Facility any report (including but not limited to reports of step-outs and reversals) associated with a previously executed trade that was not reported to that FINRA Facility, except where such report is submitted to reflect the offsetting portion of a riskless principal transaction or an agency transaction where a firm acts as agent on behalf of another member firm.

      The text of the amended rule language is available at www.finra.org/rulefilings/2007-040.

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

      Background & Discussion

      On June 22, 2007, FINRA filed with the Securities and Exchange Commission (SEC) for immediate effectiveness a proposed rule change amending the trade reporting requirements relating to the submission of non-tape reports (i.e., the transaction is not reported to the tape for publication) and clearing-only reports (i.e., the transaction is not reported to the tape but may be submitted for clearing purposes).1 In Notice 07-33, FINRA announced that the effective date of the rule amendments would be September 4, 2007. In response to feedback from firms, FINRA is extending implementation of the rule amendments until November 5, 2007.

      As amended, with certain exceptions (discussed below), the trade reporting rules prohibit firms from submitting to a FINRA Facility (i.e., the Alternative Display Facility, a Trade Reporting Facility (TRF)2 or the OTC Reporting Facility) any report (including but not limited to reports of step-outs3 and reversals) associated with a previously executed trade that was not reported to that FINRA Facility.4 Among other things, this means that a firm cannot use a FINRA Facility to step-out of an exchange trade.5 For example, a clearing-only entry for a step-out relating to a trade executed on and reported through the NASDAQ Exchange cannot be submitted to the FINRA/NASDAQ TRF.6 Clearing-only reports that provide for the re-allocation or cancellation of a transaction that was previously reported to an exchange can make it more difficult for FINRA to tabulate accurately the aggregate dollar amount of its covered sales for purposes of Section 31 fees.7 Entry of these transactions in a FINRA Facility, when the original transaction was reported and assessed a Section 31 fee by an exchange, can result in the misalignment of Section 31 fees with the appropriate market and market participants.

      Similarly, under the amended rules, firms are not permitted to report a trade to a FINRA Facility for submission to the National Securities Clearing Corporation (NSCC) for clearance and settlement purposes, if the trade was not reported to that same FINRA Facility for public dissemination or regulatory transaction fee assessment purposes. For example, except as discussed below, a member firm cannot tape report a trade toTRF A and use TRF B to clear that same trade.

      Under the amended rules, there is an exception to the above-referenced prohibition for reports that reflect the offsetting, "riskless" portion of a riskless principal transaction and firms may continue to report such transactions as they do today.8 For example, where the initial leg of the transaction is executed on and reported through an exchange, a tape report will not be submitted to FINRA to reflect the initial leg; however, a firm may (but is not required to) submit a non-tape (or clearing-only) report for the second leg of the transaction to FINRA. Similarly, this exception applies if a firm is acting in an agency capacity on behalf of another member firm and the report is necessary to reflect the offsetting portion of the agency transaction.9 Thus, for example, similar to the riskless principal reporting structure, where Firm A, as agent for Firm B, executes a trade on an exchange (and that trade is reported to the tape through the exchange), Firm A may submit a non-tape (or clearing-only) report to FINRA to reflect the offsetting portion of the agency trade between Firm A and Firm B.

      With respect to any transactions that do not fall within this exception, FINRA believes that the extended implementation date will provide sufficient time for firms to make alternative clearing arrangements, if necessary (e.g., via Qualified Service Representative (QSR) agreements with NSCC).

      Finally, FINRA has amended the trade reporting rules to clarify that where a tape and non-tape report for a riskless principal transaction (or, similarly, an agency transaction where a firm acts as agent on behalf of another member firm) are submitted to FINRA, firms are not required to submit both reports to the same FINRA Facility.10 As discussed in FINRA's filing, the current trade reporting rules could have the unintended consequence of requiring firms to be participants in all TRFs in order to comply with the trade reporting rules.11 FINRA expects that where possible, firms will submit related tape and non-tape reports to the same FINRA Facility.


      1 See Securities Exchange Act Release No. 55962 (June 26, 2007), 72 FR 36536 (July 3, 2007) (notice of filing and immediate effectiveness of SR-NASD-2007-040).

      2 Currently, there are four TRFs in operation: the FINRA/NASDAQ TRF, the FINRA/NSX TRF, the FINRA/BSE TRF and the FINRA/NYSE TRF.

      3 A step-out allows firms to allocate all or part of a previously executed trade to another broker-dealer. In other words, a step-out functions as a position transfer, rather than a trade; the parties are not exchanging shares and funds. The step-out function was designed and implemented to facilitate the clearing process for firms involved in these types of transactions. See, e.g., Notice to Members 05-11 (February 2005) and Notice to Members 98-40 (May 1998).

      4 See amendments to NASD Rules 6130 (new paragraph (i)), 6130A (new paragraph (d)), 6130C (new paragraph (h)), 6130D (new paragraph (h)) and 6130E (new paragraph (h)).

      5 Exchange trades generally are considered trades executed on or through an exchange and are submitted for public dissemination purposes by that exchange. Trades executed by FINRA firms otherwise than on an exchange must be reported to a FINRA Facility for public dissemination purposes. See NASD Rule 5000.

      6 Firms should consult the relevant exchanges to determine if they support such step-out functionality.

      7 For example, as explained in Notice to Members 05-11 (February 2005), as part of the step-out function, the transaction fee associated with a trade can be moved to the ultimate seller of the security when the trade is allocated.

      8 For purposes of over-the-counter trade reporting requirements applicable to equity securities, a "riskless principal" transaction is a transaction in which a firm, after having received an order to buy (sell) a security, purchases (sells) the security as principal and satisfies the original order by selling (buying) as principal at the same price (the offsetting, "riskless" leg). A riskless principal transaction can be submitted as a single trade report marked as riskless principal, or as two separate reports: (1) a report that is submitted to the tape to reflect the initial leg of the transaction and (2) a non-tape (or clearing-only) report to reflect the offsetting, "riskless" leg of the transaction. See NASD Rules 4632(d)(3)(B), 4632A(e)(1)(C)(ii), 4632C(d)(3)(B), 4632D(e)(3)(B), 4632E(e)(3)(B) and 6620(d)(3)(B).

      9 Since a riskless principal transaction is the functional equivalent of this type of agency transaction, the exception for riskless principal transactions under the amended rules extends to agency transactions where a firm acts as agent on behalf of another member firm.

      10 See amendments to NASD Rules 4632(d), 4632A(e), 4632C(d), 4632D(e) and 4632E(e).

      11 For example, assume Firm A is only a participant of TRF A and it executes the first leg of a riskless principal transaction otherwise than on exchange with Firm B, which is only a participant of TRF B. Assume further that Firm B has the reporting obligation under the trade reporting rules. The initial leg of the riskless principal trade will be reported by Firm B to TRF B. Firm A must report the second leg of the riskless principal transaction to FINRA, but because it is not a participant of TRF B, it cannot report the second leg to TRF B. The amended rules allow Firm A to report the second leg of the transaction to TRF A.

    • 07-37 Extension of Pilot Program Increasing Position and Exercise Limits for Stock Options

      View PDF File

      Regulatory Notice

      Notice Type

      Rule Amendment

      Referenced Rules & Notices

      NASD Rule 2860
      NTM 06-46
      NTM 06-09
      NTM 05-56
      NTM 05-31
      Suggested Routing

      Compliance
      Institutional
      Legal
      Options
      Senior Management
      Trading
      Training
      Key Topic(s)

      Exercise Limits
      Options
      Position Limits

      Options Position and Exercise Limits

      Executive Summary

      SEC amendments to NASD Rule 2860 extend until March 1, 2008, a pilot program increasing certain stock options position and exercise limits. The pilot program was scheduled to expire on September 1, 2007.

      The rules, as amended, are set forth in Attachment A. The amendments become effective September 1, 2007.

      Questions concerning this Notice may be directed to Gary L. Goldsholle, Vice President and Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8104; or James L. Eastman, Assistant General Counsel, OGC, at (202) 728-6961.

      Background and Discussion

      On July 31, 2007, FINRA filed for immediate effectiveness with the Securities and Exchange Commission (SEC) amendments to NASD Rule 2860 extending until March 1, 2008, a pilot program increasing certain stock options position and exercise limits ("Pilot Program").1 The Pilot Program was scheduled to expire on September 1, 2007.2 FINRA extended the Pilot Program to allow it to continue without interruption.

      NASD Rule 2860(b)(3)(A) imposes a ceiling or position limit on the number of conventional and standardized equity options contracts in each class on the same side of the market (i.e., aggregating long calls and short puts or long puts and short calls) that can be held or written by a member, a person associated with a member, a customer or a group of customers acting in concert.3 The rule provides that the position limits for stock options are determined according to a five-tiered system in which more actively-traded stocks with larger public floats are subject to higher position limits.

      Pursuant to the Pilot Program, which began March 30, 2005, and now ends March 1, 2008, unless extended ("Pilot Period"), the limits for each of the tiers remains increased as follows:

      (a) 13,500 contracts has been increased to 25,000 contracts;
      (b) 22,500 contracts has been increased to 50,000 contracts;
      (c) 31,500 contracts has been increased to 75,000 contracts;
      (d) 60,000 contracts has been increased to 200,000 contracts; and
      (e) 75,000 contracts has been increased to 250,000 contracts.

      These tiers apply to both conventional and standardized options. Options exercise limits, which are set forth in NASD Rule 2860(b)(4), and which incorporate by reference the position limits in NASD Rule 2860(b)(3), also have been increased during the Pilot Period.


      1 Securities Exchange Act Release No. 56265 (August 15, 2007), 72 FR 47102 (August 22, 2007) (SR-FINRA-2007-002).

      2 See Securities Exchange Act Release No. 55225 (February 1, 2007), 72 FR 6634 (February 12, 2007) (SR-NASD-2007-007); Securities Exchange Act Release No. 54334 (August 18, 2006), 71 FR 50961 (August 28, 2006) (SR-NASD-2006-097) (extending Pilot Program); NASD Notice to Members 06-46 (August 2006); Securities Exchange Act Release No. 53346 (February 22, 2006), 71 FR 10580 (March 1, 2006) (SR-NASD-2006-025) (extending Pilot Program); NASD Notice to Members 06-09 (March 2006); Securities Exchange Act Release No. 52271 (August 16, 2005), 70 FR 49344 (August 23, 2005) (SR-NASD-2005-097) (extending Pilot Program); NASD Notice to Members 05-56 (August 2005); Securities Exchange Act Release No. 51520 (April 11, 2005), 70 FR 19977 (April 15, 2005) (SR-NASD-2005-040) (establishing Pilot Program); NASD Notice to Members 05-31 (April 2005).

      3 A "standardized equity option" is an equity options contract issued, or subject to issuance by, The Options Clearing Corporation that is not a FLEX Equity Option. NASD Rule 2860(b)(2)(VV). A "conventional option" is an option contract not issued, or subject to issuance by, The Options Clearing Corporation. NASD Rule 2860(b)(2)(O). The limits on standardized equity options in NASD Rule 2860 are applicable only to those FINRA member firms that are not also members of the exchange on which the option is traded; the limits on conventional options are applicable to all FINRA member firms. NASD Rule 2860(b)(1)(A).


      ATTACHMENT A

      New text is underlined; deletions are in brackets.

      2800. SPECIAL PRODUCTS

      2860. Options

      (a) No Change.
      (b) Requirements.
      (1) and (2) No Change.
      (3) Position Limits
      (A) Stock Options—Except in highly unusual circumstances, and with the prior written approval of NASD pursuant to the Rule 9600 Series for good cause shown in each instance, no member shall effect for any account in which such member has an interest, or for the account of any partner, officer, director or employee thereof, or for the account of any customer, non-member broker, or non-member dealer, an opening transaction through Nasdaq, the over-the-counter market or on any exchange in a stock option contract of any class of stock options if the member has reason to believe that as a result of such transaction the member or partner, officer, director or employee thereof, or customer, non-member broker, or non-member dealer, would, acting alone or in concert with others, directly or indirectly, hold or control or be obligated in respect of an aggregate equity options position in excess of:
      (i) 13,500 (or 25,000 during the pilot period from March 30, 2005 through [September 1, 2007]March 1, 2008 ("Pilot Period")) option contracts of the put class and the call class on the same side of the market covering the same underlying security, combining for purposes of this position limit long positions in put options with short positions in call options, and short positions in put options with long positions in call options;
      (ii) through (viii) No Change.
      (B) through (D) No Change.
      (4) through (24) No Change.

    • 07-36 FINRA Clarifies Guidance Relating to SEC Regulation S-P under Notice to Members 07-06 (Special Considerations When Supervising Recommendations of Newly Associated Registered Representatives to Replace Mutual Funds and Variable Products)

      View PDF File

      Supervision of Recommendations after a Registered Representative Changes Firms

      Regulatory Notice

      Notice Type

      Guidance

      Referenced Rules & Notices

      NTM 07-06
      SEC Regulation S-P
      Suggested Routing

      Compliance
      Executive Representatives
      Legal
      Operations
      Senior Management
      Key Topic(s)

      SEC Regulation S-P
      Mutual Funds
      Registered Representatives
      Supervision
      Variable Products

      Executive Summary

      In February 2007, FINRA (f/k/a NASD) issued NTM 07-06, which describes special considerations firms should use to supervise recommendations of newly hired registered representatives to replace mutual funds and variable products. This Notice clarifies the guidance in NTM 07-06 regarding SEC Regulation S-P.

      Questions concerning this Notice should be directed to Patricia Albrecht, Assistant General Counsel, Office of General Counsel, at (202) 728-8026; or Kosha K. Dalal, Associate General Counsel, Office of General Counsel, at (202) 728-6903.

      Background and Discussion

      As stated in Notice to Members (NTM) NTM 07-06, registered representatives with an established customer base may change their association from one firm to another from time to time, and may wish to bring with them customer assets, including mutual funds and variable products. However, there may be impediments to the representative's ability to continue servicing or selling these investments, as well as receiving trail commissions from the sponsor for products the representative previously serviced or sold, such as the new firm not having a dealer or servicing agreement with the product sponsor or the products being proprietary to the prior firm. In such cases, NTM 07-06 states that representatives may be tempted to recommend to customers that they replace their existing mutual funds or variable products with other investments, without adequately considering the customer's best interests and the suitability for the customer of those recommendations.

      As a result, the NTM recommends that firms should have procedures in place, including supervisory procedures, that are specifically designed to review and evaluate investment recommendations relating to mutual funds and variable products that are made by newly associated persons to their existing customers. Specifically, the NTM recommends that these procedures provide that when a firm conducts due diligence concerning a prospective new registered representative, the new firm should seek to learn the nature of the representative's business and the extent to which he or she offers investment products for which the new firm would need a dealer or servicing agreement in order for the representative to sell and provide service.

      Some firms have questioned the scope of due diligence described in the NTM, and have specifically asked whether any such due diligence procedures may conflict with a firm's obligations under SEC Regulation S-P (Privacy of Consumer Financial Information), which imposes restrictions on the ability of financial institutions to disclose or share nonpublic personal information about consumers.1 The obligations set forth in NTM 07-06 do not conflict with a firm's obligations under SEC Regulation S-P. Indeed, in establishing due diligence procedures, NTM 07-06 does not recommend, nor does it suggest, that a firm obtain nonpublic personal information about any customers the prospective registered representative may seek to bring to the new firm. FINRA expects firms to keep in mind that the goal of such due diligence procedures is for the firm and its prospective new registered representative to understand the extent to which there exist mutual funds and variable products currently held in the representative's customer accounts that may not be serviced or sold by the new firm.

      Therefore, in conducting reasonable due diligence of the prospective registered representative's customer base, the new firm needs to learn only the identity of the various mutual fund and variable products held by the registered representative's customer base. Detailed, nonpublic, personal information about individual customers and their particular investments is not necessary or relevant to meet the objectives of this review. Finally, it is incumbent upon firms to educate their prospective representatives in understanding that a change of employment is not by itself a suitable basis for recommending a switch from one product to another and to supervise with respect to such conduct.


      1 17 CFR Part 248; Release No. 34-42974.

    • 07-35 Extension of Temporary Relief from NYSE Rule 409(f) (Statements of Accounts to Customers) to January 1, 2008

      View PDF File

      Extension of Regulatory Relief

      Regulatory Notice

      Notice Type

      Guidance

      Referenced Rules & Notices

      NYSE Rule 409
      Regulation NMS
      SEC Rule 10b-10
      Suggested Routing

      Compliance
      Legal
      Operations
      Senior Management
      Technology
      Key Topic(s)

      Confirmations
      Statements of Account

      PLEASE NOTE: The FINRA rulebook currently consists of both NASD Rules and certain NYSE Rules that FINRA has incorporated, including NYSE Rule 409. The incorporated NYSE Rules apply solely to members of FINRA that are also members of NYSE on or after July 30, 2007, referred to as "Dual Members." Dual Members also must comply with NASD Rules. Until the adoption of a consolidated rulebook, FINRA's Regulatory Notices will address both NASD and the incorporated NYSE Rules.

      Executive Summary

      On March 20, 2007, NYSE granted temporary relief, until September 30, 2007, from the application of NYSE Rule 409(f) regarding the disclosure of the name of the securities market on which a transaction was effected.1 FINRA is hereby extending such relief to January 1, 2008.2

      Questions regarding this Notice may be directed to your Finance Coordinator, or the FINRA Office of General Counsel, at (202) 728-8071.

      Background and Discussion

      NYSE Rule 409(f) requires that confirmations of all transactions (including those made "over-the-counter" and on other exchanges) in securities admitted to dealings on the NYSE, sent by FINRA members that are also members of NYSE (Dual Members) to their customers, shall indicate the settlement date of the transaction and the name of the securities market on which the transaction was effected. This requirement also applies to confirmations or reports from a Dual Member to a correspondent, but does not apply to reports made by floor brokers to the Dual Member from which the orders were received.3

      With the adoption of Regulation NMS (Reg NMS), an increasing number of orders routed to a given market for execution are rerouted to other markets which at that time display a better quotation. This process, required under the Reg NMS Order Protection Rule,4 may often lead to relatively small orders receiving executions in multiple market centers. This has created an operational challenge for Dual Members to capture the name of the market of execution on a timely basis for inclusion on the transaction confirmation.

      As a result of these challenges, and given that Reg NMS requires Dual Members to comply with their "best execution" obligations to exercise diligence to obtain the best price when routing customer trades for execution, the relief from the application of NYSE Rule 409(f), with respect to the name of the market of execution, is extended until January 1, 2008. During this interim period, FINRA will continue to reassess the utility of NYSE Rule 409(f) in the current regulatory environment.


      1 See NYSE Information Memorandum 07-28 (March 20, 2007).

      2 See also NYSE Information Memorandum 07-84 (August 2, 2007).

      3 See also SEC Rule 10b-10.

      4 See Rule 611 under Reg NMS, 17 CFR 242.611. The Order Protection Rule requires trading centers, including broker-dealers that internally execute orders, to establish,maintain and enforce written policies and procedures reasonably designed to protect against "trade-throughs" of protected quotations in NMS stocks.

    • 07-34 SEC Approves Amendments Relating to the Issuer-Directed Provisions of Rule 2790; Effective Date: September 5, 2007

      View PDF File

      Regulatory Notice

      Notice Type

      Rule Amendment

      Referenced Rules & Notices

      Rule 2790
      NTM 03-79
      "New Issue" Rule
      Suggested Routing

      Compliance
      Corporate Financing
      Executive Representatives
      Institutional
      Legal
      Operations
      Senior Management
      Syndicate
      Trading
      Market Making
      Training
      Underwriting
      Key Topic(s)

      IPOs
      Issuer-Directed Securities
      "New Issue" Rule
      Rule 2790

      Executive Summary

      On June 7, 2007, the SEC approved amendments to Rule 2790 to prohibit issuer-directed allocations of new issues to broker-dealers and to provide an exemption for issuer-directed non-underwritten offerings.1 The Rule, as amended, is set forth in Attachment A of this Notice. The amendments become effective on September 5, 2007.

      Questions/Further Information

      Questions concerning this Notice may be directed to Gary L. Goldsholle, Vice President and Associate General Counsel, Office of General Counsel (OGC), at (202) 728-8104; or Afshin Atabaki, Assistant General Counsel, OGC, at (202) 728-8902.

      Background and Discussion

      Rule 2790 (Restrictions on the Purchase and Sale of Initial Equity Public Offerings) protects the integrity of the public offering process by ensuring that:

      (1) member firms make bona fide public offerings of securities at the offering price;
      (2) member firms 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 member firms; and
      (3) industry insiders, including member firms 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.

      Rule 2790 provides that, except as otherwise permitted under the Rule, a firm (or an associated person) may not sell a new issue to an account in which a restricted person has a beneficial interest; a member firm (or an associated person) may not purchase a new issue in any account in which such firm or associated person has a beneficial interest; and a firm may not continue to hold new issues acquired as an underwriter, selling group member, or otherwise.

      FINRA has recognized that shares directed by an issuer do not raise the same regulatory concerns as shares allocated by a broker-dealer.2 Moreover, shares directed by an issuer often further the legitimate business interests of the issuer.3 Accordingly, Rule 2790 exempts, for most purchasers, securities that are specifically directed by the issuer.4

      Prohibition of Issuer-Directed Allocations to Broker-Dealers

      Rule 2790(d)(1) generally exempts from the scope of the Rule allocations of new issue securities that are specifically directed by the issuer. However, for securities directed to an account in which broker-dealer personnel, finders or fiduciaries, or certain members of their immediate family have a beneficial interest,5 the exemption is only applicable if such persons, or members of their immediate family, are employees or directors of the issuer, the issuer's parent, or a subsidiary of the issuer or the issuer's parent. These additional conditions are designed to ensure that broker-dealer personnel, finders, fiduciaries and certain members of their immediate family, who typically have the greatest potential to influence the IPO allocation process, have a demonstrated basis for being selected by the issuer to purchase shares in the IPO.

      FINRA is further limiting the exemption for issuer-directed securities in Rule 2790(d)(1) to exclude new issue securities directed to a broker-dealer. To the extent that broker-dealer personnel have a beneficial interest in the broker-dealer, the broker-dealer would already be subject to the limitations in Rule 2790(d)(1). However, the amendments establish a much more direct prohibition against purchases of new issues by broker-dealers, even if the securities are directed by the issuer.

      Exemption for Issuer-Directed Non-Underwritten Offerings

      In 2005, the staff received two requests for exemptive relief related to the Issuer-Directed exemption in Rule 2790(d)(1).6 Both requests came from banks that were eligible to offer their own securities pursuant to an exemption from registration under Section 3(a)(2) of the Securities Act of 1933. Both of these offerings were entirely on a non-underwritten basis, and all decisions regarding the allocation of shares in the offerings were determined at the sole discretion of the respective issuers. These issuers argued, and the staff agreed, that the heightened requirements of Rule 2790(d)(1) would impair their ability to attract capital and served no regulatory purpose in light of the fact that no broker-dealer was underwriting or otherwise involved in allocating any of the shares that were being offered. Further, Rule 2790 generally is predicated on a member firm's involvement in the allocation process. As such, the staff granted an exemption from Rule 2790 in connection with both offerings.

      FINRA has codified this position by adding new paragraph (d)(2) to Rule 2790, which provides that the prohibitions on the purchase and sale of new issues do not apply to securities that are specifically directed by the issuer to restricted persons, provided that a broker-dealer: (1) does not underwrite any portion of the offering; (2) does not solicit or sell any new issue securities in the offering; and (3) has no involvement or influence, directly or indirectly, in the issuer's allocation decisions with respect to any of the new issue securities in the offering.

      New paragraph (d)(2) would not prevent an issuer from engaging a broker-dealer to provide advisory services (such as rendering advice regarding capital structure and capital raising) or other limited services, so long as the conditions set forth in paragraph (d)(2) continue to be satisfied. In addition, for purposes of compliance with new paragraph (d)(2), a member firm or associated person that wishes to purchase new issues in such offerings may rely on a written representation obtained in good faith from the issuer that the conditions in paragraph (d)(2) are satisfied. However, the firm or associated person may not rely upon any representation from the issuer that it believes, or has reason to believe, is inaccurate.


      1 See Securities Exchange Act Release No. 55878 (June 7, 2007), 72 FR 32936 (June 14, 2007) (Order Approving Proposed Rule Change Relating to the Application of Rule 2790 to Issuer-Directed Securities; File No. SR-NASD-2006-074).

      2 See Notice to Members 03-79 (SEC Approves New Rule 2790 (Restrictions on the Purchase and Sale of IPOs of Equity Securities); Replaces Free-Riding and Withholding Interpretation) (December 2003).

      3 Id.

      4 The issuer-directed exemption is applicable only when shares are in fact directed by an issuer (that is, a member cannot seek to have an issuer direct securities to restricted persons on the member's behalf under the exemption).

      5 The term broker-dealer personnel includes, among others, any officer, director, general partner, associated person, and employee of a broker-dealer, as well as certain immediate family members of such persons. The term finders and fiduciaries, with respect to the security being offered, includes a finder or any person acting in a fiduciary capacity to the managing underwriter, including, but not limited to, attorneys, accountants, and financial consultants, as well as certain immediate family members of such persons. See Rules 2790(i)(10)(B) and (i)(10)(C).

      6 See Letter to Noel M. Gruber, Kennedy & Barris, LLP, from Afshin Atabaki, OGC, dated October 18, 2005 (available at: www.finra.org/RulesRegulation/PublicationsGuidance/ExemptiveLetters/P015421), and Letter to Bruce E. Lee from Afshin Atabaki, OGC, dated February 3, 2006 (available at: www.finra.org/RulesRegulation/PublicationsGuidance/ExemptiveLetters/P016098).


      Attachment A

      Below is the text of the rule change. New language is underlined; deletions are in brackets.

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

      (a) through (c) No Change.
      (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:
      (A) a broker-dealer; or
      (B) 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 specifically directed by the issuer and are part of an offering in which no broker-dealer:
      (A) underwrites any portion of the offering;
      (B) solicits or sells any new issue securities in the offering; and
      (C) has any involvement or influence, directly or indirectly, in the issuer's allocation decisions with respect to any of the new issue securities in the offering;
      (3)[(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
      (4)[(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) through (j) No Change.

    • 07-33 FINRA Adopts Rule Amendments Relating to Non-Tape (or Clearing-Only) Reports for Previously Executed Trades; (Including Step-outs, Reversals and Riskless Principal Transactions) Effective Date: September 4, 2007

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      Regulatory Notice

      Notice Type

      Rule Amendment

      Referenced Rules & Notices

      NASD Rules 6130, 6130A, 6130C, 6130D and 6130E
      NASD Rules 4632, 4632A, 4632C, 4632D and 4632E
      NTM 05-11
      NTM 98-40
      Suggested Routing

      Compliance
      Legal
      Operations
      Registered Representatives
      Senior Management
      Systems
      Trading
      Key Topic(s)

      Alternative Display Facility
      OTC Reporting Facility
      Riskless Principal
      Trade Reporting
      Trade Reporting Facilities

      Effective Date: September 4, 2007

      PLEASE NOTE: FINRA Notices replace Notices to Members and fall into several categories, including Regulatory Notices, Election Notices, Trade Reporting Notices and Information Notices. All Notices will be posted on our Web site. For more information on this new publication format, please see www.finra.org/notices.

      Executive Summary

      Effective September 4, 2007, firms will be prohibited from submitting to a FINRA Facility any report (including but not limited to reports of step-outs and reversals) associated with a previously executed trade that was not reported to that FINRA Facility, except where such report reflects the offsetting, "riskless" portion of a riskless principal transaction.1

      Trade reporting rules also were amended to clarify that where the first leg of a riskless principal transaction is reported to FINRA, the second leg must be reported to FINRA; however, in such circumstance, firms are not required to report both legs of the transaction to the same FINRA Facility.

      The text of the amended rule language is available at www.finra.org/rulefilings/2007-040.

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

      Background and Discussion

      FINRA has amended the trade reporting requirements relating to the submission of non-tape reports (i.e., the transaction is not reported to the tape for publication) and clearing-only reports (i.e., the transaction is not reported to the tape but may be submitted for clearing purposes). As amended, NASD rules prohibit members from submitting to a FINRA Facility (i.e., the Alternative Display Facility, a Trade Reporting Facility (TRF)2 or the OTC Reporting Facility) any report (including but not limited to reports of step-outs3 and reversals) associated with a previously executed trade that was not reported to that FINRA Facility.4 For example, a clearing-only entry for a step-out relating to a trade executed on and reported through the NASDAQ Exchange cannot be submitted to the FINRA/NASDAQ TRF.

      Similarly, firms are not permitted to report a trade to a FINRA Facility for submission to the National Securities Clearing Corporation for clearance and settlement purposes, if the trade was not reported to that same FINRA Facility for public dissemination or regulatory transaction fee assessment purposes. For example, a member cannot tape report a trade to the FINRA/NYSE TRF and use the FINRA/NASDAQ TRF to clear that same trade.

      Under the amended rules, there is an exception to this prohibition for reports that reflect the offsetting, "riskless" portion of a riskless principal transaction and members may continue to report such transactions as they do today.5 For example, where the initial leg of the transaction is executed on and reported through an exchange, a tape report will not be submitted to FINRA to reflect the initial leg; however, a member may (but is not required to) submit a non-tape (or clearing-only) report for the second leg of the transaction to FINRA. This exception is only available for transactions that meet the definition of "riskless principal" and does not apply to agency transactions.

      FINRA also has amended the trade reporting requirements applicable to riskless principal transactions to clarify that where the first leg of the transaction is reported to FINRA, the second leg must also be reported to FINRA; however, in such circumstance, members are not required to report both legs of the transaction to the same FINRA Facility.6 As discussed in FINRA's filing, the current trade reporting rules could have the unintended consequence of requiring members to be participants in all TRFs in order to comply with NASD rules.7 FINRA expects that where possible, members will report both legs of a riskless principal transaction to the same FINRA Facility.

      The rule change will become operative on Tuesday, September 4, 2007.


      1 See Securities Exchange Act Release No. 55962 (June 26, 2007), 72 FR 36536 (July 3, 2007) (notice of filing and immediate effectiveness of SR-NASD-2007-040).

      2 Currently, there are four TRFs in operation: the FINRA/NASDAQ TRF, the FINRA/NSX TRF, the FINRA/BSE TRF and the FINRA/NYSE TRF.

      3 A step-out allows firms to allocate all or part of a previously executed trade to another broker-dealer. In other words, a step-out functions as a position transfer, rather than a trade; the parties are not exchanging shares and funds. The step-out function was designed and implemented to facilitate the clearing process for firms involved in these types of transactions. See, e.g., Notice to Members 05-11 (February 2005) and Notice to Members 98-40 (May 1998).

      4 See amendments to NASD Rules 6130 (new paragraph (i)), 6130A (new paragraph (d)), 6130C (new paragraph (h)), 6130D (new paragraph (h)) and 6130E (new paragraph (h)).

      5 For purposes of over-the-counter trade reporting requirements applicable to equity securities, a "riskless principal" transaction is a transaction in which a firm, after having received an order to buy (sell) a security, purchases (sells) the security as principal and satisfies the original order by selling (buying) as principal at the same price (the offsetting, "riskless" leg). A riskless principal transaction can be submitted to FINRA as a single trade report properly marked as riskless principal, or by submitting two separate reports: (1) a report that is submitted to the tape to reflect the initial leg of the transaction and (2) a non-tape (or clearing-only) report to reflect the offsetting, "riskless" leg of the transaction.

      6 See amendments to NASD Rules 4632(d), 4632A(e), 4632C(d), 4632D(e) and 4632E(e).

      7 For example, assume Firm A is only a participant of TRF A and it executes the first leg of a riskless principal transaction otherwise than on exchange with Firm B, which is only a participant of TRF B. Assume further that Firm B has the reporting obligation under NASD rules. The initial leg of the riskless principal trade will be reported by Firm B to TRF B. Firm A must report the second leg of the riskless principal transaction to FINRA, but because it is not a participant of TRF B, it cannot report the second leg to TRF B. The amended rules allow Firm A to report the second leg of the transaction to TRF A .

    • 07-32 NASD Amends Rule 3013 and Interpretive Material 3013 to Permit Members to Designate Co-Chief Executive Officers and Multiple Chief Compliance Officers; Compliance Date: July 16, 2007

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      GUIDANCE

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Operations
      Registered Representatives
      Senior Management
      Training
      Rule 3013
      IM-3013

      Annual Certification of Compliance and Supervisory Processes

      Executive Summary

      Effective July 16, 2007, NASD member firms may designate co-chief executive officers (co-CEOs) and multiple chief compliance officers (co-CCOs) to discharge the requirements of Rule 3013 (Annual Certification of Compliance and Supervisory Processes and accompanying IM-3013. The text of the rules, as amended, are set forth in Attachment A of this Notice.1

      Questions/Further Information

      Questions regarding this Notice may be directed to Philip Shaikun, Associate Vice President and Associate General Counsel, Office of General Counsel, at (202) 728-8451.

      Background & Discussion

      NASD Rule 3013(a) requires each member to designate, and specifically identify on Schedule A of the Uniform Application for Broker-Dealer Registration (Form BD), a principal to serve as chief compliance officer (CCO). Rule 3013(b) requires that the CEO certify annually that the firm has in place processes to establish, maintain, review, modify and test policies and procedures reasonably designed to achieve compliance with applicable NASD rules, MSRB rules and federal securities laws and regulations.

      The certification language and additional guidance are set forth in IM-3013. The certification includes not only a statement that the member has in place certain compliance processes, but also that the CEO has conducted one or more meetings with the CCO in the preceding 12 months to discuss the processes. The IM explains that the mandated meetings between the CEO and CCO must include a discussion of the firm's compliance efforts to date and identify and address significant compliance problems and plans for emerging business areas. The IM further sets forth the expertise that is expected of a CCO, including the process of gaining an understanding of a member's products, services and line functions that need to be the subject of written compliance policies and written supervisory procedures.

      NASD recognizes that such expertise may reside in more than one individual in firms with distinct business segments. In those circumstances, NASD believes the purposes of the rule can be achieved equally effectively by dividing the responsibility to advise the firm on its compliance scheme among those compliance experts within each business unit. Accordingly, the amendment permits a member to designate multiple CCOs on Schedule A of Form BD, provided that:

      (1) each designated CCO is a principal;
      (2) the member precisely defines and documents the areas of primary compliance responsibility assigned to each designated CCO and makes specific provisions for which of the designated CCOs has primary compliance responsibility in areas that can reasonably be expected to overlap;
      (3) each designated CCO satisfies all of the requirements of Rule 3013 and IM-3013 with respect to his or her defined area of primary compliance responsibility as if that individual was the firm's only CCO; and
      (4) collectively, the designated CCOs have the responsibilities and expertise that enable them to consult with the CEO on the totality of the subject matters required to be addressed in the certification by the CEO under Rule 3013.

      Thus, for example, IM-3013 explains that member must conduct one or more meetings annually between the CEO and CCO to (1) discuss and review the matters that are the subject of the certification; (2) discuss and review the member's compliance efforts as of the date of such meetings; and (3) identify and address significant compliance problems and plans for emerging business areas. A member that chooses to have multiple CCOs must conduct one or more meetings annually between the CEO and each designated CCO, individually or collectively. And at each such meeting, the CEO is required to discuss with each CCO the required topics, but only as it relates to the particular CCO's defined area of primary compliance responsibility. Similarly, the IM requires review by the CCO of the report evidencing a member's processes and consultation by the CEO with the CCO prior to execution of the certification. Firms with multiple CCOs must have each CCO must review the report, and the CEO must consult with each CCO prior to certification.

      The amendment also permits the designation of a single co-CEO solely for the purposes of compliance with Rule 3013 and IM-30132 (a member firm may have a maximum of two CEOs). However, in contrast to the change that permits co-CCOs, co-CEOs may not divide up the requirements of the Rule and IM; rather, each of the two CEOs are required to individually discharge all of the obligations set forth in Rule 3013 and IM-3013, each is responsible for the representations in the certification as if they were the member's only CEO, and the signature of each co-CEO is be expected to appear on the same single annual certification.


      1 NASD filed this amendment with the Securities and Exchange Commission for immediate effectiveness on July 16, 2007. See SR-NASD-2007-049. Pursuant to Section 19(b) of the Securities Exchange Act of 1934, the SEC has authority to summarily abrogate this type of rule change within 60 days of the filing.

      2 Designation of a co-CEO pursuant to the rule amendment has no effect on any other regulatory obligation imposed on a member or its CEO.


      ATTACHMENT A

      Below is the text of the rule change. New language is underlined; deletions are in brackets.

      3013. Annual Certification of Compliance and Supervisory Processes

      (a) Designation of Chief Compliance Officer(s)

      Each member shall designate and specifically identify to NASD on Schedule A of Form BD one or more [[a]] principals to serve as a chief compliance officer.
      (b) Annual Certification

      Each member shall have its chief executive officer(s) (or equivalent officer(s)) certify annually,1 as set forth in IM-3013, that the member has in place processes to establish, maintain, review, test and modify written compliance policies and written supervisory procedures reasonably designed to achieve compliance with applicable NASD rules, MSRB rules and federal securities laws and regulations, and that the chief executive officer(s) has conducted one or more meetings with the chief compliance officer(s) in the preceding 12 months to discuss such processes.

      1 No change to text of footnote.

      IM-3013. Annual Compliance and Supervision Certification

      The NASD Board of Governors is issuing this interpretation to the requirement under Rule 3013(b), which requires that the member's chief executive officer(s) (or equivalent officer(s)) execute annually1 a certification that the member has in place processes to establish, maintain, review, test and modify written compliance policies and written supervisory procedures reasonably designed to achieve compliance with applicable NASD rules, MSRB rules and federal securities laws and regulations. A member may choose to designate a second co-chief executive officer, provided that each of the two chief executive officers must individually discharge all of the obligations set forth in Rule 3013 and this Interpretive Material, and each shall be held responsible for the representations in the certification as if they were the member's only chief executive officer.2 The certification shall state the following:


      1 No change to text of footnote.

      2 Designation of a co-chief executive officer pursuant to this Interpretive Material applies only for the purposes of Rule 3013 and IM-3013 and has no effect on any other regulatory obligation imposed on a member or its chief executive officer.

      * * *

      Annual Compliance and Supervision Certification

      The undersigned is/are the chief executive officer(s) (or equivalent officer(s)) of [name of member corporation/partnership/sole proprietorship] (the "Member"). As required by NASD Rule 3013(b), the undersigned make(s) the following certification:

      1. The Member has in place processes to:
      (a) establish, maintain and review policies and procedures reasonably designed to achieve compliance with applicable NASD rules, MSRB rules and federal securities laws and regulations;
      (b) modify such policies and procedures as business, regulatory and legislative changes and events dictate; and
      (c) test the effectiveness of such policies and procedures on a periodic basis, the timing and extent of which is reasonably designed to ensure continuing compliance with NASD rules, MSRB rules and federal securities laws and regulations.
      2. The undersigned chief executive officer(s) (or equivalent officer(s)) has/have conducted one or more meetings with the chief compliance officer(s) in the preceding 12 months, the subject of which satisfy the obligations set forth in IM-3013.
      3. The Member's processes, with respect to paragraph 1 above, are evidenced in a report reviewed by the chief executive officer(s) (or equivalent officer(s)), chief compliance officer(s), and such other officers as the Member may deem necessary to make this certification. The final report has been submitted to the Member's board of directors and audit committee or will be submitted to the Member's board of directors and audit committee (or equivalent bodies) at the earlier of their next scheduled meetings or within 45 days of the date of execution of this certification.
      4. The undersigned chief executive officer(s) (or equivalent officer(s)) has/have consulted with the chief compliance officer(s) and other officers as applicable (referenced in paragraph 3 above) and such other employees, outside consultants, lawyers and accountants, to the extent deemed appropriate, in order to attest to the statements made in this certification.[2]3

      [2]3 Members should understand that the requirements of Rule 3013 and this Interpretive Material represent, in part, a principle-based requirement to certify that the member has in place processes to establish, maintain, review, test and modify written compliance policies and written supervisory procedures reasonably designed to achieve compliance with applicable NASD rules, MSRB rules and federal securities laws and regulations. Consequently, compliance with the periodic and content requirements in this Interpretive Material pertaining to meetings between the chief executive officer(s) (or equivalent officer(s)) and the chief compliance officer(s) does not satisfy the full extent of these principle-based obligations that will vary with the facts and circumstances of a member's business activities and organizational structure. Moreover, NASD emphasizes the testing aspect of this principle-based requirement; an integral purpose of NASD rules pertaining to supervision is that members adopt policies and procedures that are effective as to both the scope of, and the achievement of compliance with, applicable NASD rules, MSRB rules and federal securities laws and regulations.

      * * *

      It is critical that each NASD member understand the importance of employing comprehensive and effective compliance policies and written supervisory procedures. Compliance with applicable NASD rules, MSRB rules and federal securities laws and regulations is the foundation of ensuring investor protection and market integrity and is essential to the efficacy of self-regulation. Consequently, the certification requirement is intended to require processes by each member to establish, maintain, review, test and modify its compliance policies and written supervisory procedures in light of the nature of its businesses and the laws and rules that are applicable thereto, and to evidence such processes in a report reviewed by the chief executive officer(s) (or equivalent officer(s)) executing the certification.

      Included in this processes requirement is an obligation on the part of the member to conduct one or more meetings annually between the chief executive officer(s) (or equivalent officer(s)) and the chief compliance officer(s) to: (1) discuss and review the matters that are the subject of the certification; (2) discuss and review the member's compliance efforts as of the date of such meetings; and (3) identify and address significant compliance problems and plans for emerging business areas.

      The periodic and content requirements for meetings between the chief executive officer(s) (or equivalent officer(s)) and the chief compliance officer(s), as well as the pertinent requirements of paragraphs 3 and 4 of the certification, are intended to indicate the unique and integral role of [[the]]a chief compliance officer both in the discharge of certain compliance processes and reporting requirements that are the subject matter of the certification and in providing a reliable basis upon which the chief executive officer(s) can execute the certification. [[The]]A chief compliance officer is [[the]]a primary advisor to the member on its overall compliance scheme and the particularized rules, policies and procedures that the member adopts. This is because [[the]]a chief compliance officer should have an expertise in the process of (1) gaining an understanding of the products, services or line functions that need to be the subject of written compliance policies and written supervisory procedures; (2) identifying the relevant rules, regulations, laws and standards of conduct pertaining to such products, services or line functions based on experience and/or consultation with those persons who have a technical expertise in such areas of the member's business; (3) developing, or advising other business persons charged with the obligation to develop, policies and procedures that are reasonably designed to achieve compliance with those relevant rules, regulations, laws and standards of conduct; (4) evidencing the supervision by the line managers who are responsible for the execution of compliance policies; and (5) developing programs to test compliance with the member's policies and procedures.

      NASD recognizes that such expertise may reside in more than one individual in firms with distinct business segments. Therefore, a member may choose to designate more than one chief compliance officer, provided that (1) each designated chief compliance officer is a principal; (2) the member precisely defines and documents the areas of primary compliance responsibility assigned to each designated chief compliance officer and makes specific provisions for which of the designated chief compliance officers has primary compliance responsibility in areas that can reasonably be expected to overlap; (3) each designated chief compliance officer satisfies all of the requirements of Rule 3013 and this Interpretive Material with respect to his or her defined area of primary compliance responsibility as if that individual was the member's only chief compliance officer and (4) collectively, the designated chief compliance officers have the responsibilities and expertise that enable them to consult with the chief executive officer(s) on the totality of the subject matters required to be addressed in the certification by the chief executive officer(s) under Rule 3013. Thus, for example, a member that chooses to have multiple chief compliance officers is required to conduct one or more meetings annually between the chief executive officer(s) (or equivalent officer(s)) and each designated chief compliance officer, individually or collectively. At each such meeting, the chief executive officer (or equivalent officer) would be required to discuss with each chief compliance officer the required topics, but only as it relates to the particular chief compliance officer's defined and documented area of primary compliance responsibility.

      It is the[[at]] expertise in the process of compliance that makes [[the]]a chief compliance officer an indispensable party to enable the chief executive officer(s) to reach the conclusions stated in the certification. Consequently, any certification made by a chief executive officer (or equivalent officer) under circumstances where [[the]]a chief compliance officer has concluded, after consultation, that there is an inadequate basis for making such certification would be, without limitation, conduct inconsistent with the observance of the high standards of commercial honor and the just and equitable principles of trade—a violation of Rule 2110. Beyond the certification requirement, it is the intention of both Rule 3013 and this Interpretive Material to foster regular and significant interaction between senior management and the chief compliance officer(s) regarding the member's comprehensive compliance program.

      The chief compliance officer(s) and other compliance officers that report to the chief compliance officer(s) (as described in the sentence that immediately follows) shall perform the compliance functions contemplated by this Interpretive Material and paragraphs 3 and 4 of the certification. Nothing in this Interpretive Material is intended to limit or discourage the participation of other employees both within and without the member's compliance department in any aspect of the member's compliance programs or processes, including those matters discussed in this Interpretive Material. However, it is understood that [[the]]a chief compliance officer and, where applicable, the most senior compliance officers having primary compliance department responsibility for each of the member's business segments, will retain responsibility for the compliance functions contemplated by this Interpretive Material and paragraphs 3 and 4 of the certification.

      As may be necessary to render their views and advice, the chief compliance officer(s) and the other officers referenced in paragraph 3 of the certification who consult with the chief executive officer(s) (or equivalent officer(s)) pursuant to paragraph 4, shall, in turn, consult with other employees, officers, outside consultants, lawyers and accountants.

      The NASD Board of Governors recognizes that supervisors with business line responsibility are accountable for the discharge of a member's compliance policies and written supervisory procedures. The signatory to the certification is certifying only as to having processes in place to establish, maintain, review, test and modify the member's written compliance and supervisory policies and procedures and the execution of this certification and any consultation rendered in connection with such certification does not by itself establish business line responsibility.

      The requirement to designate [[a]]one or more chief compliance officers does not preclude such persons from holding any other position within the member, including the position of chief executive officer, provided that such persons can discharge the duties of a chief compliance officer in light of his or her other additional responsibilities. The requirement that a member's processes include providing the report to the board of directors and audit committee (required by paragraph 3 of the certification) does not apply to members that do not utilize these types of governing bodies and committees in the conduct of their business.[3]4

      The report required in paragraph 3 of the certification must document the member's processes for establishing, maintaining, reviewing, testing and modifying compliance policies, that are reasonably designed to achieve compliance with applicable NASD rules, MSRB rules and federal securities laws and regulations, and any principal designated by the member may prepare the report. The report must be produced prior to execution of the certification and be reviewed by the chief executive officer(s) (or equivalent officer(s)), chief compliance officer(s) and any other officers the member deems necessary to make the certification and must be provided to the member's board of directors and audit committee in final form either prior to execution of the certification or at the earlier of their next scheduled meetings or within 45 days of execution of the certification. The report should include the manner and frequency in which the processes are administered, as well as the identification of officers and supervisors who have responsibility for such administration. The report need not contain any conclusions produced as a result of following the processes set forth therein. The report may be combined with any other compliance report or other similar report required by any other self-regulatory organization provided that (1) such report is clearly titled in a manner indicating that it is responsive to the requirements of the certification and this Interpretive Material; (2) a member that submits a report for review in response to an NASD request must submit the report in its entirety; and (3) the member makes such report in a timely manner, i.e., annually.


      [3]4 No change to text of footnote.

      * * * * *

    • 07-31 NASD Rule Changes to Conform with Amendments to SEC Rule 10a-1 and Regulation SHO; Compliance Date: July 6, 2007

      View PDF File

      GUIDANCE

      SUGGESTED ROUTING

      KEY TOPICS

      Internal Audit
      Legal & Compliance
      Operations
      Registered Representatives
      Senior Management
      Systems
      Trading
      Training
      IM-5100
      IM-6130
      Rule 3360
      Rule 4632
      Rule 5100
      Rule 6130
      Rule 9610
      Short Exempt Marking Requirements
      Short Sales
      TRF Trade Reporting

      Short Sale Requirements

      Executive Summary

      NASD is issuing this Notice to advise firms and other interested parties of conforming NASD rule changes in light of the elimination of Rule 10a-1 under the Securities Exchange Act of 1934 (SEC Rule 10a-1) and amendments to Regulation SHO. Specifically, on July 5, 2007, NASD filed for immediate effectiveness a proposed rule change to: (1) repeal NASD Rule 5100 and IM-5100; (2) eliminate references to NASD Rule 5100 and SEC Rule 10a-1 from NASD rules; and (3) remove any "short exempt" marking requirements in NASD rules.1 NASD also is advising firms of temporary no-action relief from Rule 200(g) of Regulation SHO granted by the Securities and Exchange Commission (SEC) for "short exempt" transactions in certain circumstances.

      The text of the affected NASD rules, as amended, is set forth in Attachment A of this Notice. The compliance date of the amendments is July 6, 2007, to coincide with the compliance date of the amendments to SEC Rule 10a-1 and Regulation SHO.

      Questions/Further Information

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

      Background & Discussion

      On June 13, 2007, the SEC adopted amendments that, among other things: (1) eliminate the short sale price test contained in SEC Rule 10a-12; (2) add Rule 201(a) of Regulation SHO to provide that no price test, including any price test of any self-regulatory organization (SRO), shall apply to short sales in any security; (3) add Rule 201(b) of Regulation SHO to prohibit any SRO from having a price test; and (4) amend Rule 200(g) of Regulation SHO to remove the requirement that a broker-dealer mark a sell order of an equity security as "short exempt" if the seller is relying on an exception from the price test of SEC Rule 10a-1, or any price test of any exchange or national securities association.3 The elimination of SEC Rule 10a-1 and amendments to Regulation SHO became effective on July 3, 2007; however, the compliance date is July 6, 2007.

      Several NASD rules are impacted by the elimination of SEC Rule 10a-1 and amendments to Regulation SHO. As a result, NASD filed for immediate effectiveness a proposed rule change to make conforming amendments to NASD rules. First, because of the elimination of SEC Rule 10a-1, NASD has removed all references to SEC Rule 10a-1 from NASD rules and also has amended Rule 3360 (Short-Interest Reporting) to replace the references to the exceptions in SEC Rule 10a-1 with the underlying rule text of each provision.4 Second, under newly adopted Rule 201 of Regulation SHO, NASD is prohibited from having a short sale price test. Accordingly, NASD has eliminated its short sale rule contained in Rule 5100 and the related interpretive material in IM-5100.5 NASD also has made conforming amendments to certain NASD rules to delete any references to Rule 5100. Lastly, in light of the SEC amendments to remove the short exempt marking requirement in Rule 200(g) of Regulation SHO, NASD has eliminated the short exempt marking requirements from NASD rules.

      Consistent with the compliance date of the amendments to SEC Rule 10a-1 and Regulation SHO, the compliance date of the amendments to NASD rules will be July 6, 2007. However, the SEC staff of the Division of Market Regulation has issued a No-Action Letter stating that SEC staff will not recommend enforcement action under Rule 200(g) of Regulation SHO if a broker-dealer marks a short sale order "short exempt," rather than "short," for a period of 90 days following the July 6, 2007 compliance date, subject to certain conditions.6 Therefore, firms are permitted to continue to mark transactions as "short exempt" for a 90-day transitional period following the July 6, 2007 compliance date, consistent with the terms and conditions of the SEC No-Action Letter.


      1 See File No. SR-NASD-2007-047.

      2 SEC Rule 10a-1(a)(1) generally provided that, subject to certain exceptions, an exchange-listed security may only be sold short (A) at a price above the price at which the immediately preceding sale was effected (plus tick), or (B) at the last sale price if it is higher than the last different price (zero-plus tick).

      3 See Securities Exchange Act Release No. 55970 (June 28, 2007) 72 FR 36348 (July 3, 2007).

      4 NASD Rule 3360 required members to record and report short interest information to NASD, with the exception of positions that meet the requirements of subsections (e)(1), (6), (7), (8) and (10) of SEC Rule 10a-1.

      5 NASD Rule 5100, which governed short sales of over-the-counter (OTC) transactions reported to the Alternative Display Facility or a Trade Reporting Facility, generally prohibited a member firm from effecting short sales in NASDAQ Global Market securities otherwise than on an exchange for a customer account, or the firm's own account, at or below the current national best (inside) bid, when the current national best (inside) bid is below the preceding national best (inside) bid.

      6 See Securities Industry and Financial Markets Association, SEC No-Action Letter (July 2, 2007). See also, American Stock Exchange LLC, SEC No-Action Letter (July 2, 2007). A copy of the letters are available on the SEC's Web site at www.sec.gov/divisions/marketreg/mr-noaction/2007/sifma070207-sho.pdf and www.sec.gov/divisions/marketreg/mr-noaction/2007/amex070207-sho.pdf.


      ATTACHMENT A

      Below is the text of the rule change. New language is underlined; deletions are in brackets.

      3360. Short-Interest Reporting

      (a) No change.
      (b) For purposes of this Rule:
      (1) "short" positions to be reported are those resulting from "short sales" as that term is defined in SEC Rule 200(a) of Regulation SHO, with the exception of positions that meet the following requirements [of Subsections (e)(1), (6), (7), (8), and (10) of SEC Rule 10a-1 adopted under the Act;]:
      (A) any sale by any person, for an account in which he has an interest, if such person owns the security sold and intends to deliver such security as soon as is possible without undue inconvenience or expense;
      (B) any sale of a security (except a sale to a stabilizing bid complying with Rule 104 of Regulation M) effected with the approval of an exchange which is necessary to equalize the price of such security thereon with the current price of such security on another national securities exchange which is the principal exchange market for such security;
      (C) any sale of a security for a special arbitrage account by a person who then owns another security by virtue of which he is, or presently will be, entitled to acquire an equivalent number of securities of the same class as the securities sold; provided such sale, or the purchase which such sale offsets, is effected for the bona fide purpose of profiting from a current difference between the price of security sold and the security owned and that such right of acquisition was originally attached to or represented by another security or was issued to all the holders of any such class of securities of the issuer;
      (D) any sale of a security registered on, or admitted to unlisted trading privileges on, a national securities exchange effected for a special international arbitrage account for the bona fide purpose of profiting from a current difference between the price of such security on a securities market not within or subject to the jurisdiction of the United States and on a securities market subject to the jurisdiction of the United States; provided the seller at the time of such sale knows or, by virtue of information currently received, has reasonable grounds to believe that an offer enabling him to cover such sale is then available to him such foreign securities market and intends to accept such offer immediately; and
      (E) any sale by an underwriter, or any member of a syndicate or group participating in the distribution of a security, in connection with an over-allotment of securities, or any lay-off sale by such a person in connection with a distribution of securities through rights or a standby underwriting commitment.
      (2) No change.
      (3) the term "OTC Equity Securities" shall mean any equity security that is not listed on [The Nasdaq Stock Market or] a national securities exchange.

      * * * * *

      4632. Transaction Reporting

      (a) through (b) No change.
      (c) Information To Be Reported

      Each last sale report shall contain the following information:
      (1) through (3) No change.
      (4) A symbol indicating whether the transaction is a buy, sell, sell short, [sell short exempt] or cross;
      (5) through (6) No change.
      (d) through (h) No change.

      * * * * *

      4632A. Transactions Reported by Members to TRACS

      (a) through (b) No change.
      (c) Information To Be Reported—Two Party Trade Reports
      (1) No change.
      (2) Each two party last sale report submitted by a reporting NASD Member should contain:
      (A) through (C) No change.
      (D) A designated symbol denoting whether the transaction, from the Reporting NASD Member's perspective, is a buy, sell, sell short, [sell short exempt,] or cross;
      (E) If known, a designated symbol denoting whether the transaction, from the perspective of the Non-Reporting Member, is a buy, sell, or sell short[, or sell short exempt];
      (F) through (T) No Change.
      (3) No change.
      (d) Information To Be Reported—Three Party Trade Reports
      (1) No change.
      (2) Each Three Party Trade Report Submitted by a Reporting Member shall contain the following information:

      Transaction Information
      (A) through (H) No change.
      (I) All three party trade reports from Non-ECNs must be denoted as riskless principal trade reports and shall include a designated symbol denoting whether the trade between the non-ECN and the buy-side OEID is a sell[,] or sell short[, or sell short exempt] transaction;
      (J) through (V) No change.
      (W) If known, a symbol denoting whether the trade, from the Sell Side OEID's perspective, is a sell[,] or sell short[, or sell short exempt] transaction;
      (X) through (BB) No change.
      (3) No change.
      (e) through (j) No change.

      * * * * *

      4632C. Transaction Reporting

      (a) through (b) No change.
      (c) Information To Be Reported

      Each last sale report shall contain the following information:
      (1) through (3) No change.
      (4) A symbol indicating whether the transaction is a buy, sell, sell short, [sell short exempt] or cross;
      (5) through (6) No change.
      (d) through (h) No change.

      * * * * *

      4632D. Transaction Reporting

      (a) through (b) No change.
      (c) Information To Be Reported—Two Party Trade Reports
      (1) No change.
      (2) Each two party last sale report submitted by a Reporting Member shall contain the following information:
      (A) through (C) No change.
      (D) A symbol indicating whether the transaction, from the perspective of the Reporting Member, is a buy, sell, sell short, [sell short exempt] or cross;
      (E) If known, a designated symbol indicating whether the transaction, from the perspective of the Non-Reporting Member (or other contra party), is a buy, sell, or sell short[, or sell short exempt];
      (F) through (Q) No change.
      (d) Information To Be Reported—Three Party Trade Reports
      (1) No change.
      (2) Each three party trade report submitted by a Reporting Member shall contain the following information:
      (A) through (H) No change.
      (I) All three party trade reports from non-ECNs must be denoted as riskless principal trade reports and shall include a designated symbol indicating whether the trade between the non-ECN and the buy-side OEID is a sell[,] or sell short[, or sell short exempt] transaction;
      (J) through (T) No change.
      (U) If known, a symbol indicating whether the trade, from the Sell Side OEID's perspective, is a sell[,] or sell short[, or sell short exempt] transaction;
      (V) through (X) No change.
      (e) through (i) No change.

      * * * * *

      4632E. Transaction Reporting

      (a) through (b) No change.
      (c) Information To Be Reported—Two Party Trade Reports
      (1) No change.
      (2) Each two party last sale report submitted by a Reporting Member shall contain the following information:
      (A) through (C) No change.
      (D) A symbol indicating whether the transaction, from the perspective of the Reporting Member, is a buy, sell, sell short, [sell short exempt] or cross;
      (E) If known, a designated symbol indicating whether the transaction, from the perspective of the Non-Reporting Member (or other contra party), is a buy, sell, or sell short[, or sell short exempt];
      (F) through (Q) No change.
      (d) Information To Be Reported—Three Party Trade Reports
      (1) No change.
      (2) Each three party trade report submitted by a Reporting Member shall contain the following information:
      (A) through (H) No change.
      (I) All three party trade reports from non-ECNs must be denoted as riskless principal trade reports and shall include a designated symbol indicating whether the trade between the non-ECN and the buy-side OEID is a sell[,] or sell short[, or sell short exempt] transaction;
      (J) through (T) No change.
      (U) If known, a symbol indicating whether the trade, from the Sell Side OEID's perspective, is a sell[,] or sell short[, or sell short exempt] transaction;
      (V) through (X) No change.
      (e) through (i) No change.

      * * * * *

      5100. [Short Sale Rule]Reserved.

      [(a) With respect to trades reported to the ADF or a Trade Reporting Facility, no member shall effect a short sale in a Nasdaq Global Market Security (as that term is defined in Rule 4200) otherwise than on an exchange for the account of a customer or for its own account at or below the current national best (inside) bid when the current national best (inside) bid is below the preceding national best (inside) bid in the security. In addition, for a transitional period ending on November 3, 2006, members may use the Nasdaq Exchange best (inside) bid rather than the national best (inside) bid for purposes of the application of this rule, provided that the member has submitted prior written notification to NASD of this selection. Members are required to use the same bid tick test on a firm-wide basis. A member using the Nasdaq Exchange best (inside) bid may not use the national best (inside) bid prior to the end of the transitional period unless the member submits prior written notification to NASD of this change. For the purposes of this rule, the term "customer" includes a non-member broker-dealer.]
      [(b) In determining the price at which a short sale may be effected after a security goes ex-dividend, ex-right, or ex-any other distribution, all quotation prices prior to the "ex" date may be reduced by the value of such distribution.]
      [(c) The provisions of paragraph (a) shall not apply to:]
      [(1) Sales by a registered market maker registered in the security in connection with bona fide market making activity. For purposes of this paragraph, transactions unrelated to normal market making activity, such as index arbitrage and risk arbitrage that are independent from a member's market making functions, will not be considered bona fide market making activity.]
      [(2) Any sale by any person, for an account in which he has an interest, if such person owns the security sold and intends to deliver such security as soon as possible without undue inconvenience or expense.]
      [(3) Sales by a member, for an account in which the member has no interest, pursuant to an order to sell that is marked "long."]
      [(4) Sales by a member to offset odd-lot orders of customers.]
      [(5) Sales by a member to liquidate a long position which is less than a round lot, provided that such sale does not change the position of the member by more than one unit of trading.]
      [(6) Sales by a person of a security for a special arbitrage account if the person then owns another security by virtue of which the person is, or presently will be, entitled to acquire an equivalent number of securities of the same class of securities sold; provided such a sale, or the purchase which such sale offsets, is effected for the bonafide purpose of profiting from a current difference between the price of the security sold and the security owned and that such right of acquisition was originally attached to or represented by another security or was issued to all the holders of any such class of securities of the issuer.]
      [(7) Sales by a person of a security effected for a special international arbitrage account for the bona fide purpose of profiting from a current difference between the price of such security on a securities market not within or subject to the jurisdiction of the United States and on such a securities market subject to the jurisdiction of the United States; provided the person at the time of such sale knows or, by virtue of information currently received, has reasonable grounds to believe that an offer enabling the person to cover such sale is then available to the person in such foreign securities market and intends to accept such offer immediately.]
      [(8) Sales by an underwriter, or any member of a syndicate or group participating in the distribution of a security, in connection with an over-allotment of securities, or any layoff sale by such a person in connection with a distribution of securities through rights or a standby underwriting commitment.]
      [(9) Sales of securities as to which all short sale price tests have been suspended by operation of a Pilot Order issued by the Commission pursuant to SEC Rule 202T.]
      [(10) Sales of securities included in the Nasdaq-100 Index.]
      [(d) No member shall effect a short sale for the account of a customer or for its own account indirectly or through the offices of a third party to avoid the application of this Rule.]
      [(e) No member shall knowingly, or with reason to know, effect sales for the account of a customer or for its own account to avoid the application of this Rule.]
      [(f) A member that is not currently registered as a market maker in a security and that has acquired a security while acting in the capacity of a block positioner shall be deemed to own such security for the purposes of this Rule notwithstanding that such member may not have a net long position in such security if and to the extent that such member's short position in such security is the subject of one or more offsetting positions created in the course of bona fide arbitrage, risk arbitrage, or bona fide hedge activities.]
      [(g) For purposes of this Rule, a depositary receipt of a security shall be deemed to be the same security as the security represented by such receipt.]
      [(h)
      (1) A member shall be permitted, consistent with its quotation obligations, to execute a short sale for the account of an options market maker that would otherwise be in contravention of this Rule, if:]
      [(A) the options market maker is registered with a qualified options exchange as a qualified options market maker in a stock options class on a Nasdaq Global Market Security or an options class on a qualified stock index; and]
      [(B) the short sale is an exempt hedge transaction.]
      [(2) For purposes of this paragraph:]
      [(A)
      (i) An "exempt hedge transaction," in the context of qualified options market makers in stock options classes, shall mean a short sale in a Nasdaq Global Market Security that was effected to hedge, and in fact serves to hedge, an existing offsetting options position or an offsetting options position that was created in a transaction(s) contemporaneous with the short sale,* provided that when establishing the short position the options market maker is eligible to receive(s) good faith margin pursuant to Section 220.12 of Regulation T under the Act for that transaction.]
      [(ii) An "exempt hedge transaction," in the context of qualified options market makers in stock index options classes, shall mean a short sale in a Nasdaq Global Market Security that was effected to hedge, and in fact serves to hedge, an existing offsetting stock index options position or an offsetting stock index options position that was created in a transaction(s) contemporaneous with the short sale, provided that:]
      [a. the security sold short is a component security of the index underlying such offsetting index options position;]
      [b. the index underlying such offsetting index options position is a "qualified stock index;" and]
      [c. the dollar value of all exempt short sales effected to hedge the offsetting stock index options position does not exceed the aggregate current index value of the offsetting options position.]
      [(iii) Notwithstanding any other provision of this paragraph (h), any transaction unrelated to normal options market making activity, such as index arbitrage or risk arbitrage that in either case is independent of an options market maker's market making functions, will not be considered an "exempt hedge transaction."]
      [(B) A "qualified options market maker" shall mean an options market maker who has received an appointment as a "qualified options market maker" for certain classes of stock options on Nasdaq Global Market securities and/or index options on qualified stock indexes pursuant to the rules of a qualified options exchange.]
      [(C) A "qualified options exchange" shall mean a national securities exchange that has approved rules and procedures providing for:]
      [(i) designating market makers as qualified options market makers, which standards shall be designed to identify options market makers who regularly engage in market making activities in the particular options class(es);]
      [(ii) the surveillance of its market maker's utilization of the exemption set forth in paragraph (h)(1) to assure that short sales effected by qualified options market makers are exempt hedge transactions and that other non-qualified market makers are not utilizing the exemption; and]
      [(iii) authorization of the Association to withdraw, suspend or modify the designation of a qualified options market maker but only if a qualified options exchange has determined that the qualified options market maker has failed to comply with the terms of the exemption, and that such a withdrawal, suspension or modification of the market maker's exemption is warranted in light of the substantial, willful, or continuing nature of the violation.]
      [(D) A "qualified stock index" shall mean any stock index that includes one or more Nasdaq Global Market securities, provided that more than 10% of the weight of the index is accounted for by Nasdaq Global Market securities and provided further that the qualification of an index as a qualified stock index shall be reviewed as of the end of each calendar quarter, and the index shall cease to qualify if the value of the index represented by one or more Nasdaq Global Market securities is less than 8% at the end of any subsequent calendar quarter.]
      [(E) "Aggregate current index value" shall mean the current index value times the index multiplier.]
      [(F) A member will not be in violation of paragraph (a) above if the member executes a short sale for the account of an options market maker that is in contravention of this paragraph (h), provided that the member did not know or have reason to know that the options market maker's short sale was in contravention of this paragraph (h).]
      [(i)
      (1) A member shall be permitted, consistent with its quotation obligations, to execute a short sale for the account of a warrant market maker that would otherwise be in contravention of this Rule, if:]
      [(A) the warrant market maker is a registered market maker for the warrant; and]
      [(B) the short sale is an exempt hedge transaction that results in a fully hedged position.]
      [(2) For purposes of this paragraph, an "exempt hedge transaction" shall mean a short sale in a Nasdaq Global Market Security that was effected to hedge, and in fact serves to hedge, an existing offsetting warrant position or an offsetting warrant position that was created in a transaction(s) contemporaneous with the short sale.* Notwithstanding any other provision of this paragraph, any transaction unrelated to normal warrant market making activity, such as index arbitrage or risk arbitrage that in either case is independent of a warrant market maker's market making functions, will not be considered an "exempt hedge transaction."]
      [(3) The Association may withdraw, suspend or modify the exemption for a warrant market maker upon determination that the market maker has failed to comply with the terms of the exemption, and that such a withdrawal, suspension or modification of the market maker's exemption is warranted in light of the substantial, willful, or continuing nature of the violation.]
      [(4) A member will not be in violation of paragraph (a) above if the member executes a short sale for the account of a warrant market maker that is in contravention of this paragraph (i), provided that the member did not know or have reason to know that the warrant market maker's short sale was in contravention of paragraph (i).]
      [(j) Pursuant to the Rule 9600 Series or on the Association's own motion, the Association may exempt either unconditionally, or on specified terms and conditions, any transaction or class of transactions from the provisions of this Rule.]
      [(k) Definitions:]
      [(1) The term "short sale" shall have the same meaning as contained in SEC Rule 200, adopted pursuant to the Act.]
      [(2) The term "block positioner" shall have the same meaning as contained in SEC Rule 3b-8(c) for "Qualified Block Positioner" adopted pursuant to the Act.]
      [(l) This section shall be in effect until December 15, 2007.]

      [IM-5100. Short Sale Rule]

      [(a)
      (1) In developing a Short Sale Rule for Nasdaq Global Market securities effected otherwise than on an exchange, NASD has adopted an exemption to the Rule for certain market making activity. This exemption is an essential component of the Rule because bona fide market making activity is necessary and appropriate to maintain continuous, liquid markets in Nasdaq Global Market securities. Rule 5100(c)(1) states that short selling prohibitions shall not apply to sales by registered market makers in connection with bona fide market making activity and specifies that transactions unrelated to normal market making activity, such as index arbitrage and risk arbitrage that are independent from a member's market making functions, will not be considered as bona fide market making. Thus, two standards are to be applied: one must be a registered market maker and one must engage in "bona fide" market making activity to take advantage of this exemption. With this interpretation, NASD wishes to clarify for members some of the factors that will be taken into consideration when reviewing market making activity that may not be deemed to be bona fide market making activity and therefore would not be exempted from the Rule's application.]
      [(2) First, as the Rule indicates, bona fide market making activity does not include activity that is unrelated to market making functions, such as index arbitrage and risk arbitrage that is independent from a member's market making functions. While these types of arbitrage activity appear to be suitable for the firm's overall hedging or risk management concerns, they do not warrant an exemption from the Rule. However, short sales of a security of a company involved in a merger or acquisition will be deemed bona fide market-making activity if made to hedge the purchase or prospective purchase (based on communicated indications of interest) of another security of a company involved in the merger or acquisition, which purchase was made, or is to be made, in the course of bona fide market making activity. The purchase of a security of a company involved in a merger or acquisition made to hedge a short sale of another security involved in the merger or acquisition, which sale was made in the course of bona fide market making activity, will not cause the sale to be deemed unrelated to normal market-making activity. Short sales made to hedge any such purchases or prospective purchases must be reasonably consistent with the exchange ratio (or exchange ratio formula) specified by the terms of the merger or acquisition.]
      [(3) Similarly, bona fide market making would exclude activity that is related to speculative selling strategies of the member or investment decisions of the firm and is disproportionate to the usual market making patterns or practices of the member in that security. The Association does not anticipate that a firm could properly take advantage of its market maker exemption to effectuate such speculative or investment short selling decisions. Disproportionate short selling in a market making account to effectuate such strategies will be viewed by the Association as inappropriate activity that does not represent bona fide market making and would therefore be in violation of Rule 5100.]
      [(b) With respect to trades reported to the ADF or a Trade Reporting Facility, Rule 5100 requires that no member shall effect a short sale in a Nasdaq Global Market Security (as that term is defined in Rule 4200) otherwise than on an exchange for the account of a customer or for its own account at or below the current national best (inside) bid when the current national best (inside) bid is below the preceding national best (inside) bid in the security. For purposes of this rule, the term "customer" includes a non-member broker-dealer. NASD has determined that in order to effect a "legal" short sale when the current best bid is lower than the preceding best bid the short sale must be executed at a price of at least $0.01 above the current inside bid when the current inside spread is $0.01 or greater. The last sale report for such a trade would, therefore, be above the inside bid by at least $0.01.]
      [(c)
      (1) Rule 5100 prohibits a member from effecting a short sale for the account of a customer or for its own account directly or through the offices of a third party for the purpose of avoiding the application of the Short Sale Rule. Further, the Rule prohibits a member from knowingly, or with reason to know, effecting sales for the account of a customer or for its own account for the purpose of avoiding the Rule. With this interpretation, the Association wishes to clarify some of the circumstances under which a member would be deemed to be in violation of Rule 5100.]
      [(2) For example, in instances where the current best bid is below the preceding best bid, if a market maker alone at the inside best bid were to lower its bid and then raise it to create an "up bid" for the purpose of facilitating a short sale, NASD would consider such activity to be a manipulative act and a violation of NASD's Short Sale Rule. NASD also would consider it a manipulative act and a violation of the Rule if a market maker with a long stock position were to raise its bid above the inside bid and then lower it to create a "down bid" for the purpose of precluding market participants from selling short. In addition, if a market maker agrees to an arrangement proposed by a member or a customer whereby the market maker raises its bid in order to effect a short sale for the other party and is protected against any loss on the trade or on any other executions effected at its new bid price, the market maker would be deemed to be in violation of Rule 5100. Similarly, a market maker would be deemed in violation of the Rule if it entered into an arrangement with a member or a customer whereby it used its exemption from the rule to sell short at the bid at successively lower prices, accumulating a short position, and subsequently offsetting those sales through a transaction at a prearranged price, for the purpose of avoiding compliance with the Rule, and with the understanding that the market maker would be guaranteed by the member or customer against losses on the trades.]
      [(3) The Association believes that members' activities to circumvent the Rule through indirect actions such as executions with other members or through facilitation of customer orders while being protected from loss are antithetical to the purposes of the Rule. Accordingly, the Association will consider any such activity as a violation of Rule 5100.]

      * * * * *

      6130. Trade Report Input

      (a) through (c) No change.
      (d) Trade Information To Be Input

      Each report to the System shall contain the following information:
      (1) through (5) No change.
      (6) A symbol indicating whether the transaction is a buy, sell, sell short, [sell short exempt] or cross;
      (7) through (13) No change.
      (e) through (i) No change.

      IM-6130. Trade Reporting of Short Sales

      [The NASD's short sale rule (Short Sale Rule or Rule 5100) generally prohibits members from effecting short sales in NGM securities at or below the inside bid when the current inside bid is below the previous inside bid.] Rule 6130(d)(6) requires that members indicate on System reports whether a transaction is a short sale]or a short sale exempt] transaction ("short sale reporting requirements"). Rule 6130 explicitly requires members to file reports [not just for NGM securities transactions, but] for [other securities] transactions in all Reportable Securities, including transactions in exchange-listed, [Capital Market,] convertible debt, OTC Bulletin Board, and OTC equity securities. Thus, all short sale transactions in these securities reported to the System must carry a "short sale" indicator [(or a "short sale exempt" indicator if it is a short sale transaction in an NGM or exchange-listed security that qualifies for an exemption from Rule 5100 or SEC Rule 10a-1)].

      * * * * *

      6130C. Trade Report Input

      (a) through (c) No change.
      (d) Trade Information To Be Input

      Each report to the System shall contain the following information:
      (1) through (5) No change.
      (6) A symbol indicating whether the transaction is a buy, sell, sell short, [sell short exempt] or cross;
      (7) through (13) No change.
      (e) through (h) No change.

      IM-6130C. Trade Reporting of Short Sales

      [NASD's short sale rule (Short Sale Rule or Rule 5100) generally prohibits members from effecting short sales in Nasdaq Global Market ("NGM") securities at or below the inside bid when the current inside bid is below the previous inside bid.] Rule 6130C(d)(6) requires that members indicate on System reports whether a transaction is a short sale [or a short sale exempt] transaction ("short sale reporting requirements"). Rule 6130C applies to members that submit reports to the NASD/NSX Trade Reporting Facility [not just for NGM securities transactions, but] for transactions in all exchange-listed securities. Thus, all short sale transactions in these securities reported to the System must carry a "short sale" indicator [(or a "short sale exempt" indicator if it is a short sale transaction in any exchange-listed security that qualifies for an exemption from Rule 5100 or SEC Rule 10a-1)].

      * * * * *

      6130D. Trade Report Input

      (a) through (c) No change.
      (d) Trade Information To Be Input

      Each report to the System shall contain the following information:
      (1) through (5) No change.
      (6) A symbol indicating whether the transaction is a buy, sell, sell short, [sell short exempt] or cross;
      (7) through (13) No change.
      (e) through (h) No change.

      IM-6130D. Trade Reporting of Short Sales

      [NASD's short sale rule (Short Sale Rule or Rule 5100) generally prohibits members from effecting short sales in Nasdaq Global Market ("NGM") securities at or below the inside bid when the current inside bid is below the previous inside bid.] Rule 6130D(d)(6) requires that members indicate on System reports whether a transaction is a short sale [or a short sale exempt] transaction ("short sale reporting requirements"). Rule 6130D applies to members that submit reports to the NASD/BSE Trade Reporting Facility [not just for NGM securities transactions, but] for transactions in all exchange-listed securities. Thus, all short sale transactions in these securities reported to the System must carry a "short sale" indicator [(or a "short sale exempt" indicator if it is a short sale transaction in any exchange-listed security that qualifies for an exemption from Rule 5100 or SEC Rule 10a-1)].

      * * * * *

      6130E. Trade Report Input

      (a) through (c) No change.
      (d) Trade Information To Be Input

      Each report to the System shall contain the following information:
      (1) through (5) No change.
      (6) A symbol indicating whether the transaction is a buy, sell, sell short, [sell short exempt] or cross;
      (7) through (13) No change.
      (e) through (h) No change.

      IM-6130E. Trade Reporting of Short Sales

      [NASD's short sale rule (Short Sale Rule or Rule 5100) generally prohibits members from effecting short sales in Nasdaq Global Market ("NGM") securities at or below the inside bid when the current inside bid is below the previous inside bid.] Rule 6130E(d)(6) requires that members indicate on System reports whether a transaction is a short sale [or a short sale exempt] transaction ("short sale reporting requirements"). Rule 6130E applies to members that submit reports to the NASD/NYSE Trade Reporting Facility not just for NGM securities transactions, but for transactions in all exchange-listed securities. Thus, all short sale transactions in these securities reported to the System must carry a "short sale" indicator [(or a "short sale exempt" indicator if it is a short sale transaction in any exchange-listed security that qualifies for an exemption from Rule 5100 or SEC Rule 10a-1)].

      * * * * *

      9610. Application

      (a) Where to File

      A member seeking exemptive relief as permitted under Rules 1021, 1050, 1070, 2210, 2315, 2320, 2340, 2520, 2710, 2720, 2790, 2810, 2850, 2851, 2860, Interpretive Material 2860-1, 3010(b)(2), 3020, 3150, 3230, [5100,] 6958, 8211, 8213, 11870, or 11900, or Municipal Securities Rulemaking Board Rule G-37 shall file a written application with the appropriate department or staff of NASD and provide a copy of the application to the Office of General Counsel of NASD.
      (b) through (c) No change.

    • 07-30 NASD and NYSE Request Comment on Proposed Joint Guidance Regarding the Review and Supervision of Electronic Communications; Comment Period Expires July 13, 2007

      View PDF File

      JOINT REQUEST FOR COMMENT

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Operations
      Registered Representatives
      Senior Management
      Training
      Correspondence—General
      Electronic Communications
      Rule 2210 (Communications with the Public)
      Rule 2211 (Institutional Sales Material and Correspondence)
      Rule 3010 (Supervision) Supervision

      Supervision of Electronic Communications

      Executive Summary

      Given the pace of technological innovations in electronic communications, and the breadth of possible communications subject to review, NASD and NYSE are issuing this Joint Request for Comment to solicit comments from members and other interested parties on proposed Joint Guidance regarding the review and supervision of electronic communications. The proposed Joint Guidance sets forth principles for members to consider when developing supervisory systems and procedures for electronic communications that are reasonably designed to achieve compliance with applicable federal securities laws and self-regulatory organization rules.

      Attachment A sets forth the proposed Joint Guidance on the review and supervision of electronic communications.

      Action Requested

      Comment on the proposed Joint Guidance. Comments must be received by July 13, 2007. Members and other interested persons can submit their comments using the following methods:

      •  E-mailing comments to pubcom@nasd.com
      •  Mailing comments in hard copy to:

      Barbara Z. Sweeney
      NASD
      Office of the Corporate Secretary
      1735 K Street, NW
      Washington, D.C. 20006-1506
      Important Notes: The only comments that will be considered are those submitted pursuant to the methods set forth above (or submitted pursuant to NYSE's stated methods). All comments received by NASD in response to this Joint Request for Comment will be made available to the public on the NASD Web site. Generally, comments will be posted on the NASD Web site one week following the expiration of the comment period.1

      Questions/Further Information

      Questions concerning this Joint Request for Comment should be directed to Donald K. Lopezi, Deputy Director, Examinations Program, at (202) 728-8132; or Patricia Albrecht, Assistant General Counsel, Office of General Counsel, at (202) 728-8026.


      1 See NASD Notice to Members 03-73 (November 2003) (NASD Announces Online Availability of Comments). Personal identifying information, such as names or email addresses, will not be edited from submissions. Submit only information that you wish to make publicly available.


      ATTACHMENT A—PROPOSED JOINT GUIDANCE

      REVIEW AND SUPERVISION OF ELECTRONIC COMMUNICATIONS

      I. INTRODUCTION

      Technological innovations in the area of electronic communications1 have altered how people deliver, receive, and store communications. These innovations have brought, and continue to bring, new challenges to members2 in the establishment of supervisory systems and procedures for electronic communications that are reasonably designed to achieve compliance with applicable federal securities laws and self-regulatory organization rules.3

      With these challenges in mind, the NYSE and NASD (the "SROs") are issuing this guidance for members to consider when developing such systems and procedures. In the course of formulating this guidance, the SROs have consulted with industry experts in addition to drawing on their own experience in the area of electronic communication supervision. This guidance does not specifically address every regulatory issue that may arise in connection with the supervision of electronic communications. Further, the SROs recognize that policies and procedures may differ among members depending on their business model (e.g., size, structure, customer base, and product mix).4
      II. REVIEW AND SUPERVISION OF ELECTRONIC COMMUNICATIONS

      At one time, the SROs required that members review all correspondence of their registered representatives pertaining to the solicitation or execution of any securities transactions. In 1998, recognizing that the growing use of electronic communications such as e-mail made adherence to this requirement difficult, the SROs amended their rules to allow members the flexibility to design supervisory review procedures for correspondence with the public that are appropriate to the individual member's business model.5

      In considering this Joint Guidance, members generally may decide by employing risk-based principles the extent to which the review of electronic communications, both internal and external, is necessary in accordance with the supervision of their business. However, members must have policies and procedures for the review by a supervisor of employees' 6 incoming and outgoing electronic communications that are of a subject matter that require review under SRO rules and federal securities laws. For example (without limitation):
      (1) NYSE Rule 472(b)(3) and NASD Rule 2711(b)(3)(A) require that a member's legal and compliance department be copied on communications between non-research and research departments concerning the content of a research report; NYSE Rule 472(a) and NASD Rules 2210 and 2211 require pre-approval by a principal of specified communications with the public;
      (2) NYSE Rule 351(d) and NASD Rule 3070(c) require the identification and reporting of customer complaints; NYSE Rule 401A requires that the receipt of each complaint be acknowledged by the member to the customer within 15 business days; and
      (3) NYSE Rule 410 and NASD Rule 3110(j) require the identification and prior written approval of every order error and other account designation change.
      When employing risk-based procedures to review electronic communications, members should consider how to effectively:
      (1) "flag" electronic communications that may evidence or contain customer complaints, problems, errors, orders, or other instructions for an account; or evidence conduct inconsistent with SRO rules, federal securities laws, and other matters of importance to the member's ability to adequately supervise its business and manage the member's reputational, financial, and litigation risk;
      (2) identify such other business areas the member may identify as warranting supervisory review; and
      (3) educate employees to understand and comply with the member's policies and procedures regarding electronic communications.
      In adopting such supervisory review procedures, existing interpretive material directs members to, among other things:7
      •  Identify the types of correspondence that will be pre- or post-reviewed;
      •  Identify the organizational position(s) responsible for conducting reviews of the different types of correspondence;
      •  Monitor the implementation of, and compliance with, the member's procedures for reviewing public correspondence;8
      •  Periodically re-evaluate the effectiveness of the member's procedures for reviewing public correspondence and consider any necessary revisions;9
      •  Provide that all customer complaints, whether received via e-mail or in other written form, are reported to the SROs in compliance with the SRO reporting requirements;10
      •  Prohibit employees from the use of electronic communications unless such communications are subject to supervisory and review procedures developed by the member;11 and
      •  Conduct necessary and appropriate training and education.
      Member electronic communications related to a member's business are subject to its overall supervisory and review procedures.12 They are also subject to SRO rule requirements specifically addressing communications with the public.13

      The growth of electronic communications has raised the need for further interpretative guidance. For ease of use, the guidance that follows is divided into six categories:
      •  Written Policies and Procedures
      •  Types of Electronic Communications Requiring Review
      •  Identification of the Person(s) Responsible for the Review of Electronic Communications
      •  Method of Review for Correspondence
      •  Frequency of the Review of Correspondence
      •  Documentation of the Review of Correspondence
      A. WRITTEN POLICIES AND PROCEDURES

      The path towards an effective supervisory system starts with clear policies and procedures for the general use and supervision of electronic communications, both internal and external, which are updated to address new technologies. For example, a general electronic communications policy written five years ago may well not include policies to regulate employees' use of technologies such as weblogs14 and podcasting15 to communicate with the public.

      From a general procedural perspective, members should provide their employees with the following:
      •  Quick and easy access to electronic communication policies and procedures through, for example, the member's intranet system. (Members should make clear to all employees that they are responsible for complying with these policies and procedures upon their employment. Updates to such policies should be made accessible to all employees in a timely manner, pursuant to the member's procedures.)
      •  A clear list of permissible electronic communication mechanisms (including a clear statement that all other mechanisms are prohibited). For example, if employees are permitted to utilize only the member's e-mail and instant messaging system, then this should be clearly and unambiguously stated in the member's policies and procedures. Members should also make clear if certain communication mechanisms may only be used for communications between employees of the member (versus mechanisms that may also be used for communications with the public). Members should be cognizant that vague language addressing these issues may leave room for unwanted individual interpretation.
      •  Specific language explaining to employees the potential consequences of non-compliance (e.g., disciplinary action).
      •  Training on a regular and as-needed basis. Members should include information in their training and compliance programs describing examples of permissible and prohibited technologies. In addition, while all employees should receive training with respect to the member's general electronic communication policies and procedures, there may be certain employees whose training should be further tailored to their specific business function. For example, a member may implement additional prohibitions on internal communications between business units that are privy to certain non-public information (e.g., investment banking and research and proprietary trading).
      B. TYPES OF ELECTRONIC COMMUNICATIONS REQUIRING REVIEW

      External Communications

      As discussed above, members must have reasonable policies and procedures for the supervisory review of electronic communications that require review under SRO rules16 and federal securities laws. Members may employ risk-based principles to determine the extent to which additional supervisory policies and procedures are required to adequately supervise their business and manage the member's reputational, financial, and litigation risk.

      Members also are required to establish policies and procedures regarding the forms of electronic communications that they permit employees to use when conducting business with the public and to take reasonable steps to monitor for compliance with such policies and procedures.

      Traditionally, members have limited employees' electronic communications with customers to a member-supplied e-mail address that is connected to the member's communication network. However, as technology has evolved, employees now have a myriad of ways to communicate electronically with the public. To the extent members prohibit certain types of communication media, consideration should be given to taking technological steps to block or otherwise regulate their external and internal use. In particular, members should consider the following options:
      Non-Member E-Mail Platforms—Employees have the ability to communicate via e-mail through means other than their member-issued e-mail address by accessing e-mail platforms through the Internet (e.g., through AOL or Yahoo mail) and through third-party communication systems such as Bloomberg and Reuters. If a member permits employees to communicate with customers through these systems or through other non-member e-mail addresses, the member is required to supervise and retain those communications. Some members prohibit, through policies and procedures, employees from accessing non-member e-mail platforms for business purposes, and require employees to certify on an annual or more frequent basis that they are acting consistent with such policies and procedures. Where possible, some members have chosen to block access to these e-mail platforms through their networks. Thus, an employee would be able to access the Internet but not the e-mail functionality. Members utilizing this blocking functionality should periodically conduct tests to ensure that it is functioning as designed or intended.

      Similarly, the SROs expect members to prohibit, through policies and procedures, communications with the public for business purposes from employees' own electronic devices unless the member is capable of supervising, receiving, and retaining such communications.17 Absent a prohibition, members should consider requiring pre-approval for the business-related use of any personal electronic communications device. The approval process might require a detailed business justification for using the personal device and an annual re-certification of the approval that includes a re-evaluation of the business justification for its use. In addition, members should consider obtaining agreements from employees authorizing the member to access any such personal electronic communications devices. Members should also consider prohibiting, where appropriate, the use of personal electronic communication devices in certain sensitive firm locations (e.g., where material non-public information could be accessed).
      Message Boards—There are various publicly accessible message boards related to the securities industry. Members may consider blocking access by their employees to these message boards18 to prevent them from communicating through these boards for business purposes.

      E-Faxes—The use of traditional facsimile machines has started to decline as E-fax software has developed. The SROs view E-faxes as electronic communications and, thus, members should supervise them accordingly.19
      When a member permits the use of any technology, the member's system of supervision should be reasonably designed to achieve compliance with applicable laws, rules, and regulations.

      Internal Communications

      As stated above, with the exception of the enumerated areas requiring review by a supervisor, members may decide, employing risk-based principles, the extent to which review of any internal communications is necessary in accordance with the supervision of their business.

      Subject to any such specific rule requirement mandating reviews, in reaching a risk-based assessment regarding the review of internal communications, consideration should be given to, for instance: detecting when a member's information barriers are not working to protect customer or issuer information; protecting against undue influence on research personnel contrary to SRO rules; and segregating the member's proprietary trading desk activity from all or part of the other operating areas of the member.20

      In addition, members may consider various relevant existing processes, such as:
      •  Conflict-management efforts—Steps taken to reduce, manage, or eliminate potential conflicts of interest, including implementing firewalls to prevent electronic communications between certain individuals/groups or monitoring communications as required by SRO rules (e.g., between non-research and research departments) or as otherwise appropriate. Members should review to determine whether adequate information barriers are in place.
      •  Reviews of internal electronic communications that occur in connection with branch or desk examinations and regulatory inquiries, examinations, or investigations.
      •  Reviews of internal electronic communications that occur in connection with transaction reviews, internal disciplinary reviews, and reviews relating to customer complaints or arbitration.
      •  Reviews of internal electronic communications that occur as a result of issues identified in connection with external electronic communication reviews.
      C. IDENTIFICATION OF THE PERSON(S) RESPONSIBLE FOR THE REVIEW OF ELECTRONIC COMMUNICATIONS

      Members' procedures for review of electronic communications (internal and external) should address the following:
      •  Members' procedures should clearly identify the person(s) responsible for performing the reviews. Evidence of review can be satisfied by use of a log or other record from the electronic communication system that identifies the reviewers.
      •  The supervisor/principal must evidence his or her supervision as required by SRO rules.21
      •  In the course of supervising electronic communications, a supervisor/principal may delegate certain functions to persons who need not be registered.22 However, the supervisor/principal remains ultimately responsible for the performance of all necessary supervisory reviews, irrespective of whether he or she delegates functions related to the review. Accordingly, supervisors must take reasonable and appropriate action to ensure delegated functions are properly executed and should evidence performance of their procedures sufficiently to demonstrate overall supervisory control.23
      •  Where review functions are delegated, the procedures must provide a protocol to escalate regulatory issues to the designated supervisor or other appropriate department.
      •  All reviewers must have sufficient knowledge, experience, and training to adequately perform the reviews. Members should be able to demonstrate that the reviewers meet these criteria. This could include: prior supervisory or other experience, years of service in the industry, professional licenses, completion of firm and regulatory element training, product knowledge, educational degrees, knowledge of member products and services, lecturing at, or attending, industry seminars and courses, other training, length of service at the member, familiarity with member systems and tools, and prior regulatory experience.
      •  Unless a member's size and/or structure (e.g., a sole proprietor) is such that the member has no other reasonable alternative for reviewing an individual's electronic communications, an individual may not conduct supervisory reviews of his or her own electronic communications.
      D. METHOD OF REVIEW FOR CORRESPONDENCE

      Members should develop review procedures that are both reasonably designed to achieve compliance with applicable securities laws, regulations, and SRO rules and appropriate for their business and structure, consistent with the principles set forth in this Joint Guidance. In addition, members should monitor for compliance with their supervisory procedures' prescribed frequency, timeliness, and quantity parameters.

      Regardless of the method utilized, members should alert their reviewers as to the issues to be raised and material to be examined, including acceptable content. For example, members should make reference to the content standards in NYSE Rule 472 and NASD Rule 2210 and provide guidance concerning other applicable areas of concern (e.g., the use of confidential, proprietary, and inside information; anti-money laundering issues; gifts and gratuities; private securities transactions; customer complaints; front-running; and rumor spreading). When reviewing customer complaints, members should look for indicia that a customer has received a communication that is not in conformance with the member's policies and procedures.

      In addition, where members permit the use and receipt of encrypted electronic communications, they must be able to monitor and supervise those communications and must educate reviewers on how this can be accomplished. (See "Combination of Lexicon and Random Review of Electronic Correspondence" below).

      Furthermore, members must be able to review electronic correspondence in all languages in which they conduct business with the public. Therefore, if the reviewer is not fluent in the language used in an e-mail, the member should require proper independent interpretation and review (i.e., not by the author/recipient of the correspondence).

      Under limited circumstances, members should consider having their legal and/or compliance departments re-review e-mails that have already been reviewed by line supervisors and their delegatees in certain situations. Re-review might be advisable when specific problems have been identified at a branch office resulting, for instance, in a registered representative becoming the subject of an internal investigation. Members should also consider re-reviewing selected electronic communications as part of their standard branch office inspection program.

      Against this background, members may consider the following methods of review:
      •  Lexicon-based Reviews of Electronic Correspondence—Members using lexicon-based reviews (those based on sensitive words or phrases, the presence of which may signal problematic communications) of correspondence should utilize an appropriate lexicon, take reasonable security measures to keep the list confidential, and periodically evaluate the efficacy of the lexicon. Members must make informed decisions regarding how best to utilize the surveillance tools they have chosen. Thus, a member that conducts lexicon-based reviews may determine that it is not necessary to review each and every lexicon "hit" in order to maintain an effective review system. The rationale for such determinations should be maintained as part of the member's policies and procedures.

      Members should also consider regular periodic reviews of the lexicon system to determine whether any changes/updates are necessary, such as adding or deleting phrases and/or words. Members should periodically inquire as to the effectiveness of the system, especially if the system is that of a vendor.24 Members are responsible for ensuring that the system utilized is functioning properly. As discussed more fully below, if a member does not have confidence in the effectiveness of its lexicon system, a supplemental random review of electronic communications should be considered.

      Members should consider targeted concentrated reviews of employees' e-mails when warranted (e.g., when concerns are raised in connection with regulatory examination findings, internal audits, customer complaints, or regulatory inquiries).

      When assessing the effectiveness of a lexicon-based system, members should consider the following features:
      (a) A meaningful list of phrases and/or words (including industry "jargon") based on the size of the member, its type of business, its customer base, and its location (including any branch offices that may require the inclusion of certain foreign language components). The lexicon system should be comprehensive enough to yield a meaningful sample of "flagged" communications.
      (b) Ability to add and delete phrases and words on an ongoing basis.
      (c) Ability to review attachments and identify attachments that could circumvent lexicon-based reviews.
      (d) Ability to restrict access to the phrases and/or words that make up the lexicon system.
      (e) Ability to conduct searches that exclude any trailers or disclaimers used by the member, as these trailers or disclaimers often contain sensitive words such as "guarantee" (e.g., "firm does not guarantee") which would "flag" every such e-mail.
      •  Random Review of Electronic Correspondence—Members may choose to use a reasonable percentage sampling technique, whereby some percentage of the electronic communications generated by the member is reviewed. There is no prescribed minimum or fixed percentage that is required by regulation. However, the amount of electronic communications chosen for review must be reasonable given the circumstances (for example, member size, nature of business, customer base, and individual employee circumstances). In this regard, members conducting random reviews may consider factors such as:
      (a) Percentage of Electronic Correspondence Based on a Branch Office, Department, or Business Unit—For a branch office, department, or business unit, a member could establish a percentage of electronic communications requiring review that is based on its size, type of business, customer base, and location (including its sales locations), which includes e-mails from each individual in that branch office, department, or business unit.
      (b) Percentage of Electronic Correspondence for Each Individual—For each individual in a branch office, department, or business unit, a member could establish a percentage of e-mails requiring review based on its size, type of business, supervisory structure (including whether certain locations are supervised remotely), customer base, and location including its branch offices. Members should not necessarily limit themselves to reviewing the same percentage of e-mails for each employee. For example, an individual with disciplinary history or subject to special supervision may warrant a review encompassing a higher percentage of e-mails.
      •  Combination of Lexicon and Random Review of Electronic Correspondence—Given the strengths and weaknesses of any single review tool, members should consider complementary review techniques. For instance, members should note that while lexicon system-tracking capabilities have become considerably more sophisticated and effective over the past few years, as of this writing they are incapable of reading documents or document attachments that are password protected or encrypted. Further, the use of image files, such as "jpgs," can be used to pass information through lexicon filters undetected. In addition, a registered representative determined to circumvent a lexicon system may be able to do so by simply avoiding the use of words likely to "trigger" the system.
      •  Standards Applicable to All Review Systems—The manner and extent to which review tools are utilized is a determination to be made by each member, based on its business model. However, to best assure the effectiveness over time of any system, members should incorporate ongoing evaluation procedures to identify and address any "loopholes" or other issues that may arise as the means of transmitting sensitive information "under the regulatory radar" become more sophisticated and difficult to capture. Members' written procedures should delineate the additional reviews that will be conducted when such issues are identified. Members utilizing automated tools or systems in the course of their supervisory review of electronic communications must have an understanding of the limitations of such tools or systems (for example, see the potential limitations of lexicon systems noted above) and should consider what, if any, further supervisory review is necessary in light of such limitations.25
      E. FREQUENCY OF THE REVIEW OF CORRESPONDENCE
      •  Frequency of correspondence review may vary depending on the business. For instance, the frequency of review should be related to the type of business conducted (i.e., the market sensitivity of the activity); the type of customers involved; the scope of the activities; the geographical location of the activities; the disciplinary record of covered persons; and the volume of the communications subject to review.
      •  Members should prescribe reasonable timeframes within which supervisors are expected to complete their reviews of correspondence, taking into consideration the type of review being conducted and the method of review being used. When determining the reasonableness of such timeframes, members should carefully consider the type of business their firm is conducting and the extent to which a review's usefulness, in the context of that business, is diminished by the passage of time. For example, a member with a primarily retail customer base may need to conduct more frequent reviews than a member that exclusively conducts institutional business.
      F. DOCUMENTATION OF THE REVIEW OF CORRESPONDENCE
      •  Members must evidence their reviews, whether electronically or on paper,26 and be able to reasonably demonstrate that such reviews were conducted.
      •  The evidence of review should, at a minimum, clearly identify the reviewer, the communication that was reviewed, the date of review, and the steps taken as a result of any significant regulatory issues that were identified during the course of the review. Members should remind their reviewers that merely opening the communication will not be deemed a sufficient review.
      III. CONCLUSION

      As noted above, the SROs are issuing this Joint Guidance to assist members in the establishment and maintenance of supervisory systems for electronic communications that are reasonably designed to achieve compliance with the federal securities laws and self-regulatory organization rules. Members must recognize, however, that this guidance is not all-inclusive and does not represent all areas of inquiry that a member should consider when establishing and maintaining a supervisory system for electronic communications, including any existing and future electronic communications technology that this guidance may not address. In addition, members are advised that this guidance does not serve to establish a safe harbor with respect to potential supervisory or compliance deficiencies.

      1 For purposes of this Joint Guidance, "electronic communications," "e-mail," and "electronic correspondence" may be used interchangeably and can include such forms of electronic communications as instant messaging and text messaging. Notwithstanding such use of terminology, as further detailed herein, the manner of application of SRO rules specifically addressing particular communications with the public (see, e.g., NASD Rules 2210 and 2211 and NYSE Rules 342 and 472) will depend on the type of communication.

      2 For purposes of this Joint Guidance, the term "member" refers to NYSE member organizations and NASD members.

      3 See NYSE Rule 342 (Offices—Approval, Supervision and Control) and NASD Rule 3010 (Supervision).

      4 The SROs have fashioned rule provisions that, where appropriate, take into account variations in members' size or business model. See, e.g., NYSE Rules 342.23 (Offices—Approval, Supervision and Control—Internal Controls) and 472(m) (Communications with the Public—Small Firm Exception). See also NASD Rules 3012 (Supervisory Control System) and 2711 (Research Analysts and Research Reports).

      5 See NYSE Information Memo 98-3 (January 16, 1998) and NASD Notices to Members 98-11 (January 1998) and 99-03 (January 1999). See also NYSE Rule 342.17 (Offices—Approval, Supervision and Control—Review of Communications with Public) and NASD Rule 3010 (Supervision). Additionally, NASD Rule 2211 (Institutional Sales Material and Correspondence) defines "correspondence" as any written letter or electronic mail message distributed by a member to (1) one or more existing retail customers, and (2) fewer than 25 prospective retail customers within any 30 calendar-day period. Members are not required to approve outgoing "correspondence" prior to use unless the correspondence is sent to 25 or more existing retail customers within a 30 calendar-day period and makes a financial or investment recommendation or otherwise promotes a product or service of the member. NASD Rule 2211 also allows members to adopt supervisory procedures for communications distributed only to certain institutional investors that do not require principal pre-use review and approval. See also SR-NYSE-2007-49 which proposes amendments that would generally exempt from pre-use review and approval correspondence and institutional sales material, as defined.

      6 For purposes of NASD rules, the term "employees" includes all associated persons.

      7 See NYSE Information Memo 98-3 (January 16, 1998) and NASD Notice to Members 98-11 (January 1998).

      8 The SROs recognize that, as appropriate evidence of review, e-mail related to members' investment banking or securities business may be reviewed electronically and the evidence of the review may be recorded electronically (see NYSE Information Memo 98-3 and NASD Notice to Members 98-11).

      9 See also NYSE Rule 342 and NASD Rule 3012, requiring implementation of a supervisory control system.

      10 See NYSE Rule 351(d) (Reporting Requirements) and NASD Rule 3070(c) (Reporting Requirements).

      11 For example, the SROs expect members to prohibit, through policies and procedures, communications with the public from employees' home computers unless the member is capable of supervising and retaining such communications.

      12 See NYSE Rules 342.16 and 342.17 (Offices-Approval, Supervision and Control—Supervision of Registered Representatives and Review of Communications with the Public) and NASD Rules 2210 (Communications with the Public) and 2211 (Institutional Sales Material and Correspondence). See also NASD Rule 3010 (Supervision) and NASD Rule 3010(d) (Review of Transactions and Correspondence). (NASD staff notes its intention to propose amendments to Rule 3010(d)(2) to eliminate outdated distinctions between certain hard copy and electronic communications and to reflect this Joint Guidance.)

      13 See NASD Rules 2210 and 2211. See also NASD Guide to the Internet for Registered Representatives, available at http://www.nasd.com/RulesRegulation/IssueCenter/Advertising/NASDW_0061 18. See also NYSE Rule 472(a), which requires pre-approval for any advertisement, market letter, sales literature, communication, or research report that is distributed or made available to a customer or the public by a member.

      14 A "weblog" (often referred to as a "blog") is a web-based publication consisting primarily of periodic reports (generally in reverse chronological order). Similar to other media, blogs often focus on particular subjects (e.g., politics) and combine text, images, and links to other blogs, web pages, and other media related topics.

      15 "Podcasting" is a method of distributing multimedia files (i.e., audio or video content) over the Internet for playback on mobile devices and personal computers.

      16 See Section II, page 1, of this Joint Guidance (page 3 of this Notice).

      17 Firms should be aware that pursuant to NYSE Rule 342.10(B) and NASD Rule 3010(g)(2), employees working at their primary residences and relying on the exception from branch office registration cannot use their personal e-mail accounts to communicate with potential or existing customers from such locations; electronic communications from such locations must be made through the member's electronic system consistent with the terms of the exception. See generally NYSE Information Memos 05-74 (October 6, 2005) and 06-13 (March 22, 2006) and NASD Notice to Members 06-12 (March 2006).

      18 NASD views message boards as advertisements under NASD Rule 2210, and such board postings must be approved prior to use and in writing by a registered principal. (See "Ask the Analyst About Electronic Communications," NASD Regulatory & Compliance Alert, April 1996.)

      19 NASD views E-faxes sent to 25 or more prospective retail customers within a 30 calendar-day period to be sales literature under NASD Rule 2210, and they must be approved prior to use and in writing by a registered principal. NASD also requires principal pre-use approval for E-faxes sent to 25 or more existing retail customers within any 30 calendar-day period that make any financial or investment recommendation or otherwise promote a product or service of the member. See NASD Notice to Members 06-45 (August 2006).

      20 See NYSE Information Memo 91-22 (June 28, 1991) and NASD Notice to Members 91-45 (June 1991) (Joint NASD/NYSE Memo on Chinese Wall Policies and Procedures).

      21 See, e.g., NASD Rules 3010(d)(1), 2210, and 2211 and NYSE Rules 342(b)(2) and 472.

      22 Cf. NASD Notice to Members 99-03 (January 1999) (allowing unregistered persons who have received sufficient training to review written, non-electronic correspondence).

      23 See NYSE Rules 342(b) and 342.13 and NASD Rule 3010.

      24 See proposed NYSE Rule 340 (Outsourcing: Due Diligence in the Use of Service Providers) at SR-NYSE-2005-22 and NASD Notice to Members 05-48 (July 2005) (Members' Responsibilities When Outsourcing Activities to Third-Party Service Providers).

      25 See NYSE Information Memo No. 98-3 (January 16, 1998).

      26 See, e.g., NASD Rules 3010(d)(1), 2210 and 2211 and NYSE Rules 342.16, 342.17, and 472.

    • 07-29 SEC Approves Rule 2342 Setting Forth Requirements for Providing SIPC Information to Customers; Effective Date: November 6, 2007

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      GUIDANCE

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Operations
      Senior Management
      Clearing Firms
      Introducing Firms
      NASD Rule 2342
      Securities Investor Protection Act of 1970 (SIPA)
      Securities Investor Protection Corporation (SIPC)
      SIPC Brochure
      SIPC Web Site

      SIPC Information

      Executive Summary

      On May 10, 2007, the Securities and Exchange Commission (SEC) approved NASD Rule 2342 setting forth requirements for providing Securities Investor Protection Corporation (SIPC) information to customers.1 Under Rule 2342, all members—unless they are excluded from membership in SIPC and are not SIPC members, or they exclusively sell investments that are ineligible for SIPC protection—are required to advise all new customers that they may obtain information about SIPC, including the SIPC brochure, by contacting SIPC. Such members also must provide SIPC's Web site address and telephone number. Members must provide this disclosure to new customers, in writing, at the opening of an account and also must provide customers with the same information, in writing, at least once each year. The effective date is November 6, 2007.

      Included with this Notice is Attachment A, the text of Rule 2342.

      Questions/Further Information

      Questions concerning this Notice may be directed to Susan M. DeMando, Associate Vice President, Financial Operations, Department of Member Regulation, at (202) 728-8411; or Patricia Albrecht, Assistant General Counsel, Office of General Counsel, at (202) 728-8026.

      Background and Discussion

      On May 25, 2001, the Government Accountability Office (GAO) issued Securities Investor Protection: Steps Needed to Better Disclose SIPC Policies to Investors (GAO-01-653). In that report, the GAO made recommendations to the SEC and SIPC about ways to improve the information available to the public about SIPC and the Securities Investor Protection Act of 1970 (SIPA). Among other things, the GAO recommended that self-regulatory organizations (SROs) explore ways to encourage broader dissemination of the SIPC brochure to customers so that they can become more aware of the scope of coverage of SIPA.2 The GAO also recommended that the SROs consider requiring firms to include information on periodic statements or trade confirmations advising investors that they should document account discrepancies in writing. In July 2003, the GAO issued an updated report (Securities Investor Protection: Update on Matters Related to the Securities Investor Protection Corporation), in which it noted that the SEC was working with SROs to explore ways in which the GAO's recommendations could be implemented.

      As described below, NASD has made two rule changes in response to the GAO's recommendations.3

      New Rule 2342

      This Notice announces the SEC's recent approval of new Rule 2342, which requires all members, except those members that (1) pursuant to Section 3(a)(2)(A)(i) through (iii) of SIPA are excluded from membership in SIPC4 and that are not SIPC members, or (2) those members whose business consists exclusively of the sale of investments that are ineligible for SIPC protection, to advise all new customers, in writing, at the opening of an account, that they may obtain information about SIPC, including the SIPC brochure, by contacting SIPC. Such members also must provide SIPC's Web site address (www.sipc.org) and telephone number ((202) 371-8300). In addition, such members must provide customers with the same information, in writing, at least once each year. In cases where both an introducing firm and clearing firm service an account, the firms may assign these requirements to one of the firms. Rule 2342 becomes effective on November 6, 2007.

      Amendment to Rule 2340

      NASD previously announced the SEC's approval of an amendment to Rule 2340 (Customer Account Statements) in Notice to Members 06-72 (December 2006). The amendment to Rule 2340 requires account statements to include a statement advising each customer to report promptly any inaccuracy or discrepancy in that person's account to his or her brokerage firm and clearing firm (where these are different firms). This statement also must advise the customer that any oral communication should be re-confirmed in writing to further protect the customer's rights, including rights under SIPA. The amendment to Rule 2340 went into effect on May 31, 2007.5


      1 Securities Exchange Act Release No. 55737 (May 10, 2007), 72 FR 27606 (May 16, 2007) (SR-NASD-2006-124), as corrected by SR-NASD-2007-036 (June 1, 2007).

      2 In brief, the SIPC brochure describes such things as the role of SIPC, what SIPC covers and what it does not, and how SIPC operates if a brokerage firm fails.

      3 The New York Stock Exchange has made similar amendments to NYSE Rule 409 (Statements of Accounts to Customers) in response to the GAO's recommendations. See Securities Exchange Act Release No. 54904 (December 8, 2006), 71 FR 75600 (December 15, 2006) (SR-NYSE-2005-09) (effective May 31, 2007).

      4 Under Section 3(a)(2)(A)(i) through (iii) of SIPA, members of SIPC include all persons registered as brokers or dealers under section 15(b) of the Exchange Act, other than:

      (1) persons whose principal business, in the determination of SIPC, taking into account business of affiliated entities, is conducted outside the United States and its territories and possessions;
      (2) persons whose business as a broker or dealer consists exclusively of (a) the distribution of shares of registered open end investment companies or unit investment trusts, (b) the sale of variable annuities, (c) the business of insurance, or (d) the business of rendering investment advisory services to one or more registered investment companies or insurance company separate accounts; and
      (3) persons who are registered as a broker or dealer pursuant to section 15(b)(11)(A) of the Exchange Act [pertaining to registration with respect to transactions in security futures products].

      5 See Securities Exchange Act Release No. 54411 (September 7, 2006), 71 FR 54105 (September 13, 2006) (SR-NASD-2004-171), as corrected by Securities Exchange Act Release No. 54411A (October 6, 2006), 71 FR 61115 (October 17, 2006) (SR-NASD-2004-171). See also Securities Exchange Act Release No. 54872 (December 5, 2006) (Notice of Filing and Order Granting Accelerated Approval of Proposed Rule Change Relating to Establishing an Effective Date for Amendments to NASD Rule 2340); File No. SR-NASD-2006-128.


      ATTACHMENT A

      * * * * *

      2000. BUSINESS CONDUCT

      * * * * *

      2300. Transactions with Customers

      * * * * *

      2342. SIPC Information

      All members, except those members: (a) that pursuant to Section 3(a)(2)(A)(i) through (iii) of the Securities Investor Protection Act of 1970 (SIPA) are excluded from membership in the Securities Investor Protection Corporation (SIPC) and that are not SIPC members; or (b) whose business consists exclusively of the sale of investments that are ineligible for SIPC protection, shall advise all new customers, in writing, at the opening of an account, that they may obtain information about SIPC, including the SIPC brochure, by contacting SIPC, and also shall provide the Web site address and telephone number of SIPC. In addition, such members shall provide all customers with the same information, in writing, at least once each year. In cases where both an introducing firm and clearing firm service an account, the firms may assign these requirements to one of the firms.

    • 07-28 SEC Approves Additional Mark-Up Policy for Transactions in Debt Securities, Except Municipal Securities; Effective Date: July 5, 2007

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      GUIDANCE

      SUGGESTED ROUTING

      KEY TOPICS

      Fixed Income
      Trading and Market Making
      Sales
      Senior Management
      Legal and Compliance
      Internal Audit
      Training
      Mark-Ups
      Debt Securities
      Rule 2440
      Pricing of Debt Securities

      Mark-Ups on Debt Securities

      Executive Summary

      On April 16, 2007, the Securities and Exchange Commission (SEC) approved IM-2440-2, "Additional Mark-Up Policy for Transactions in Debt Securities, Except Municipal Securities" (Debt Mark-Up Interpretation or Interpretation), and renumbered IM-2440 as IM-2440-1.1 The Debt Mark-Up Interpretation supplements Rule 2440, "Fair Prices and Commissions," which requires broker-dealers to charge customers fair mark-ups and commissions, and IM-2440-1, "Mark-Ups."

      In a debt security transaction with a customer, the broker-dealer's mark-up (mark-down) must be calculated from the prevailing market price of that security. The new Debt Mark-Up Interpretation states that, presumptively, the prevailing market price of a debt security is the broker-dealer's contemporaneous cost (or, in a sale, the broker-dealer's contemporaneous proceeds).

      The Interpretation also addresses the procedures for determining prevailing market price (as a price other than contemporaneous cost) when a broker-dealer has the discretion, under the Interpretation, not to use its contemporaneous cost as the measure. In addition, the Interpretation includes an exemption for transactions in non-investment grade debt securities between broker-dealers and qualified institutional buyers (QIBs), as defined in Rule 144A under the Securities Act of 1933 (Securities Act) (QIB Exemption).2 The Interpretation and the amendment to IM-2440 are set forth in Attachment A of this Notice.

      The Interpretation and the amendment to IM-2440 become effective July 5, 2007.

      Questions/Further Information

      Questions regarding this Notice may be directed to Sharon K. Zackula, Associate Vice President and Associate General Counsel, Office of General Counsel, Regulatory Policy and Oversight, at (202) 728-8985; Malcolm P. Northam, Director, Fixed Income Securities Regulation, Regulation Policy, Member Regulation, at (202) 728-8085; and the Legal Section, Market Regulation, at (240) 386-5126.

      Background

      Generally, under NASD Rule 2440 and IM-2440-1, broker-dealers may not charge compensation for the execution of customer transactions, whether in the form of a mark-up (mark-down) or commission, that is unfair, unreasonable or excessive. Unfair, unreasonable or excessive compensation for customer trades also violates Rule 2110, which requires broker-dealers to conduct their business in accordance with just and equitable principles of trade.3 The Debt Mark-Up Interpretation approved on April 16, 2007, supplements Rule 2440 and IM-2440-1.4

      Rule 2440, IM-2440-1 and the Interpretation apply to transactions in debt securities between a broker-dealer and a customer except transactions in municipal securities, as defined in Section 3(a)(29) of the Securities Exchange Act of 1934 (Act),5 and exempted securities (other than municipal securities), as defined in Section 3(a)(12) of the Act.6

      Prevailing Market Price

      In a debt security transaction with a customer, the broker-dealer's mark-up (mark-down) must be calculated from the prevailing market price of that security. The Debt Mark-Up Interpretation focuses particularly on the key issue of the proper identification of the prevailing market price. The Interpretation states that, presumptively, the prevailing market price of a debt security is the broker-dealer's contemporaneous cost (or, in a sale, the broker-dealer's contemporaneous proceeds).7 The Interpretation also addresses the procedures for determining prevailing market price (as a price other than contemporaneous cost) when a broker-dealer, under the Interpretation, may chose not to use its contemporaneous cost as the measure of the prevailing market price. This occurs when there is no contemporaneous cost (proceeds) or certain events have occurred, as discussed on the next page.

      Contemporaneous Cost

      A broker-dealer may seek to overcome the presumption that its contemporaneous cost (proceeds) is indicative of the prevailing market price in any of three events:

      (i) interest rates changed after the broker-dealer's contemporaneous transaction to a degree that such change would reasonably cause a change in debt securities pricing;
      (ii) the credit quality of the debt security changed significantly after the broker-dealer's contemporaneous transaction; or
      (iii) news was issued or otherwise distributed and known to the marketplace that had an effect on the perceived value of the debt security after the broker-dealer's contemporaneous transaction.8

      Pricing Alternatives to Contemporaneous Cost

      Hierarchy

      When the broker-dealer has no contemporaneous transaction, or any of the events set forth above have occurred, the Debt Mark-Up Interpretation identifies three factors that must be considered, in the order listed, to determine the prevailing market price (hierarchy pricing factors). As set out more fully in the Interpretation, the hierarchy pricing factors are as follows in the order of consideration: contemporaneous inter-dealer transactions in the same security; qualifying contemporaneous institutional account-dealer trades in the same security; or qualifying contemporaneous quotations.9 The broker-dealer must determine that the relevant pricing information does not exist in each of the hierarchy pricing factors in their specified order before proceeding to any consideration of the next factor.

      "Similar" Securities

      If none of the three hierarchy pricing factors are determinative of the relevant pricing information, the broker-dealer may then consider the pricing information from "similar" securities.10 The Interpretation provides specific guidance about what constitutes "similar" securities for purposes of the Interpretation.11 A broker-dealer should consider, among other things, credit quality of both securities, ratings, collateralization, spreads (over U.S. Treasury securities of similar duration) at which the securities are usually traded, general structural similarities (such as calls, maturity, embedded options), the size of the issue, float, recent turnover, and transferability or restrictions thereto.12 Also, the Interpretation recognizes that there may not be "similar" securities for certain securities.13 Generally, a "similar" security should be sufficiently equivalent to the subject security that it would serve as a reasonably fungible alternative investment. In addition, at a minimum, a broker-dealer must be able to fairly estimate the market yield for the subject security from the yields of "similar" securities.14

      The pricing factors incorporating "similar" securities are not hierarchal; that is, they may be considered in any order. However, when reviewing them, the broker-dealer must consider that the burden on the broker-dealer is the correct identification of the prevailing market price.15

      Economic Models

      Finally, where neither the hierarchy pricing factors nor similar securities can be used to establish the prevailing market price, the Debt Mark-Up Interpretation allows that the broker-dealer may use pricing information derived from an economic model to determine the prevailing market price of a debt security for purposes of a mark-up.16

      An economic model used to identify prevailing market price must take into account measures such as credit quality, interest rates, industry sector, time to maturity, call provisions and any other embedded option, coupon rate and face value, and all applicable pricing terms and conventions (e.g., coupon frequency and accrual methods).17

      The Qualified Institutional Buyer (QIB) Exemption

      The Interpretation contains a QIB Exemption, removing certain institutional customer transactions from the requirements of Rule 2440, IM-2440-1 and the Interpretation.18 To rely upon the QIB Exemption, a broker-dealer must determine that:

      (i) the customer is a QIB as defined in Rule 144A under the Securities Act;
      (ii) the security that the QIB wishes to buy or sell is a non-investment grade debt security as defined for purposes of IM-2440-2; and
      (iii) after considering the factors set forth in IM-2310-3, which addresses institutional customer suitability factors, the QIB has the capacity to evaluate independently the investment risk and in fact is exercising independent judgment in deciding to enter into the transaction to which the broker-dealer seeks to apply the exemption.19

      If the broker-dealer establishes all three elements, then the QIB Exemption may be applied by the broker-dealer.

      IM-2310-3 contains extensive factors to be considered in making the determination as to whether a QIB has the expertise to make an independent decision in respect of a transaction and in fact is making an independent decision. Therefore, members are advised to fully review this rule when applying the QIB exemption.

      NASD is providing 30 days from publication of this Notice for implementation to provide members with adequate time to comply with the amended requirements. As such, the amendments become effective July 5, 2007.


      1 See Securities Exchange Act Release No. 55638 (April 16, 2007), 77 FR 20150 (April 23, 2007) (File No. SR-NASD-2003-141) (approval order).

      In this Notice, the term "mark-up" generally refers to both mark-ups and mark-downs, and the term "contemporaneous cost" refers to both contemporaneous cost and contemporaneous proceeds (or either of them). Single terms in parentheses within sentences, such as the term "(proceeds)," refer specifically to customer sale transactions where the member charges a mark-down.

      2 Under Rule 144A of the Securities Act of 1933 (Securities Act), the definition of QIB includes, among others: (1) specified entities (including insurance companies, registered investment companies, employee benefit plans or similar plans maintained by a state, or a state agency or political subdivision, and investment advisors) that act for their own account or the accounts of other QIBs, that in the aggregate own and invest on a discretionary basis at least $100 million in securities of issuers that are not affiliated with the entity; (2) any broker-dealer registered pursuant to Section 15 of the Securities Exchange Act of 1934 (Act), acting for its own account or the accounts of other QIBs, that in the aggregate owns and invests on a discretionary basis at least $10 million of securities of issuers that are not affiliated with the broker-dealer; (3) any broker-dealer acting in a riskless principal transaction on behalf of a QIB; (4) any investment company registered under the Investment Company Act of 1940, acting for its own account or for the accounts of other QIBs, that is part of a family of investment companies that own in the aggregate at least $100 million in securities of issuers, other than issuers that are affiliated with the investment company or are part of such family of investment companies; and (5) any bank or certain other domestic and foreign financial institutions, acting for its own account or the accounts of other QIBs, that in the aggregate owns and invests on a discretionary basis at least $100 million in securities of issuers that are not affiliated with it and that has an audited net worth of at least $25 million.

      3 A broker-dealer may also be liable for excessive mark-ups under the anti-fraud provisions of the Securities Act and the Act. See Section 10(b)(5) of the Act and Rule 10b-5 thereunder, and Section 17(a) of the Securities Act.

      4 See IM-2440-2, paragraph (a)(1).

      5 See Section 3(a)(29) of the Act. "Municipal securities" include, among others, tax-exempt general obligation bonds and tax-exempt industrial revenue bonds. Transactions in municipal securities involving unfair pricing, including unfair mark-ups, are subject to the rules of the Municipal Securities Rulemaking Board (MSRB) and the anti-fraud provisions of the Securities Act and the Act. See note 3.

      6 See Section 3(a)(12) of the Act. "Exempted securities" include, among others: government securities, as defined in Section 3(a)(42) of the Act; municipal securities, as defined in Section 3(a)(29) of the Act; any interest in any common trust fund or similar fund that is excluded from the definition of the term "investment company" under the Investment Company Act of 1940; any interest in any common trust fund, or a collective trust fund maintained by a bank, or any security arising out of a contract issued by an insurance company, which interest, participation or security is issued in connection with a qualified plan; any security issued by or any interest or participation in any pooled income fund, collective trust fund, collective investment fund, or similar fund that is excluded from the definition of an investment company; certain securities issued by or any interest in any church plan, company, or account that is excluded from the definition of an investment company; and other securities that the Commission may, by rules, exempt from any one or more provisions of the federal securities laws

      NASD Rule 2110 (J&E rule) applies to broker-dealers charging excessive mark-ups or commissions in exempted securities transactions (other than municipal securities transactions). See Securities Exchange Act Release No. 37588 (August 20, 1996), 61 FR 44100 (August 27, 1996) (SR-NASD-1995-39) (order approving the application of the NASD's Rules of Fair Practice to transactions in exempted securities (except municipal securities)). In the order, the Commission states that for transactions in government securities between broker-dealers and customers, NASD may address conduct that is "similar to conduct that may violate the 'Fair Prices and Commissions' provision and the 'Mark-Up Policy'" under Rule 2110. The Commission said an NASD statement in the rule filing regarding this application of the J&E rule "merely clarifies and reminds members that its rules requiring members to adhere to just and equitable principles of trade apply to conduct that may violate the Fair Prices and Commissions provision and the Mark-Up Policy..." and the "rule requiring that members adhere to just and equitable principles of trade would have applied to such conduct regardless of this clarification." 61 FR 44100, 44113. Also, such conduct is subject to the anti-fraud provisions of the Securities Act and the Act. See note 3. See also NASD Rule 0116, paragraph (b).

      7 See IM-2440-2, paragraphs (b)(1), (2) and (4).

      8 See IM-2440-2, paragraph (b)(4).

      9 See IM-2440-2, paragraphs (b)(5)(A) through (C).

      10 See IM-2440-2, paragraph (b)(6).

      11 See IM-2440-2, paragraphs (c)(1) and (2).

      12 See IM-2440-2, paragraphs (c)(2)(A) through (D).

      13 See IM-2440-2, paragraph (c)(3).

      14 See IM-2440-2, paragraph (c)(1).

      15 See IM-2440-2, paragraphs (b)(6) and (b)(8).

      16 See IM-2440-2, paragraph (b)(7).

      17 Id.

      18 See IM-2440-2, paragraph (b)(9).

      19 Id.


      ATTACHMENT A

      New language is underlined; deletions are in brackets.

      IM-2440-1. Mark-Up Policy

      The question of fair mark-ups or spreads is one which has been raised from the earliest days of the Association. No definitive answer can be given and no interpretation can be all-inclusive for the obvious reason that what might be considered fair in one transaction could be unfair in another transaction because of different circumstances. In 1943, the Association's Board adopted what has become known as the "5% Policy" to be applied to transactions executed for customers. It was based upon studies demonstrating that the large majority of customer transactions were effected at a mark-up of 5% or less. The Policy has been reviewed by the Board of Governors on numerous occasions and each time the Board has reaffirmed the philosophy expressed in 1943. Pursuant thereto, and in accordance with Article VII, Section 1(a)(ii) of the By-Laws, the Board has adopted the following interpretation under Rule 2440.

      It shall be deemed a violation of Rule 2110 and Rule 2440 for a member to enter into any transaction with a customer in any security at any price not reasonably related to the current market price of the security or to charge a commission which is not reasonable.

      (a) through (d) No change.

      * * * * *

      IM-2440-2. Additional Mark-Up Policy For Transactions in Debt Securities, Except Municipal Securities1

      (a) Scope
      (1) IM-2440-1 applies to debt securities transactions, and this IM-2440-2 supplements the guidance provided in IM-2440-1.
      (b) Prevailing Market Price
      (1) A dealer that is acting in a principal capacity in a transaction with a customer and is charging a mark-up or mark-down must mark-up or mark-down the transaction from the prevailing market price. Presumptively for purposes of this IM-2440-2, the prevailing market price for a debt security is established by referring to the dealer's contemporaneous cost as incurred, or contemporaneous proceeds as obtained, consistent with NASD pricing rules. (See, e.g., Rule 2320).
      (2) When the dealer is selling the security to a customer, countervailing evidence of the prevailing market price may be considered only where the dealer made no contemporaneous purchases in the security or can show that in the particular circumstances the dealer's contemporaneous cost is not indicative of the prevailing market price. When the dealer is buying the security from a customer, countervailing evidence of the prevailing market price may be considered only where the dealer made no contemporaneous sales in the security or can show that in the particular circumstances the dealer's contemporaneous proceeds are not indicative of the prevailing market price.
      (3) A dealer's cost is considered contemporaneous if the transaction occurs close enough in time to the subject transaction that it would reasonably be expected to reflect the current market price for the security. (Where a mark-down is being calculated, a dealer's proceeds would be considered contemporaneous if the transaction from which the proceeds result occurs close enough in time to the subject transaction that such proceeds would reasonably be expected to reflect the current market price for the security.)
      (4) A dealer that effects a transaction in debt securities with a customer and identifies the prevailing market price using a measure other than the dealer's own contemporaneous cost (or, in a mark-down, the dealer's own proceeds) must be prepared to provide evidence that is sufficient to overcome the presumption that the dealer's contemporaneous cost (or, the dealer's proceeds) provides the best measure of the prevailing market price. A dealer may be able to show that its contemporaneous cost is (or proceeds are) not indicative of prevailing market price, and thus overcome the presumption, in instances where (i) interest rates changed after the dealer's contemporaneous transaction to a degree that such change would reasonably cause a change in debt securities pricing; (ii) the credit quality of the debt security changed significantly after the dealer's contemporaneous transaction; or (iii) news was issued or otherwise distributed and known to the marketplace that had an effect on the perceived value of the debt security after the dealer's contemporaneous transaction.
      (5) In instances where the dealer has established that the dealer's cost is (or, in a mark-down, proceeds are) no longer contemporaneous, or where the dealer has presented evidence that is sufficient to overcome the presumption that the dealer's contemporaneous cost (or proceeds) provides the best measure of the prevailing market price, such as those instances described in (b)(4)(i), (ii) and (iii), a member must consider, in the order listed, the following types of pricing information to determine prevailing market price:
      (A) Prices of any contemporaneous inter-dealer transactions in the security in question;
      (B) In the absence of transactions described in (A), prices of contemporaneous dealer purchases (sales) in the security in question from (to) institutional accounts with which any dealer regularly effects transactions in the same security; or
      (C) In the absence of transactions described in (A) and (B), for actively traded securities, contemporaneous bid (offer) quotations for the security in question made through an inter-dealer mechanism, through which transactions generally occur at the displayed quotations.

      (A member may consider a succeeding category of pricing information only when the prior category does not generate relevant pricing information (e.g., a member may consider pricing information under (B) only after the member has determined, after applying (A), that there are no contemporaneous inter-dealer transactions in the same security).) In reviewing the pricing information available within each category, the relative weight, for purposes of identifying prevailing market price, of such information (i.e., either a particular transaction price, or, in (C) above, a particular quotation) depends on the facts and circumstances of the comparison transaction or quotation (i.e., such as whether the dealer in the comparison transaction was on the same side of the market as the dealer is in the subject transaction and timeliness of the information).
      (6) In the event that, in particular circumstances, the above factors are not available, other factors that may be taken into consideration for the purpose of establishing the price from which a customer mark-up (mark-down) may be calculated, include but are not limited to:
      •  Prices of contemporaneous inter-dealer transactions in a "similar" security, as defined below, or prices of contemporaneous dealer purchase (sale) transactions in a "similar" security with institutional accounts with which any dealer regularly effects transactions in the "similar" security with respect to customer mark-ups (mark-downs);
      •  Yields calculated from prices of contemporaneous inter-dealer transactions in "similar" securities;
      •  Yields calculated from prices of contemporaneous dealer purchase (sale) transactions with institutional accounts with which any dealer regularly effects transactions in "similar" securities with respect to customer mark-ups (mark-downs); and
      •  Yields calculated from validated contemporaneous inter-dealer bid (offer) quotations in "similar" securities for customer mark-ups (mark-downs).

      The relative weight, for purposes of identifying prevailing market price, of the pricing information obtained from the factors set forth above depends on the facts and circumstances surrounding the comparison transaction (i.e., whether the dealer in the comparison transaction was on the same side of the market as the dealer is in the subject transaction, timeliness of the information, and, with respect to the final factor listed above, the relative spread of the quotations in the similar security to the quotations in the subject security).
      (7) Finally, if information concerning the prevailing market price of the subject security cannot be obtained by applying any of the above factors, NASD or its members may consider as a factor in assessing the prevailing market price of a debt security the prices or yields derived from economic models (e.g., discounted cash flow models) that take into account measures such as credit quality, interest rates, industry sector, time to maturity, call provisions and any other embedded options, coupon rate, and face value; and consider all applicable pricing terms and conventions (e.g., coupon frequency and accrual methods). Such models currently may be in use by bond dealers or may be specifically developed by regulators for surveillance purposes.
      (8) Because the ultimate evidentiary issue is the prevailing market price, isolated transactions or isolated quotations generally will have little or no weight or relevance in establishing prevailing market price. For example, in considering yields of "similar" securities, except in extraordinary circumstances, members may not rely exclusively on isolated transactions or a limited number of transactions that are not fairly representative of the yields of transactions in "similar" securities taken as a whole.
      (9) "Customer," for purposes of Rule 2440, IM-2440-1 and this IM-2440-2, shall not include a qualified institutional buyer ("QIB") as defined in Rule 144A under the Securities Act of 1933 that is purchasing or selling a non-investment grade debt security when the dealer has determined, after considering the factors set forth in IM-2310-3, that the QIB has the capacity to evaluate independently the investment risk and in fact is exercising independent judgment in deciding to enter into the transaction. For purposes of Rule 2440, IM-2440-1 and this IM-2440-2, "non-investment grade debt security" means a debt security that: (i) if rated by only one nationally recognized statistical rating organization ("NRSRO"), is rated lower than one of the four highest generic rating categories; (ii) if rated by more than one NRSRO, is rated lower than one of the four highest generic rating categories by any of the NRSROs; or (iii) if unrated, either was analyzed as a non-investment grade debt security by the dealer and the dealer retains credit evaluation documentation and demonstrates to NASD (using credit evaluation or other demonstrable criteria) that the credit quality of the security is, in fact, equivalent to a non-investment grade debt security, or was initially offered and sold and continues to be offered and sold pursuant to an exemption from registration under the Securities Act of 1933.
      (c) "Similar" Securities
      (1) A "similar" security should be sufficiently similar to the subject security that it would serve as a reasonable alternative investment to the investor. At a minimum, the security or securities should be sufficiently similar that a market yield for the subject security can be fairly estimated from the yields of the "similar" security or securities. Where a security has several components, appropriate consideration may also be given to the prices or yields of the various components of the security.
      (2) The degree to which a security is "similar," as that term is used in this IM-2440-2, to the subject security may be determined by factors that include but are not limited to the following:
      (A) Credit quality considerations, such as whether the security is issued by the same or similar entity, bears the same or similar credit rating, or is supported by a similarly strong guarantee or collateral as the subject security (to the extent securities of other issuers are designated as "similar" securities, significant recent information of either issuer that is not yet incorporated in credit ratings should be considered (e.g., changes to ratings outlooks));
      (B) The extent to which the spread (i.e., the spread over U.S. Treasury securities of a similar duration) at which the "similar" security trades is comparable to the spread at which the subject security trades;
      (C) General structural characteristics and provisions of the issue, such as coupon, maturity, duration, complexity or uniqueness of the structure, callability, the likelihood that the security will be called, tendered or exchanged, and other embedded options, as compared with the characteristics of the subject security; and
      (D) Technical factors such as the size of the issue, the float and recent turnover of the issue, and legal restrictions on transferability as compared with the subject security.
      (3) When a debt security's value and pricing is based substantially on, and is highly dependent on, the particular circumstances of the issuer, including creditworthiness and the ability and willingness of the issuer to meet the specific obligations of the security, in most cases other securities will not be sufficiently similar, and therefore, other securities may not be used to establish the prevailing market price.

      1 The Interpretation does not apply to transactions in municipal securities. Single terms in parentheses within sentences, such as the terms "(sale)" and "(to)" in the phrase, "contemporaneous dealer purchase (sale) transactions with institutional accounts," refer to scenarios where a member is charging a customer a mark-down.

    • 07-27 NASD Requests Comment on Proposed Rule 2721 to Regulate Member Private Securities Offerings; Comment Period Expires July 20, 2007

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      REQUEST FOR COMMENT

      SUGGESTED ROUTING

      KEY TOPICS

      Corporate Financing
      Executive Representatives
      Legal & Compliance
      Senior Management
      Operations
      Affiliates
      Control Entity
      Institutional Accounts
      Member Private Offerings
      Private Placements
      Private Placement Memorandum
      Regulation D

      Member Private Offerings

      Executive Summary

      NASD is issuing this Notice to Members to solicit comments from members and other interested parties on proposed Rule 2721 pertaining to private placements of unregistered securities issued by a member (Member Private Offerings or MPOs), which would require that:

      •  a private placement memorandum (PPM) be provided to each investor with information regarding risk factors, intended use of proceeds, offering expenses and any other information necessary to ensure that required information is not misleading;
      •  the PPM be filed with NASD's Corporate Financing Department at or prior to the time it is provided to any investor; and
      •  at least 85 percent of the offering proceeds be used for the business purposes identified under the "use of proceeds" disclosure in the PPM.

      Rule 2721 is proposed in response to problems NASD has identified in connection with the private offerings of members' securities or those of a control entity. The proposed Rule also contains several exemptions for offerings to certain types of institutional investors, offerings under various provisions of the federal securities laws for which NASD believes the protections of the proposed rule are not necessary, and offerings in which investors otherwise would be expected to have access to sufficient information about the issuer.

      Action Requested

      NASD encourages all interested parties to comment on the proposal. Comments must be received by July 20, 2007. Members and other interested parties can submit their comments through the following methods:

      •  Mailing comments in hard copy to the address below; or
      •  Emailing written comments to pubcom@nasd.com.

      To help NASD process and review comments more efficiently, persons commenting on this proposal should use only one method. Comments sent by hard copy should be mailed to:

      Barbara Z. Sweeney
      Office of the Corporate Secretary
      NASD
      1735 K Street, NW
      Washington, DC 20006-1506

      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 eb site one week after the end of the comment period.1

      Before becoming effective, a proposed rule change (or certain policies) must be authorized for filing with the Securities and Exchange Commission (SEC) by the NASD Board, and then must e approved by the SEC, following publication for public comment in the Federal Register.2

      Questions/Further Information

      As noted above, hard copy comments should be mailed to Barbara Z. Sweeney. Questions concerning this Notice may be directed to Thomas M. Selman, Executive Vice President, Investment Companies/Corporate Financing, at (240) 386-4533; Gary L. Goldsholle, Vice President and Associate General Counsel, Office of General Counsel, at (202) 728-8104; or Joseph E. Price, Vice President, Corporate Financing, at (240) 386-4623.

      Background and Discussion

      In recent years, NASD has brought numerous enforcement cases concerning abuses in connection with Member Private Offerings.3 In addition, NASD conducted a sweep of firms that had engaged in MPOs and found widespread problems. Allegations in these cases include the failure to provide PPMs to investors, as well as misleading, incorrect or selective disclosure in PPMs that were provided, including omissions and misrepresentations regarding selling compensation and the use of offering proceeds.4

      Typically, MPOs are private placements that rely on the SEC Regulation D exemption from the registration and disclosure requirements in the Securities Act of 1933 (Securities Act).5 Inasmuch as MPOs are private placements, they are not subject to the existing NASD rules governing underwriting terms and arrangements in public offerings and conflicts of interest by members that participate in public offerings.6

      1. Proposed Rule 2721
      A. Offerings by Members or a Control Entity

      Proposed Rule 2721 (set forth in Attachment A) would establish disclosure and filing requirements and limits on offering expenses for private placements by members of their own securities or those of a "control entity." A "control entity" for purposes of the proposed rule would be defined as an entity that controls, is controlled by or is under common control with a member or its associated persons. The term "control" for purposes of the proposed rule would be determined based on beneficial ownership of more than 50 percent of the outstanding voting securities of a corporation, or the right to more than 50 percent of the distributable profits or losses of a partnership.7 The power to direct the management or policies of a corporation or partnership alone (e.g., a general partner)—absent meeting the majority ownership or right to the majority of profits—would not constitute "control" for the control entity definition in the proposed rule.
      B. Disclosure Requirements

      Proposed Rule 2721 would require members to provide each investor in an MPO (whether accredited or unaccredited) by a member or a control affiliate with a PPM that contains the following information:
      •  risk factors associated with the investment, including company risks, industry risks and market risks;
      •  intended use of offering proceeds;
      •  offering expenses and selling compensation; and
      •  any other information necessary to ensure that the required information is not misleading.
           This requirement would help ensure that every investor in an MPO by a member or a control entity receives basic information concerning the nature of the offering.
      C. Filing Requirements

      The proposed rule also would require members to file the PPM with NASD at or prior to the first time the PPM is provided to any investor. In addition, any amendment or exhibit to the PPM would be required to be filed with NASD within ten days of being provided to any investor. However, unlike filings with NASD under Rules 2710, 2720 and 2810, a member could begin offering MPO securities immediately after filing the PPM.8
      D. Use of Offering Proceeds

      Proposed Rule 2721 would require that at least 85 percent of the offering proceeds of an MPO be used for the business purposes identified in the PPM. This condition is in response to abuses we have seen where substantial amounts of offering proceeds have been dedicated to purposes other than the business purpose identified in the PPM, including selling compensation and related party benefits.9 Consequently, under the proposed rule, offering and other expenses of the MPO could not exceed 15 percent of the offering proceeds. This figure is consistent with the limitation of offering fees and expenses, including compensation, in NASD Rule 2810 (Direct Participation Programs), and the North American Securities Administrators Association (NASAA) guidelines with respect to public offerings subject to state regulation. When a member engages in a private placement of its own securities or those of a control entity, investors should be assured that, at a minimum, 85 percent of the proceeds of the offering are dedicated to the business purposes described in the PPM. We request comment on whether this threshold is appropriate.
      E. Proposed Exemptions

      Proposed Rule 2721 would include several exemptions. Specifically, the proposed Rule would exempt MPOs sold solely to:
      •  institutional accounts (as defined in NASD Rule 3110(c)(4));
      •  qualified purchasers (as defined in Section 2(a)(51)(A) of the Investment Company Act of 1940);
      •  qualified institutional buyers (as defined in SEC Rule 144A of the Securities Act);
      •  investment companies (as defined in Rule SEC Rule 144A);
      •  an entity composed exclusively of qualified institutional buyers (as defined in SEC Rule 144A); and
      •  banks (as defined in SEC Rule 144A).

      In addition, the following types of offerings would be exempt from the proposed rule:

      •  offerings made pursuant to SEC Rule 144A or SEC Regulation S;
      •  offerings in which a member acts solely in a wholesaling capacity and sells unregistered securities to other unaffiliated broker-dealers;
      •  offerings of exempt securities with short term maturities under Section 3(a)(3) of the Securities Act; and
      •  offerings of subordinated loans under SEC Rule 15c3-1, Appendix D.

      Finally, the proposed rule also would exempt MPOs in which investors would be expected to have access to sufficient information about the issuer and its securities in addition to the information provided by the member conducting the MPO. These include exemptions for:
      •  offerings of unregistered investment grade rated debt;
      •  offerings to employees and affiliates of the issuer; and
      •  offerings of securities issued in stock splits and restructuring transactions.
      F. Scope of Proposed Rule 2721

      Proposed Rule 2721 is intended to provide investor protections with respect to private offerings by a member that are parallel, but not identical, to the protections provided by Rule 2720 with respect to a member's public offerings.10 Therefore, Rule 2721, like Rule 2720, would apply only to private placements by a member or its control entities. The proposed rule would apply to offerings by an entity that is under common control with the member, or that the member firm or its associated persons control. For purposes of proposed Rule 2721, "control" is defined as beneficial ownership of more than 50 percent of the outstanding voting securities if the entity is a corporation, or in the case of a partnership, more than a 50 percent interest in its distributable profits or losses.11

      Consequently, proposed Rule 2721 would not apply to private placements by any entity that does not meet this control test, including investment partnerships, direct participation programs, and other private funds that the member might organize but in which the member, its associated persons, or any parent of the member does not beneficially own the requisite ownership position. NASD requests comment on whether the proposed rule should apply to these other entities.

      1 See Notice to Members 03-73 (November 2003) (NASD Announces Online Availability of Comments). Personal identifying information, such as names or email addresses, will not be edited from submissions. Submit only information you wish to make publicly available.

      2 Section 19 of the Securities Exchange Act of 1934 (Exchange Act) permits certain limited types of proposed rule changes to take effect upon filing with the SEC. The SEC has the authority to summarily abrogate these types of rule changes within 60 days of filing. See Exchange Act Section 19 and the rules thereunder.

      3 E.g., Franklin Ross, Inc., NASD No. E072004001501 (settled April 2006), summarized in NASD NTM Disciplinary Actions, p. 1 (May 2006); Capital Growth Financial, LLC, NASD No. E072003099001 (settled February 2006), summarized in NASD NTM Disciplinary Actions, p. 1 (April 2006); Craig & Associates, NASD No. E3B2003026801 (settled August 2005), summarized in NASD NTM Disciplinary Actions, p. D6 (October 2005); Online Brokerage Services, Inc., NASD No. C8A050021 (settled March 2005), summarized in NASD NTM Disciplinary Actions, p. D5 (May 2005); IAR Securities/Legend Merchant Group, NASD No. C10030058 (settled July 2004), summarized in NASD NTM Disciplinary Actions, p. D1 (July 2004); Shelman Securities Corp., NASD No. C06030013 (settled December 2003), summarized in NASD NTM Disciplinary Actions, p. D1 (February 2004); Neil Brooks, NASD No. C06030009 (settled June 2003), summarized in NASD Press Release, NASD Files Three Enforcement Actions for Fraudulent Hedge Fund Offerings (August 18, 2003); Dep't of Enforcement v. L.H. Ross & Co., Inc., Complaint No. CAF040056 (Hearing Panel decision January 15, 2005); Dep't of Enforcement v. Win Capital Corp., Complaint No. CLI030013 (Hearing Panel decision August 6, 2004). In addition to these cases, NASD has numerous ongoing investigations involving MPOs.

      4 SEC Regulation D does not require disclosure documents to be prepared or provided in offerings made solely to accredited investors. However, in some MPOs, NASD found that no PPM was prepared even though sales were made to persons who are not accredited investors. In others, a PPM was prepared, but it was not provided to certain investors, including those that were unaccredited.

      5 In 1982, the SEC adopted Regulation D as a safe harbor from the registration requirements of the Securities Act. NASD members and their control entities raise capital under Regulation D in MPOs to finance their operations or to pool customer funds to create investment vehicles that provide revenue to the members. MPOs also can be offered privately pursuant to other available exemptions from registration under the Securities Act, such as Section 4(2).

      6 NASD Conduct Rules 2710, 2720 and 2810 only govern member participation in public offerings of securities.

      7 For purposes of quantifying the percent of profits or losses in a partnership attributable to the general partner, NASD will not include performance and management fees earned by the general partner. However, if such performance and management fees are subsequently re-invested in the partnership, thereby increasing the general partner's ownership interest, then such interests would be considered in determining whether the partnership is a control entity.

      8 NASD would not issue a "no objections opinion." However, if NASD subsequently determined that disclosures in the PPM appeared to be incomplete, inaccurate or misleading, NASD could make further inquiries. The filing requirement also could facilitate the creation of a database on MPO activity that would be used in connection with the member examination process.

      9 The MPO sweep revealed that in some cases, offering proceeds were used for individual bonuses, sales contest awards, commissions in excess of 20 percent, or other undisclosed compensation.

      10 Members would remain subject to other NASD rules that govern a member's participation in the offer and sale of a security, including Rules 2110, 2120 and Rule 2310. Members also are subject to the anti-fraud provisions of the Securities Act, including Sections 10(b), 11, 12 and 17.

      11 Rule 2720 presumes control when there is beneficial ownership of 10 percent of an entity's outstanding voting securities if the entity is a corporation, or in the case of a partnership, more than a 10 percent interest in its distributable profits or losses. See Rule 2720(b)(1)(B).


      ATTACHMENT A

      Proposed Rule Text

      2721. Private Placements of Securities Issued by Members

      (a) Definitions
      (1) Member Private Offering or MPO

      A private placement of unregistered securities issued by a member or a control entity in a transaction exempt from registration under the Securities Act and the filing requirements under Rules 2710, 2720 and 2810.
      (2) Control Entity

      Any entity that controls or is under common control with a member, or that is controlled by a member or its associated persons. The term "control" for purposes of this Rule means beneficial ownership of more than 50 percent of the outstanding voting securities of a corporation, or the right to more than 50 percent of the distributable profits or losses of a partnership.
      (b) Filing Requirements

      No member or associated person may offer or sell any security in a Member Private Offering unless the private placement memorandum has been filed with the Corporate Financing Department at or prior to the first time the private placement memorandum is provided to any investor. An amendment or exhibit to the private placement memorandum also must be filed with the Corporate Financing Department within ten days of being provided to any investor.
      (c) Disclosure Requirements

      No member or associated person may participate in a Member Private Offering unless a private placement memorandum is provided to each investor and the private placement memorandum discloses:
      (1) risk factors associated with the investment, including company risks, industry risks and market risks;
      (2) intended use of the offering proceeds;
      (3) offering expenses and the amount of selling compensation that will be paid to the member and its associated persons; and
      (4) any other information necessary to ensure that required information is not misleading.
      (d) Use of Offering Proceeds

      At least 85 percent of the offering proceeds raised in a Member Private Offering must be used for the business purpose identified in the "intended use of the offering proceeds" disclosure in the private placement memorandum.
      (e) Exemptions

      The following Member Private Offerings are exempt from the requirements of this Rule:
      (1) offerings sold solely to:
      (A) institutional accounts (as defined in NASD Rule 3110(c)(4));
      (B) qualified purchasers (as defined in Section 2(a)(51)(A) of the Investment Company Act of 1940);
      (C) qualified institutional buyers (as defined in SEC Rule 144A);
      (D) investment companies (as defined in Rule SEC Rule 144A);
      (E) an entity composed exclusively of qualified institutional buyers (as defined in SEC Rule 144A); and
      (F) banks (as defined in SEC Rule 144A).
      (2) offerings made pursuant to SEC Rule 144A or SEC Regulation S;
      (3) offerings in which a member acts solely in a wholesaling capacity and sells unregistered securities to other unaffiliated broker-dealers;
      (4) offerings of exempt securities with short term maturities under Section 3(a)(3) of the Securities Act;
      (5) offerings of subordinated loans under SEC Rule 15c3-1, Appendix D; (6) offerings of unregistered investment grade rated debt;
      (7) offerings to employees and affiliates of the issuer; and
      (8) offerings of securities issued in stock splits and restructuring transactions.
      (f) Application for Exemption

      Pursuant to the Rule 9600 Series, NASD may exempt a member or person associated with a member from the provisions of this Rule for good cause shown.

    • 07-26 Securities Industry/Regulatory Council on Continuing Education Issues Firm Element Advisory Update

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      GUIDANCE

      SUGGESTED ROUTING

      KEY TOPICS

      Continuing Education
      Legal & Compliance
      Registration
      Senior Management
      Continuing Education
      Firm Element

      Continuing Education

      Executive Summary

      In the fourth quarter of every year, the Securities Industry/Regulatory Council on Continuing Education (Council) publishes the annual Firm Element Advisory (FEA). The Council is now updating the FEA in the second quarter of each year. Topics added to the FEA in the second-quarter update will be flagged as such, and will also appear in the year-end FEA.

      Background and Discussion

      The Council's FEA identifies regulatory and sales practice topics that firms should consider including in their Firm Element training plans. The topics are based on a review of recent industry and self-regulatory organizations' publications and other communications.

      The FEA topics are not exhaustive and are intended as a guide to firms when they determine what to include in their training plans. Firms should consider the specific nature of their business, clients, products and services when creating their training plans.

      The updated FEA is available on the Council's Web site at www.cecouncil.com/publications/council_publications/FEA_2007_Semi_Annual_Update.pdf

      Questions/Further Information

      Questions concerning this Notice may be directed to Joseph McDonald, Associate Director, Testing and Continuing Education, at (240) 386-5065.

    • 07-25 NASD Provides Guidance Concerning Trade Reporting Obligations for Transactions in Foreign Securities and American Depositary Receipts

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      GUIDANCE

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Market Making
      Operations
      Registered Representatives
      Senior Management
      Systems
      Trading
      Foreign Securities
      American Depositary Receipts (ADRs)
      Trade Reporting

      Trade Reporting of Foreign Securities

      Executive Summary

      NASD is publishing this Notice to provide members with guidance on trade reporting issues involving transactions in foreign securities and American Depositary Receipts (ADRs). NASD is announcing that, on April 20, 2007, NASD filed a rule change with the Securities and Exchange Commission (SEC) for immediate effectiveness to codify existing NASD guidance regarding members' trade reporting obligations for transactions in foreign equity securities.1 NASD is also publishing this Notice to provide guidance to members concerning their trade reporting obligations with respect to certain transactions involving ADRs.

      The new rule language is available in Attachment A of this Notice.

      Questions/Further Information

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

      Discussion

      Trade Reporting Obligations for Transactions in Foreign Equity Securities

      Pursuant to Rule 6620, NASD members generally are required to report transactions in OTC Equity Securities to NASD's OTC Reporting Facility.2 Rule 6610 defines an "OTC Equity Security" as any non-exchange-listed security3 and certain exchange-listed securities that do not otherwise qualify for real-time trade reporting.

      The definition of "OTC Equity Security" is broad and includes foreign equity securities, even those that trade exclusively outside the United States. Because of the breadth of this definition, NASD had published guidance that the transaction reporting requirements of Rule 6620 do not apply to transactions in foreign equity securities4 if: (1) the transaction is executed on and reported to a foreign securities exchange; or (2) the transaction is executed over the counter in a foreign country and is reported to the regulator of securities markets for that country.5 To ensure that all members are aware of their trade reporting obligations regarding foreign equity securities, on April 20, 2007, NASD filed for immediate effectiveness a rule change with the SEC to codify this guidance in NASD Rule 6620(g). The reporting requirements do, however, continue to apply to transactions in foreign equity securities that are executed over the counter in the United States or abroad that are not reported to a foreign exchange or regulator. All such transactions must be reported to NASD.6

      Trade Reporting Obligations for ADR/Ordinary Swap Transactions

      Over-the-counter transactions in ADRs are subject to the trade reporting requirements under NASD rules.7 NASD staff recently has received several inquiries relating to trade reporting requirements for ADR swap transactions (sometimes called "cross-book" transactions). In these types of transactions, a firm matches holders of ADRs with holders of the foreign ordinary equity security (referred to as the "ordinary" or "ordinaries") in the same company. To effect the "swap," a firm typically will execute the equivalent of two cross transactions in the two securities between the holders. Because the ADRs and the ordinary shares are separate securities and they are executed in separate transactions, both the ADR and the foreign ordinary share transactions must be reported separately to NASD for public dissemination, as required by NASD rules.


      1 See Securities Exchange Act Release No. 55745 (May 11, 2007), 72 FR 27891 (May 17, 2007) (SR-NASD-2007-030).

      2 Transactions in OTC Equity Securities generally must be reported to the OTC Reporting Facility within 90 seconds of execution. Foreign securities (excluding ADRs and Canadian issues), however, may be transmitted to the OTC Reporting Facility on T+1 (or next day) basis regardless of the time of execution.

      3 A non-exchange-listed security is an equity security that is not traded on any national securities exchange. The term does not include "restricted securities" as defined in SEC Rule 144(a)(3) under the Securities Act of 1933 or any securities designated in the PORTAL Market (NASD Rule 6700 Series). See NASD Rule 6610(c).

      4 The amendments define a foreign equity security as "any OTC Equity Security that is issued by a corporation or other organization incorporated or organized under the laws of any foreign country."

      5 See OTC Bulletin Board Update (Spec. Ed. Dec. 1993). See also, NASD Notice to Members 90-58 (Sept. 1990).

      6 Any transaction reported to NASD must be reported in U.S. dollars, regardless of the currency in which the transaction occurred. The methodology employed by the member for currency conversion is left to the NASD member; however, the member should document its practice and employ the same method consistently.

      7 See NASD Rules 4632, 4632A, 4632C, 4632D, 4632E, 6620. Members should note, however, that the conversion of ordinary shares into ADRs (or vice versa) at a bank depository, is not considered an OTC transaction for purposes of NASD trade reporting rules and is, therefore, not a reportable event.


      ATTACHMENT A

      Below is the text of the rule change. New language is underlined.

      6620. Transaction Reporting

      (a) through (f) No change.
      (g) Transactions in Foreign Equity Securities
      (1) For purposes of this paragraph, the term "foreign equity security" means any OTC Equity Security that is issued by a corporation or other entity incorporated or organized under the laws of any foreign country.
      (2) Transactions in foreign equity securities shall be reported to the OTC Reporting Facility unless:
      (A) the transaction is executed on and reported to a foreign securities exchange; or
      (B) the transaction is executed over the counter in a foreign country and is reported to the regulator of securities markets for that country.

    • 07-24 New Requirement for the Reporting of Consolidated Short Interest Positions to the Intermarket Surveillance Group (ISG); Effective September 2007

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      ACTION REQUIRED

      SUGGESTED ROUTING

      KEY TOPICS

      Legal and Compliance
      Operations
      Senior Management
      Short Interest Reporting

      Intermarket Surveillance Group

      Executive Summary

      This Notice to Members advises member firms that, effective September 2007, they are required to increase the frequency of short interest reporting from monthly to twice a month.1 Attachment A outlines the revised Short Interest Reporting Schedule for September 2007 through December 2007. Additionally, the short interest reporting rules of certain ISG self-regulatory organizations (SROs) are included as Attachment B.

      This Notice was prepared by the following SROs acting jointly as members of the ISG:

      •  American Stock Exchange LLC (Amex)
      •  Boston Stock Exchange, Inc. (BSE)
      •  Chicago Board Options Exchange, Inc. (CBOE)
      •  Chicago Stock Exchange, Inc. (CHX)
      •  International Securities Exchange (ISE)
      •  NASD, Inc. (NASD)
      •  The Nasdaq Stock Market LLC (NASDAQ)
      •  National Stock Exchange, Inc. (NSX)
      •  New York Stock Exchange, Inc. (NYSE)
      •  NYSE Arca, Inc. (NYSE Arca)
      •  Philadelphia Stock Exchange, Inc. (PHLX)

      Questions/Further Information

      Questions concerning short interest reporting requirements may be directed to any of the following SRO staff:

      SRO Individual Telephone No. Email Address
      Amex James Turnbull (212) 306-1526 james.turnbull@nasd.com
      BSE Sharon Melanson (617) 235-2152 sharon.melanson@bostonstock.com
      CBOE Pat Sizemore (312) 786-7752 sizemore@cboe.com
      CHX Mike Cardin (312) 663-2204 mcardin@chx.com
      ISE Ron Veith (212) 897-8130 rveith@iseoptions.com
      NASD Jocelyn Mello (240) 386-5091  
      NASDAQ NASDAQ OGC (301) 978-8400  
      NSX Nicole Guiffra (312) 786-8809 nicole.guiffra@nsx.com
      NYSE Glen Garofalo (212) 656-2084 ggarofalo@nyse.com
      NYSE Arca John Chapin (312) 442-7790 jchapin@nyse.com
      PHLX Joseph Cusick (215) 496-1576 joseph.cusick@phlx.com

      Technical or system questions should be directed to:

      Organization Contact Telephone No. Email Address
      Amex Helpdesk (800) 321-NASD nasdregfiling@nasd.com
      NASD Helpdesk (800) 321-NASD nasdregfiling@nasd.com
      NYSE Tom McNally (212) 656-2237 tmcnally@nyse.com
      NYSE Eugene Kosoy (212) 656-5740 ekosoy@nyse.com

      ISG Regulatory Memorandum, ISG 2007-01

      On March 6, 2007, the Securities and Exchange Commission (SEC) approved rule changes by the Amex, NASD and NYSE to require members and member organizations to increase the frequency of short interest reporting from monthly to twice a month.2 The amended short interest reporting requirements become effective 180 days after SEC approval to give members and member organizations adequate time to make any changes necessary to comply with the new requirements. In addition to the rule changes at the Amex, NASD and NYSE, the other U.S. securities marketplace members of the ISG are also revising their short interest reporting requirements to correspond to the twice-a-month reporting cycle. Therefore, beginning in September 2007, all ISG SROs will require members and member organizations to submit short interest information twice a month.

      The Mid-Month Short Interest Report will continue to be based on short positions3 held by members on the settlement date of the 15th of each month. If the 15th falls on a weekend or another non-settlement date, the designated settlement date will be the previous business day on which transactions settled. The End-of—Month Short Interest Report will be based on short positions held on the last business day of the month on which transactions settle.

      All members and member organizations of the ISG SROs will continue to be required to report short positions in all securities they carry, irrespective of where the securities are listed. It is not expected that the current reporting processes or reporting systems offered by the ISG SROs will change other than having to report twice a month.4


      1 See Securities Exchange Act Release No. 55406 (March 6, 2007), 72 FR 11071 (March 12, 2007) (order approving SR-NASD-2006-131, SR-NYSE-2006-111, SR-Amex-2007-005).

      2 Currently, the Amex requires members to report End-of-Month Short Interest for "ETF type products."

      3 Short positions to be reported are those resulting from short sales as the term is defined in SEC Rule 200 of Regulation SHO, subject to certain limited exceptions.

      4 In connection with the implementation of the changes to NASDAQ symbology, certain of the ISG SROs may have changes to their reporting processes or systems.


      ATTACHMENT A

      September through December 2007—Short Interest Reporting Schedule

      Trade Date Settlement Date Report Due to Amex & NYSE Report Due to NASD (ExchangeListed except NASDAQ) Report Due to NASD (NASDAQ-Listed & OTC Equity) Report Published by Amex & NYSE Report Published by NASDAQ and NASD
      September 11 (Tuesday) September 14 (Friday) September 18 1:00 p.m. (Tuesday) September 18 1:00 p.m. (Tuesday) September 18 6:00 p.m. (Tuesday) September 20 (Thursday) September 26 (Wednesday)
      September 25 (Tuesday) September 28 (Friday) October 2 1:00 p.m. (Tuesday) October 2 1:00 p.m. (Tuesday) October 2 6:00 p.m. (Tuesday) October 4 (Thursday) October 10 (Wednesday)
      October 10 (Wednesday) October 15 (Monday) October 17 1:00 p.m. (Wednesday) October 17 1:00 p.m. (Wednesday) October 17 6:00 p.m. (Wednesday) October 19 (Friday) October 25 (Thursday)
      October 26 (Friday) October 31 (Wednesday) November 2 1:00 p.m. (Friday) November 2 1:00 p.m. (Friday) November 2 6:00 p.m. (Friday) November 6 (Tuesday) November 12 (Monday)
      November 9 (Friday) November 15 (Thursday) November 19 1:00 p.m. (Monday) November 19 1:00 p.m. (Monday) November 19 6:00 p.m. (Monday) November 21 (Wednesday) November 28 (Wednesday)
      November 27 (Tuesday) November 30 (Friday) December 4 1:00 p.m. (Tuesday) December 4 1:00 p.m. (Tuesday) December 4 6:00 p.m. (Tuesday) December 6 (Thursday) December 12 (Wednesday)
      December 11 (Tuesday) December 14 (Friday) December 18 1:00 p.m. (Tuesday) December 18 1:00 p.m. (Tuesday) December 18 6:00 p.m. (Tuesday) December 20 (Thursday) December 27 (Thursday)
      December 26 (Wednesday) December 31 (Monday) January 3, 2008 1:00 p.m. (Thursday) January 3, 2008 1:00 p.m. (Thursday) January 3, 2008 6:00 p.m. (Thursday) January 7, 2008 (Monday) January 11, 2008 (Friday)

      All Times: Eastern Time


      ATTACHMENT B

      Short Interest Reporting Rules

      Amex Rule:

      30A Periodic Reports—Short Positions

      Every member organization shall submit, as required by the Exchange, periodic reports with respect to short positions in securities.

      Commentary

      .01 Short positions.—Member organizations are required to report "short" positions, including odd lots, in each Amex-listed stock, warrant or other security treated as an equity, and in each other stock, warrant or other security treated as an equity not listed on the Exchange (and not otherwise reported to another self-regulatory organization), using such format and method as prescribed by the Exchange. Such reports must include customer and proprietary positions and must be made at such times and cover such time periods as may be designated by the Exchange.

      For the purposes of this report, the term "customer" means any account other than the proprietary account of the reporting member organization.

      "Short" positions to be reported are those resulting from "short sales" as that term is defined in Rule 200 of SEC Regulation SHO, but excluding positions resulting from sales specified in Securities Exchange Act Rule 10a-1(e) (1), (6), (7), (8) or (10). Also to be excluded are "short" positions carried for other members and member organizations reporting for themselves.

      Only one report should be made for each stock, warrant or other security treated as an equity in which there is a short position. If more than one "account" has a short position in the same stock, warrant or other security treated as an equity, the combined aggregate should be reported.

      NOTE: A member organization which does not carry customers' margin accounts and does not clear its own transactions may obtain an exemption from reporting by notifying the Exchange in writing.

      Adopted. March 6, 2007 (Amex-2007-05).

      CBOE Rule:

      15.1. Maintenance, Retention and Furnishing of Books, Records and Other Information

      Each member shall make, keep current and preserve such books and records as the Exchange may prescribe and as may be prescribed by the Securities Exchange Act of 1934 and the Rules and Regulations thereunder as though such member were a broker or dealer registered pursuant to Section 15 of such Act. No member shall refuse to make available to the Exchange such books, records or other information as may be called for under the Rules or as may be requested in connection with an investigation by the Exchange.

      Interpretations and Policies:

      .01 The following Rules contain specific requirements with regard to the maintenance and retention of books, records and other information: Rules 3.4, 3.6, 8.9, 9.6, 9.7, 9.8, 9.10, 9.21, 9.23, 11.2, 12.12 and Chapter XV. In addition, the following Rules contain specific requirements with regard to the furnishing of information to the Exchange: Rules 3.7, 3.9, 3.17, 3.18, 3.20, 3.21, 3.23, 3.25, 4.9, 4.13, 6.49, 6.51, 6.56, 6.59, 6.71, 6.72, 7.2, 7.3, 7.6, 8.2, 8.3, 8.5, 8.10, 8.11, 9.1, 9.2, 9.3, 12.11, 13.4, 14.2 and 19.2. The foregoing list is not intended to be exhaustive and members must comply with all applicable recordkeeping and reporting requirements whether or not listed above.

      Issued August 23, 1978; amended March 26, 1980; July 19, 2000, effective August 18, 2000 (99-15).
      .02 Each member organization that clears stock transactions and for which the Exchange is the Designated Examining Authority shall maintain records of short stock positions in all customer and proprietary firm accounts for securities listed on a United States registered national securities exchange or for securities whose bids and offers are reported on the automated quotation system operated by the National Association of Securities Dealers, Inc. ("NASD"). Each such member that is not required to report short interest data to another stock exchange or to the NASD as a result of being a member of such organization shall report these short stock positions to either a stock exchange or to the NASD, as the Exchange so directs. The form, manner, and time of such report shall be specified by the appropriate exchange or the NASD.

      Approved January 27, 1995 (94-55).
      .03 In addition to the existing obligations under Exchange rules regarding the production of books and records, a Market-Maker in non-U.S. currency, non-U.S. currency options, futures or options on futures on such currency, or any other derivatives based on such currency, shall make available to the Exchange such books, records or other information pertaining to transactions in non-U.S. currency and the applicable non-U.S. currency, non-U.S. currency options, futures or options on futures on such currency, or any other derivatives on such currency, as may be requested by the Exchange.

      Amended November 2, 2006 (06-74).
      .04 In addition to the existing obligation under Exchange rules regarding the production of books and records, a Market-Maker in options on Commodity Pool Units, shall make available to the Exchange such books, records or other information pertaining to transactions in the applicable physical commodity, physical commodity options, commodity futures contracts, options on commodity futures contracts, or any other derivatives on such commodity, as may be requested by the Exchange.

      Amended April 13, 2007 (07-21).

      NASD Rule:

      3360. Short-Interest Reporting

      (a) Each member shall maintain a record of total "short" positions in all customer and proprietary firm accounts in OTC Equity Securities, securities listed on a national securities exchange and not otherwise reported to another self-regulatory organization and shall regularly report such information to NASD in such a manner as may be prescribed by NASD. Reports shall be made as of the close of the settlement date designated by NASD. Reports shall be received by NASD no later than the second business day after the reporting settlement date designated by NASD.
      (b) For purposes of this Rule:
      (1) "short" positions to be reported are those resulting from "short sales" as that term is defined in SEC Rule 200 of Regulation SHO, with the exception of positions that meet the requirements of Subsections (e)(1), (6), (7), (8), and (10) of SEC Rule 10a-1 adopted under the Act;
      (2) the term "customer" includes a broker-dealer; and
      (3) the term "OTC Equity Securities" shall mean any equity security that is not listed on The Nasdaq Stock Market or a national securities exchange.

      Amended by SR-NASD-2005-087 eff. Aug. 1, 2006.
      Amended by SR-NASD-2005-112 eff. July 3, 2006.
      Amended by SR-NASD-2005-001 eff. Jan. 7, 2005.
      Amended by SR-NASD-2002-178 eff. Dec. 16, 2002.
      Amended by SR-NASD-94-67 eff. May 1, 1995.
      Amended eff. Aug. 31, 1987.
      Adopted by SR-NASD-85-34 eff. Jan. 20, 1986.

      Selected Notices to Members: 85-77, 85-87, 86-4, 86-15, 86-61, 87-15, 95-8, 03-08.

      NASDAQ Rule:

      3360. Short-Interest Reporting

      (a) To the extent such information is not otherwise reported to the NASD in conformance with NASD Rule 3360, each member shall maintain a record of total "short" positions in all customer and proprietary firm accounts in securities listed on Nasdaq and shall regularly report such information to Nasdaq in such a manner as may be prescribed by Nasdaq. Reports shall be made as of the close of the settlement date designated by Nasdaq. Reports shall be received by Nasdaq no later than the second business day after the reporting settlement date designated by Nasdaq.
      (b) For purposes of this Rule:
      (1) "short" positions to be reported are those resulting from "short sales" as that term is defined in SEC Rule 200 of Regulation SHO, with the exception of positions that meet the requirements of Subsections (e)(1), (6), (7), (8), and (10) of SEC Rule 10a-1 adopted under the Act; and
      (2) the term "customer" includes a broker-dealer.

      Amended by SR-NASDAQ-2006-018 eff. July 25, 2006.
      Adopted by SEC Release 34-53128 (Jan. 13, 2006).

      NYSE Rule

      421. Periodic Reports

      Member organizations shall submit, as required by the Exchange, periodic reports with respect to

      (1) Short positions in securities;
      (2) Customers' debit and credit balances.

      Amended April 4, 1968.
      Amended October 7, 1982.
      Amended March 6, 2007 (NYSE-2006-111).

      Supplementary Material:

      .10 Short positions.—Member organizations for which the Exchange is the designated examining authority are required to report "short" positions, including odd lots, in each stock or warrant listed on the Exchange, and in each other stock or warrant not listed on the Exchange which is not otherwise reported to another United States securities exchange or securities association, using such automated format and methods as prescribed by the Exchange. Such reports must include customer and proprietary positions and must be made at such times and covering such time period as may be designated by the Exchange.

      Member organizations for which the Exchange is not the designated examining authority must report "short" positions to the self-regulatory organization which is its designated examining authority ("DEA") if such DEA has a requirement for such reports. If the DEA does not have such a reporting requirement, then such member organization must comply with the provisions of Rule 421.

      The term "designated examining authority" means the self-regulatory organization which has been assigned responsibility for examining a member organization for compliance with applicable financial responsibility rules. (See Rule 17d-1 under the Securities Exchange Act of 1934 (the "Exchange Act").)

      "Short" positions to be reported are those resulting from "short" sales as defined in Rule 200 of the Securities and Exchange Commission's Regulation SHO, but excluding positions resulting from sales specified in clauses (1), (6), (7), (8), and (10) of paragraph (e) of Rule 10a-1 under the Exchange Act. Also to be excluded are "short" positions carried for other member organizations reporting for themselves.

      Only one report should be made for each stock or warrant in which there is a short position. If more than one "account" has a short position in the same stock or warrant, the combined aggregate should be reported.

      NOTE: A member organization which does not carry customers' margin accounts and does not clear its own transactions may obtain an exemption from reporting by notifying the Exchange in writing.

      Amended March 30, 1993.
      Amended March 6, 2007 (NYSE-2006-111).

    • 07-23 NASD Trade Reporting Requirements Related to Regulation NMS

      View PDF File

      GUIDANCE

      SUGGESTED ROUTING

      KEY TOPICS

      Executive Representative
      Legal & Compliance
      Operations
      Registered Representatives
      Senior Management
      Systems
      Trading
      Alternative Display Facility
      ADF Trading Centers
      Regulation NMS
      SEC Rule 611
      Trade Reporting
      Trade Reporting Facilities

      Effective Dates: Regulation NMS Trading Phase Date (March 5, 2007) for Alternative Display Facility Participants; and Regulation NMS Pilot Stocks Phase Date (Scheduled to Occur July 9, 2007) for NASD Trade Reporting Facility Participants

      Executive Summary

      NASD is issuing this Notice to provide additional guidance to broker-dealer member firms on the proper use of NASD's new transaction reporting modifiers. These trade reporting modifiers were amended and expanded to allow reporting of certain exceptions and exemptions to Rule 611 of Regulation NMS to NASD facilities. The amended trade reporting requirements were effective for Alternative Display Facility (ADF) participants on March 5, 2007, the Regulation NMS Trading Phase Date. They will be operative for each of the NASD Trade Reporting Facilities (the TRFs) on the Regulation NMS Pilot Stocks Phase Date, which is scheduled to occur on July 9, 2007. In addition to this Notice, NASD members that are also members of the New York Stock Exchange (NYSE) should review Information Memo 07-44, which is being issued by the NYSE contemporaneously with this Notice.

      Questions/Further Information

      Questions or comments concerning this Notice may be directed to Dave Chapman, Deputy Director, Market Regulation, at (240) 386-4995; Lisa Horrigan, Associate General Counsel, Office of General Counsel, at (202) 728-8190; Kathleen A. O'Mara, Associate General Counsel, Office of General Counsel, at (202) 728-8071; Peter D. Santori, Chief Counsel, Market Regulation, at (240) 386-5098; and Chris Stone, Associate Chief Counsel, Transparency Services, at (202) 728-8457.

      Background and Discussion

      On June 9, 2005, the Securities and Exchange Commission (SEC) issued its release adopting Regulation NMS.1 Regulation NMS established substantive rules designed to modernize and strengthen the regulatory structure of the U.S. equities markets. In particular, for purposes of the information provided in this Notice, Regulation NMS includes the Order Protection Rule (SEC Rule 611), which requires trading centers to establish, maintain and enforce written policies and procedures reasonably designed to prevent the execution of trades at prices inferior to protected quotations displayed by automated trading centers (commonly referred to as a "trade-through"), subject to applicable exceptions and exemptions.2 For quotations to be protected under the rule, a quotation must be immediately and automatically accessible.

      On September 28, 2006, the SEC approved amendments to the ADF3 rules to, among other things, align them with Regulation NMS.4 NASD issued Notice to Members 06-67 summarizing the amendments to the ADF rules, which became effective on the Regulation NMS Trading Phase Date, March 5, 2007.5 In addition, NASD has adopted substantially similar provisions to the trade reporting rules for each of the TRFs.6 Specifically, on January 8, 2007, NASD filed a proposed rule change to make conforming changes consistent with the requirements of Regulation NMS to the rules governing the NASD/NASDAQ TRF and on February 12, 2007, filed a similar proposed rule change relating to the NASD/NSX TRF, the NASD/BSE TRF and the NASD/NYSE TRF.7 These proposed rule changes were filed for immediate effectiveness and will be operative on the Regulation NMS Pilot Stocks Phase Date, which is currently scheduled to occur on July 9, 2007.8

      Among other changes, NASD has adopted new transaction reporting modifiers that require members to indicate in transactions reported to NASD facilities whether the transaction qualified for an exception or exemption to SEC Rule 611 at the time of the trade. This Notice covers the proper use of these new transaction reporting modifiers. Note that NASD may, where appropriate, prescribe additional modifiers in the future and will provide at least 30-days advance written notice of any such additional modifiers to ensure that firms have sufficient time to accommodate such changes.

      Guidance Regarding the Proper Use of Regulation NMS-Related Trade Modifiers

      The Trade Reporting Modifier Chart below demonstrates generally how member firms should use the new trade report modifiers when reporting a transaction that meets a recognized SEC Rule 611 exception or exemption. This chart provides the uniform methodology for reporting trade modifiers; however, the specific data entries used to report trades may vary depending upon the specific platform or system used. Therefore, the chart should be read in conjunction with the applicable system specifications.9

      The new modifier format allows firms to submit significantly more trade reporting information than permitted under the previous format. Thus, for the most part, firms no longer have to program their systems to prioritize the use of transaction reporting modifiers. That said, members must ensure that they submit the appropriate information in the appropriate field or the subject transaction report will be rejected. In general, the Trade Reporting Modifier Chart specifies the information that is required to be reported for the various SEC Rule 611 exceptions or exemptions. The pertinent trade reporting fields are as follows:

      1. SEC Rule 611 Exception/Exemption Trade-Through Flag: indicates that a trade-through exception or exemption applies to a reportable transaction; the firm must indicate that in its transaction report by populating the Trade-Through Exception/Exemption Flag;
      2. Trade Modifier Field 1: Settlement Type: indicates the manner in which a transaction will settle (e.g., regular, cash, next day, etc.);
      3. Trade Modifier Field 2: Reason for SEC Rule 611 Exception or Exemption: indicates which specific SEC Rule 611 exception or exemption applies to the transaction;
      4. Trade Modifier Field 3: Extended Hours/Sold: indicates whether the transaction was reported late or executed outside normal market hours, as applicable; and
      5. Trade Modifier Field 4: SRO Required Detail: identifies additional trade information required pursuant to NASD rules, as applicable (e.g., weighted average price, stopped stock, etc.).

      Trade Reporting Modifier Chart

      Applicable Regulation NMS Exception/ Exemption Trade Reporting Information to be Entered by Reporting Firm
      SEC Rule 611 Exception/ Exemption Trade-Through Flag Settlement Type Field 110 Reason for SEC Rule 611 Exception/Exemption Field 2 Extended Hours/Sold Field 311 SRO Required Detail Field 412
      SEC Rule 611(b)(1) (Self Help) If applicable indicate Yes Enter applicable settlement modifer Self Help (Note: for SRO audit trail only—will not be disseminated) Enter modifier if applicable Enter modifier if applicable
      SEC Rule 611(b)(2) (Not Regular Way) If applicable indicate Yes Cash, Next Day or Seller If applicable, enter other SEC Rule 611 exception/exemption modifier for transaction Enter modifier if applicable Enter modifier if applicable
      SEC Rule 611(b)(4) (Crossed Market) If applicable indicate Yes Enter applicable settlement modifer If applicable, enter other SEC Rule 611 exception/exemption modifier for transaction Enter modifier if applicable Enter modifier if applicable
      SEC Rule 611(b)(5) (Intermarket Sweep Order (inbound)) If applicable indicate Yes Enter applicable settlement modifer Inbound Intermarket Sweep Order (Note: This will be disseminated generically as an ISO) Enter modifier if applicable Enter modifier if applicable
      SEC Rule 611(b)(6) (Intermarket Sweep Order (outbound)) If applicable indicate Yes Enter applicable settlement modifer Outbound Intermarket Sweep Order (Note: This will be disseminated generically as an ISO) Enter modifier if applicable Enter modifier if applicable
      SEC Rule 611(b)(7) (Benchmark/ Derivatively Priced) If applicable indicate Yes Enter applicable settlement modifer Derivatively Priced Enter modifier if applicable Prior Reference Price, Weighted Average Price or other modifier as applicable for transaction
      SEC Rule 611(b)(9) (Stopped Stock) If applicable indicate Yes Enter applicable settlement modifer Derivatively Priced Enter modifier if applicable Stopped Stock (Note: for SRO audit trail only—this will be disseminated as Weighted Average Price)
      SEC Rule 611(d) (Qualified Contingent Trades) If applicable indicate Yes Enter applicable settlement modifer Qualified Contingent Trade (Note: for SRO audit trail only—will not be disseminated) Enter modifier if applicable Enter modifier if applicable
      SEC Rule 611(d) (Sub-Penny Trade-Throughs) If applicable indicate Yes Enter applicable settlement modifer Sub-Penny Trade Through (Note: for SRO audit trail only—will not be disseminated) Enter modifier if applicable Enter modifier if applicable

      It should be noted that the exception to Rule 611 for flickering quotations (see SEC Rule 611(b)(8))13 is not included in this chart because firms are not required to identify their reliance on that exception for purposes of NASD trade reporting requirements. In addition, the exception for a transaction in a single-priced opening, reopening or closing (see SEC Rule 611(b)(3)) is not included in this chart because NASD staff currently is not aware of a scenario in which the exception would apply to the execution of broker-dealer transactions otherwise than on an exchange (commonly referred to as over-the-counter or OTC trades).14

      Moreover, it should be noted that NASD filed an immediately effective rule change with the SEC to address concerns raised by some firms that they may not be able to implement certain new Regulation NMS modifiers by the applicable effective date.15 Specifically, the proposed rule change provides NASD with exemptive authority to address implementation issues concerning: (1) the self-help modifier; (2) the qualified contingent trade modifier; (3) the sub-penny modifier; and (4) the modifier used to distinguish between inbound and outbound intermarket sweep orders.

      Firms that cannot make the requisite technology changes by the applicable compliance date may request an exemption from NASD in writing. NASD will provide specific procedures and the information required to request such an exemption. It should be noted that any exemption will only be granted for good cause shown, after taking into consideration all relevant factors, and must be consistent with the protection of investors and the public interest. The duration of any exemption will be determined by NASD, but shall not exceed a six-month period.

      As is always the case when reporting a transaction, the particular circumstances surrounding the execution of the transaction will determine the information that must be included in the corresponding transaction report. As previously noted, firms should always consult the technical specifications to determine what must be included in a particular transaction report. Additionally, firms should be aware that the specific form and content of a particular transaction report may vary depending on the interface (such as FIX, QIX or CTCI) used to report transactions to NASD. Lastly, NASD reiterates that firms using the trade report modifiers under the amended rules are responsible for determining that the transaction satisfies all requirements of the specific SEC Rule 611 exception or exemption.

      Examples

      For illustrative purposes, the following are two example trade reports—one where the transaction trades through protected quotations but is entitled to an exception pursuant to SEC Rule 611, and another for a transaction that does not constitute a trade through of a protected quotation.

      Example #1: Trade-Through Trade Report Using the Benchmark/Derivatively Priced Exception

      Assume that a market-on-open order has been executed and reported at 10:00:00 and it qualifies for a trade-through exception pursuant to SEC Rule 611(b)(7). Assume further that the price of the execution was based on the 9:30:00 market opening price and will settle regular way. The modifiers to be used when reporting the execution are determined through the following analysis:

      Field Value
      SEC 611 Exception/Exemption Trade-Through Flag Yes—the firm has determined that the execution qualifies for a trade-through exception pursuant to SEC Rule 611(b)(7).
      Trade Modifier Field 1: Settlement Type Regular way settlement
      Trade Modifier Field 2: SEC Rule 611 Exception/Exemption Reason Benchmark/Derivatively priced modifier must be used, consistent with SEC Rule 611(b)(7).
      Trade Modifier Field 3: Extended Hours/Sold Sales Conditions None—no modifier should be used in this field because none of the modifiers applies to this transaction.
      Trade Modifier Field 4: SRO Required Detail Sales Condition Prior reference price modifier must be used for this trade, given that the execution of this transaction occurred at 10:00:00 with a price based on the 9:30:00 market opening price.

      Example #2: Trade Report of a Transaction that Does Not Constitute a Trade Through of a Protected Quote

      Assume an order has been executed at 10:00:00 and the price is based on a weighted average price and would meet the requirements of SEC Rule 611(b)(7). Assume further that the execution did not trade through a protected quote; therefore, no Regulation NMS trade-through exception or exemption is applicable. The execution was reported within 1 second of execution at 10:00:01 and will settle regular way. The modifiers to be used when reporting this execution are determined through the following analysis:

      Field Value
      SEC 611 Exception/Exemption Trade-Through Flag The firm has two reporting options:
      (1) No—the execution did not trade through a protected quote and therefore an exemption or exception did not apply; or
      (2) Yes—if a valid exception or exemption exists from SEC Rule 611, the firm may identify the transaction as a trade-through exemption or exception, even though the transaction did not trade through a protected quotation.NASD is providing this option in recognition that quotations may move quickly in a Regulation NMS environment and firms may choose to operate in accordance with a trade-through exception or exemption, even when a trade-through did not actually occur.
      Trade Modifier Field 1: Settlement Type Regular way settlement
      Trade Modifier Field 2: Rule 611 Exception/Exemption Reason Consistent with what is entered in the "SEC Rule 611 Exception/Exemption Trade-Through Flag" column, this can be reported as follows:
      (1) None—if the firm did not mark the trade-through flag; or
      (2) Benchmark/Derivatively priced modifier—if the firm is entitled to an exception in accordance with SEC Rule 611(b)(7) and determined to mark the trade-through exception or exemption flag.
      Trade Modifier Field 3: Extended Hours/Sold Sales Conditions None. The extended hours/sold conditions do not apply to this transaction.
      Trade Modifier Field 4: SRO Detail Sales Condition The weighted average price code must be used.

      Questions and Answers Relating to Amendments to NASD Rules and Trade Reporting with New Regulation NMS Modifiers

      General Questions about Trade Reporting Modifiers

      Q1: What is the purpose of the new Regulation NMS-related trade reporting modifier requirements?
      A1: The purpose of the new Regulation NMS-related trade reporting modifier requirements is two-fold. First, the new requirements ensure that NASD obtains necessary regulatory information about the application of an exception or exemption to the Order Protection Rule with respect to a particular OTC trade. Second, certain information relating to the application of an exception or exemption to the Order Protection Rule will be provided to the SIP, which will disseminate that information to the tape.
      Q2: Will any of the trade reporting modifiers that are currently used change in terms of meaning or value?
      A2: For the most part, the modifiers used today will not change. For example, the prior reference price (.PRP) modifier will continue to be used to identify transactions executed at a price different from the current market when the price is based on a prior reference point in time and is not reported within 90 seconds of that prior reference point. However, there have been some minor modifications to certain trade report modifiers consistent with Regulation NMS. For example, firms previously used one identifier (.W) to identify stopped stock, exchange-for physicals, volume-weighted average-price trades, or another special pricing formula. Going forward, the .W modifier will no longer be used for stopped stock transactions. Instead, NASD has created a new, separate modifier for such transactions.16
      Q3: Does the new modifier format allow for combinations of modifiers, where appropriate?
      A3: Yes. For example, a firm will now be able to report that a transaction is both a weighted average price (.W) and extended hours (.T) transaction. In the past, when both the .W and .T modifiers applied to a particular transaction, firms were instructed to use the .W modifier rather than the .T modifier.17 Under the new modifier format, both modifiers can be accommodated on the transaction report and must be used if applicable.
      Q4: Is there a correlation between the Regulation NMS modifiers found in Field 1 through Field 4 (i.e., what is reported in Field 2 for a particular transaction dictates what must be reported in Field 4 for the same transaction)?
      A4: No. While there is generally no direct correlation or interrelationship between the separate columns, NASD expects that certain combinations of modifiers will occur frequently as the result of normal trading patterns. The facts and circumstances of the particular trade dictate the appropriate modifier that must be reported in each field. Accordingly, the reporting firm must include in the transaction report all of the information that is pertinent to a particular transaction. To determine what modifiers must be included in a particular transaction report, firms should analyze each column individually in the Trade Reporting Modifier Chart to determine what, if any, modifier is applicable for the transaction that is being reported.
      Q5: Can the Trade Reporting Modifier Chart be used to report trades that do not constitute a trade through of a protected quote?
      A5: Yes, as illustrated in Example 2 on page 7, the chart should be used in determining how to report such trades. As noted above, the facts and the circumstances of the particular trade dictate the appropriate modifier that must be included in the corresponding transaction report. Accordingly, the reporting firm should attach all the information that is pertinent to a particular transaction.
      Q6: When reporting a trade as an ISO, is it permissible to use the Rule 611 exception/ exemption trade-through flag even if the transaction does not result in a trade through of a protected quotation?
      A6: Yes. As described above in A5 and in Example 2 found on page 7, NASD understands that quotations may move rapidly in a Regulation NMS environment and that there will be instances when ISO trades (or trades executed and reported in reliance on other trade-through exceptions or exemptions) will be reported as trade-through exempt even when a trade-through did not actually occur.
      Q7: Can firms include both the prior reference price modifier in Field 4 and the late or late extended hours execution modifiers in Field 3 on the same transaction report?
      A7: No. Trade reports should not contain both the prior reference price and the late or late extended hours execution modifiers.
      Q8: Which trade reporting modifiers included in a transaction report will be publicly disseminated?
      A8: Most of the modifiers identified in the Trade Reporting Modifier Chart will be disseminated to the tape (in conformity with each of the SIP's specifications). However, there are certain modifiers that will be submitted to NASD solely for regulatory purposes, and NASD will not forward them to the SIPs for public dissemination. The modifiers that will not be forwarded to the SIPs for dissemination include: (1) self-help; (2) qualified contingent trades; and (3) sub-penny trade-through. In addition, while firms are required to distinguish between the use of inbound and outbound Intermarket Sweep Order (ISO) exceptions (see SEC Rule 611(b)(5) and (6)) when reporting such trades to NASD, this information will be generically identified as an ISO when sent to the SIPs. Lastly, firms will expressly identify stop stock transactions when reporting a transaction to NASD, but NASD will send this trade to the SIPs as a weighted-average price modifier.
      Q9: If multiple SEC Rule 611 exception/exemptions apply, which takes priority for purposes of populating the SEC Rule 611 Exception/Exemption Reason in Field 2?
      A9: At this time, NASD is aware of only one instance that will commonly occur where a firm must prioritize multiple SEC Rule 611 exceptions or exemptions for purposes of determining the appropriate modifier to populate Field 2. Specifically, when both the self-help exception and an ISO exception are applicable to a particular trade-through scenario, the firm should identify in Field 2 that the transaction is an ISO rather than a self-help transaction.
      Q10: When do the new modifiers go into effect?
      A10: The new modifiers will go into effect in accordance with the effective dates provided in the applicable rule filings. The ADF rules became effective on March 5, 2007. The TRF rules currently are scheduled to go into effect with the start of the Pilot Stocks Phase on July 9, 2007.18 Firms, however, are advised to check the technical specifications for each TRF to determine message formatting requirements. The TRF technical specifications can be found on NASD's TRF Web page, www.nasd.com/RegulatorySystems/TRF/index.htm.
      Q11: ADF and TRF rules have prohibited the aggregation of transactions; does this prohibit a firm from reporting a cross as one transaction?
      A11: No. The prohibition only applies to the aggregation of separate, multiple executions, for transaction reporting purposes, into a single transaction report submitted to the ADF and the TRFs, which previously were permitted using the .B modifier. It does not apply to the matching of multiple buy and sell orders in a single execution (e.g., through the facilities of an Alternative Trading System (ATS)) or to transactions that are designated as .W (i.e., exchange-for physicals, volume-weighted average-price trades or another special pricing formula). Such transactions previously were not reported as bunched or aggregated using the ".B" modifier.
      Q12: Do Regulation NMS trade reporting requirements apply to all OTC transactions?
      A12: No. The new Regulation NMS trade reporting requirements only apply to OTC transactions in NMS stocks, as defined in SEC Rule 600(b)(46).19
      Q13: A firm intends to use the ISO (outbound) exception, pursuant to SEC Rule 611(b)(6), to execute a block transaction for a customer that will trade-through one or more trading centers. What are the firm's trade reporting obligations under NASD rules in this circumstance?
      A13: To comply with the ISO exception, simultaneously with execution of the block trade, the firm is required to route an ISO to execute against the full displayed size of any protected quotation with a price superior to the block trade price.20 The ultimate handling and execution of the customer's block order, however, may depend on the preference of the customer.

      If a customer represents that it does not want to receive the benefit of any better prices obtained by the ISOs, the firm could promptly report the full size of the block to NASD as an ISO pursuant to SEC Rule 611(b)(6) since all material terms are known.21 If, however, the firm's customer is silent or affirmatively chooses to receive the benefit of any better prices obtained by the execution of any routed ISOs against the superior price protected quotations of other trading centers, any fills received from the execution of the routed ISO orders will reduce the size of the block trade that is reported to NASD as an ISO pursuant to SEC Rule 611(b)(6).22 Accordingly, in this instance the firm that was responsible for executing the block trade will only report the amount of the block that it executed (minus the number of shares executed by another trading center).
      Q14: If Firm A receives and executes an ISO order from Firm B, what is Firm A's trade reporting obligation?
      A14: Assuming Firm A has the trade reporting obligation, Firm A should report the trade with the trade-through exception/exemption flag marked "yes" and with the ISO inbound trade modifier pursuant to SEC Rule 611(b)(5). However, as noted in Q8, the transaction will be identified by the SIP with a generic ISO indicator for the purposes of dissemination to the public.
      Q15: If the SEC suspends the operation of the trade-through provisions of Regulation NMS by issuing notice of an industry-wide "self help" exception to the Order Protection Rule, how will such notice be communicated to member firms and the industry generally?
      A15: The SEC stated that, if serious market-wide systems problems arise, the SEC may suspend the operation of the trade-through provisions of Regulation NMS by issuing notice of an industry-wide "self help" exception to the Order Protection Rule.23 Accordingly, NASD member firms should be advised that, if the SEC issues notice of an industry-wide self-help exception, NASD also will communicate the issuance of such a notice via a Member Alert, which will be posted in the Member Alert section of the NASD Web site24 and distributed via email to those on the executive representative email distribution list. To the extent that the executive representative of an NASD member firm receives such an email and such individual is not the appropriate person at the firm to take the necessary actions, that executive representative should be prepared to forward immediately the email to the appropriate individual(s) at the member.

      OATS Reporting Question

      Q16: Are there any Order Audit Trail System (OATS) reporting obligations for NASDAQ securities relating to Regulation NMS?
      A16: Yes. For orders subject to the OATS Rules, members will be required to identify on the applicable OATS report the receipt and routing of an ISO. Specifically:
      1. A new Special Handling Code of "ISO" has been added to the New Order Report, Combined Order/Route Report, Combined Order/Execution Report and Cancel/Replace Report to reflect the receipt of an ISO by a trading center; and
      2. A new Routing Method Code of "I" will be added to the Route Report and Combined Order/Route Report to identify orders, or portions of orders, that are routed to another trading center and identified to such trading center as an ISO.

      The ISO Special Handling Code for trading centers receiving an ISO will be mandatory on July 9, 2007, the Pilot Stocks Phase Date under Regulation NMS. NASD has filed a proposed rule change with the SEC to establish the new Routing Method Code.25 If the rule change is approved, the Routing Method Code "I" for members routing ISOs to other trading centers will be available on June 11, 2007, but will not be mandatory until February 4, 2008. This will provide firms with additional time to program for the new code. For illustrative purposes, the following are examples of the applicability of these new OATS codes:

      Example #1: "ISO" Special Handling Code: An ADF trading center is displaying a protected quotation in the ADF. Another broker-dealer wishes to access this protected quotation by routing an ISO to execute against its full displayed size, as required by SEC Rule 611(b)(6). This broker-dealer therefore routes an ISO to the ADF trading center to access the protected quote.

      OATS reporting obligations of the ADF trading center in Example #1:

      The ADF trading center must submit to OATS: (1) a New Order Report with a Special Handling Code of ISO to reflect the receipt of an order; and (2) an Execution Report reflecting execution of the routed ISO, if applicable.

      Example #2: "I" Routing Method Code: A member firm intends to utilize the ISO exception to the trade-through rule to obtain executions for an order that it has received from its customer. To satisfy its obligations under SEC Rule 611, the member firm routes ISOs, which it chooses to send on an agency basis, to execute against the relevant protected quotations.

      OATS reporting obligations of the member firm in Example #2:

      The member firm must submit to OATS: (1) a New Order Report reflecting receipt of the order from its customer; (2) a Route Report for each ISO sent, on an agency basis, to another trading center with a Routing Method Code of "I" and a Destination Code reflecting the specific exchange or trading center to which the order was routed; and (3) to the extent that the member routed the ISOs, on an agency basis, with the intent of executing on a principal basis the balance, if any, of the customer order not satisfied by the routing (and subsequent execution, if any) of such ISOs, an Execution Report to reflect the execution of the balance of the block order with its customer.

      Questions Relating to ADF Requirements

      In addition to the questions and answers below, firms should also review Notice to Members 06-67 for additional information on Regulation NMS requirements relating to the ADF.

      Q17: Can member firms, exchange trading facilities, or other ADF trading centers access ADF trading centers through NASD or the ADF?
      A17: No. The ADF is a display-only facility. Accordingly, neither NASD nor the ADF offers a single common access point or central connectivity linkage. ADF trading center quotes are accessible through direct and/or indirect access in accordance with ADF rules. Please refer to the specifications of the applicable ADF trading center located on NASD's ADF Web page for specific quote access information: www.nasd.com/RegulatorySystems/ADF/Participants/index.htm.
      Q18: Will market participants be able to tell which ADF trading center is posting a quote that represents the best bid or offer (BBO) in the ADF at any given time (particularly if multiple ADF trading centers are posting equally priced bids or offers on the same side of the market)?
      A18: Yes. The quotation data feeds for NMS stocks display the specific ADF trading center MPID that is setting the ADF BBO.
      Q19: What securities does the ADF support?
      A19: As of March 5, 2007, all NMS stocks became eligible for quoting, trade reporting and comparison through the ADF. Previously, only NASDAQ-listed securities were supported.
      Q20: Will participants quoting through NASD facilities continue to be accessible through the Intermarket Trading System (ITS)?
      A20: No. As of March 5, 2007, participants quoting through NASD facilities are no longer accessible through ITS for CQS securities. ADF trading center quotes are currently accessible through direct and/or indirect access, as set forth in NASD's ADF rules.

      1 17 CFR 242.600 et seq. See also Securities Exchange Act Release No. 51808 (June 9, 2005), 70 FR 37496 (June 29, 2005) (Regulation NMS Approval Order).

      2 In addition, Regulation NMS adopted: (1) an Access Rule that, among other things, requires fair and non-discriminatory access to quotations; (2) a Sub-Penny Rule that, in general, prohibits market participants from accepting, ranking or displaying orders, quotations or indications of interest in a pricing increment smaller than a penny, except for orders, quotations or indications of interest that are priced at less than $1.00 per share; and (3) amendments to Market Data Rules to update the requirements for consolidating, distributing and displaying market information, as well as amendments to the joint industry plans for disseminating market information that modify the formulas for allocating plan revenue and broadening participation in plan governance. This Notice describes changes to NASD's trade reporting rules that primarily relate to implementation of the Order Protection Rule.

      3 The ADF is a quotation collection, trade comparison and trade reporting facility developed by NASD, which provides ADF trading centers the ability to post quotations in NMS stocks and provides all firms that participate in the ADF the ability to view quotations and report transactions in NMS stocks to the appropriate Exclusive Securities Information Processor (SIP or Processor) for consolidation and dissemination of data to vendors.

      4 See Securities Exchange Act Release No. 54537 (September 28, 2006), 71 FR 59173 (October 6, 2006) (File No. SR-NASD-2006-91).

      5 The SEC also approved changes to the ADF Trading Center Certification Record, which became effective on September 28, 2006.

      6 Generally, the TRFs are mechanisms for firms to report trades in NMS stocks effected otherwise than on an exchange. Currently, four TRFs are operational: the NASD/NASDAQ TRF, the NASD/NSX TRF, the NASD/BSE TRF and the NASD/NYSE TRF. Each TRF is a facility of NASD, subject to regulation by NASD and NASD's registration as a national securities association. Unlike the ADF, the TRFs are trade reporting mechanisms only; they do not permit quoting.

      7 See Securities Exchange Act Release No. 55101 (January 12, 2007), 72 FR 2568 (January 19, 2007) (notice of filing and immediate effectiveness of SR-NASD-2007-002) and Securities Exchange Act Release No. 55346 (February 26, 2007), 72 FR 9807 (March 5, 2007) (notice of filing and immediate effectiveness of SR-NASD-2007-014) available at www.nasd.com/RulesRegulation/RuleFilings/2007RuleFilings/NASDW_018634.

      8 While the new NASD trade reporting requirements for the TRFs are effective on this date, it should be noted, however, that the Order Protection Rule will only be applicable to certain NMS stocks on that date, in accordance with the compliance schedule set forth by the SEC in Securities Exchange Act Release No. 55160 (January 24, 2007), 72 FR 4202 (January 30, 2007). Accordingly, members will not be required to comply with the new Regulation NMS trade reporting modifiers for those NMS stocks that are not yet subject to the Order Protection Rule. However, members may voluntarily report such information to NASD for all NMS stocks.

      9 AADF and TRF technical specifications can be found on the NASD Web site at www.nasd. com/RegulatorySystems/ADF/FIXInformation/index.htm and www.nasd.com/RegulatorySystems/TRF/Exchange Participants/ index.htm, respectively.

      10 The full universe of settlement type modifiers that can be used, as appropriate, in the "Settlement Type—Field 1" are found in the applicable technical specifications.

      11 The full universe of trade type modifiers that can be used, as appropriate, in the "Extended Hours/Sold—Field 3" are found in the applicable technical specifications.

      12 The full universe of trade type modifiers that can be used, as appropriate, in the "SRO Required Detail—Field 4" are found in the applicable technical specifications.

      13 See SEC Rule 611(b)(8) which states: [t]he trading center displaying the protected quotation that was traded through had displayed, within one second prior to execution of the transaction that constituted the trade-through, a best bid or best offer, as applicable, for the NMS stock with a price that was equal or inferior to the price of the trade-through transaction.

      14 To the extent that an NASD member firm believes that it can properly rely on the exception set forth in SEC Rule 611(b)(3) for an OTC trade, it should verify this with SEC staff. In addition, once the SEC staff determines that it is appropriate for the NASD member firm to rely on such exception, the firm should promptly notify NASD.

      15 See SR-NASD-2007-032. The rule filing is available on NASD's Web site at www.nasd.com/RulesRegulation/RuleFilings/2007RuleFilings/NASDW_019139.

      16 It is important to note, however, that consistent with the Commission's prior guidance concerning the applicability of the exception in SEC Rule 611(b)(9) (Stopped Stock) to certain "error corrections," firms should use the derivatively priced modifier in Field 2 to identify such situations, and not the stopped stock modifier in Field 4. See Question 3.11, Division of Market Regulation: Responses to Frequently Asked Questions concerning SEC Rule 611 and Rule 610 of Regulation NMS (October 31, 2006 update).

      17 See NASDAQ Head Trader Alert 2004-081 (June 22, 2004).

      18 See note 8.

      19 Firms reporting OTC transactions in Non-NMS Stocks, e.g., OTC Bulletin Board and Pink Sheet securities, to the OTC Reporting Facility will be required to use the new four byte messaging format because the OTC Reporting Facility uses the same technology platform as the NASD/ NASDAQ TRF. However, as noted above, the Regulation NMS-related trade reporting modifiers do not apply to transactions in these securities and, accordingly, should not be used when reporting transactions in Non-NMS Stocks.

      20 To meet this requirement, the trading center will need to utilize an automated system that is capable of ascertaining current protected quotations and simultaneously routing the necessary ISOs.

      21 See Question 3.03, Division of Market Regulation: Responses to Frequently Asked Questions concerning SEC Rule 611 and Rule 610 of Regulation NMS (October 31, 2006 update).

      22 It is possible that the execution of the routed ISOs would satisfy the customer's order such that there would be no need to execute a block transaction with the customer pursuant to SEC Rule 611(b)(6).

      23 See SEC Press Release 2007-029, dated March 2, 2007 (www.sec.gov/news/press/2007/2007-29.htm).

      24 See www.nasd.com/RulesRegulation/MemberAlerts/2007MemberAlerts/index.htm.

      25 See SR-NASD-2007-028. The rule filing is available on NASD's Web site at www.nasd.com/RulesRegulation/RuleFilings/2007RuleFilings/NASDW_018978

    • 07-22 NASD Establishes New OTC Equity Trade and Quote Halt Codes; Effective Date: May 7, 2007

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      GUIDANCE

      SUGGESTED ROUTING

      KEY TOPICS

      Legal and Compliance
      Operations
      Registered Representatives
      Senior Management
      Trading
      IM-6660-1
      NASD Rule 6660
      OTC Equity Securities
      Quotations
      Trading Halts

      OTC Equity Trade and Quote Halt Codes

      Executive Summary

      On December 18, 2006, the Securities and Exchange Commission (SEC) approved amendments to NASD Rule 6660 to expand the scope of NASD's authority to initiate trade and quote halts in OTC Equity Securities and new IM-6660-1 to identify certain factors that NASD may consider in determining, in its discretion, whether imposing a trading and quoting halt in an OTC Equity Security is appropriate.1 The amendments became effective on March 16, 2007.

      The purpose of this Notice is to provide firms with information on the halt codes NASD will use with respect to its new authority. The new halt codes become effective May 7, 2007.

      Questions/Further Information

      Questions or comments regarding this Notice may be directed to Chris Stone, Associate Chief Counsel, Transparency Services, at (202) 728-8457; or Kosha K. Dalal, Associate General Counsel, Office of General Counsel (OGC), at (202) 728-6903.

      Background and Discussion

      In February 2007, NASD published Notice to Members 07-09 announcing SEC approval of NASD Rule 6660 (Trading and Quotation Halts in OTC Equities Securities) and IM-6660-1. Rule 6660 expanded NASD's existing trading halt authority to provide more general trading and quoting halt authority beyond halts related to non-compliance with SEC Rule 10b-17, while limiting such authority to only those extraordinary events that have a material effect on the market for the OTC Equity Security, and have the potential to cause major disruption to the marketplace and/or significant uncertainty in the settlement and clearance process.

      Specifically, under Rule 6660(a)(3), NASD has the authority to impose a trading and quoting halt for material events, where NASD determines, in its discretion, based on the facts and circumstances of the particular event, that halting trading and quoting in the security is the appropriate mechanism to protect investors and ensure a fair and orderly marketplace. In addition, Rule 6660 increased the maximum number of business days that NASD can impose a trading and quoting halt from up to five business days to ten business days. NASD also adopted IM-6660-1 to identify certain factors that NASD may consider in determining, in its discretion, whether halting trading and quoting in an OTC Equity Security under proposed Rule 6660(a)(3) is appropriate.

      NASD has developed new halt codes and expanded market originator IDs to correspond to Rule 6660 and to designate whether the specific halt in question is with respect to an issue that is eligible for quotation on the Over-the-Counter Bulletin Board (OTCBB), or is otherwise a non-OTCBB OTC Equity Security—i.e., an American Depository Receipt (ADR) that trades in the OTC market, securities quoted in quotation mediums other than the OTCBB (e.g., the Pink Sheets) and OTC Equity Securities not otherwise quoted publicly. Announcements regarding trading and quoting halts will continue to be disseminated/published through the BBDS (Bulletin Board Dissemination Service), including through NASDAQ MarketWatch and OTCBB.com.

      The Market Center ID Originator code of lowercase "u" will be used to denote that the security for which the trading action message is being generated trades over-the-counter and is not quoted on the OTCBB service. The Market Center ID code of uppercase "U" will continue to denote that the security for which the trading action message is being generated is quoted on the OTCBB service.

      Market Center Originator ID

      Character Description
      U OTCBB Quoted Issue
      u Over-the-Counter Equity Security (Non-OTCBB Issue)

      The new halt codes and the Market Center Originator IDs for both OTCBB and non-OTCBB issues are as follows:

      Halt Reason Codes

      Code Reason Description
      U1 Halt—Foreign Market/Regulatory

      Trading is halted because the OTC Equity Security or the security underlying an ADR that is an OTC Equity Security (OTC ADR) is listed on or registered with a foreign securities exchange or market, and the foreign securities exchange, market or regulatory authority overseeing such issuer, exchange or market has halted trading in such security for regulatory reasons because of public interest concerns.
      U2 Halt—Component/Derivative of Exchange-Listed Security

      Trading is halted because the OTC Equity Security or the security underlying an OTC ADR is a derivative or component of a security listed on or registered with a national securities exchange or foreign securities exchange or market (listed security), and the national securities exchange, or foreign securities exchange or market has imposed a trading halt in the listed security.
      U3 Halt—Extraordinary Events

      Trading is halted because NASD has determined that an extraordinary event has occurred or is ongoing that has had a material effect on the market for the OTC Equity Security or has caused or has the potential to cause major disruption to the marketplace and/or significant uncertainty in the settlement and clearance process.

      In addition to the changes to BBDS, NASD will update the "Trade Halts" section of OTCBB.com to include the new halt reason codes as well as halt announcements.

      NASD will support the new halt reason codes and the Market Center Originator ID within the Trading Action messages on BBDS on May 7, 2007.

      NASD Contacts

      Questions concerning trading and quotation halts in OTC Equity Securities should be directed to NASD Operations at (866) 776-0800.


      1 See Exchange Act Release No. 54952 (December 18, 2006), 71 FR 78242 (December 28, 2006) (File No.2006-039).

    • 07-21 Reporting of Transactions in TRACE-Eligible Securities With Execution Dates More Than T+365 Days Before Date of Report; TRACE System Enhancement Effective on June 4, 2007

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      INFORMATIONAL

      SUGGESTED ROUTING

      KEY TOPICS

      Corporate Finance
      Legal and Compliance
      Operations
      Senior Management
      Technology
      Trading and Market Making
      Training
      Debt Securities
      Operations
      Rule 6200 Series
      TRACE
      Transaction Reporting

      Corporate Debt Securities

      Executive Summary

      The TRACE System is being enhanced to accept reports of transactions in TRACE-eligible securities in cases where the execution date is more than T+365 days old.1 With this enhancement, members must report such transactions electronically using the TRACE System and in accordance with the Rule 6200 Series. Also, reports relating to such transactions that correct previously reported information are subject to the same requirements.

      The effective date of the TRACE System enhancement is June 4, 2007.

      Questions/Further Information

      Questions concerning this Notice should be directed to tracefeedback@nasd.com; Orlando Cortes, Senior Business Analyst, Transparency Services, at (212) 858-5143; Elliot Levine, Chief Counsel, Transparency Services, at (202) 728-8405; or Patrick Geraghty, Director, Market Regulation, at (240) 386-4973.

      Background and Discussion

      Currently, the TRACE System only accepts transaction reports that are submitted electronically not later than T+365 days after the trade date. In other words, the TRACE System currently accepts transaction reports for trades for up to 365 days after the trade date (the trade date is included in the 366-day period). NASD has now enhanced the TRACE System to accept reports on transactions submitted electronically with execution dates going back to TRACE inception on July 1, 2002. The enhancement will be effective on June 4, 2007.

      With the enhancement, when a member (or a service provider) inputs a transaction report that refers to an execution date that occurred more than T+365 days before the report date, the reports will be processed on an As/of basis. Corrections of reports submitted on a prior day will continue to be submitted as Reversal trade reports. As is the case with currently submitted As/of and Reversal trade reports, public transactions older than T+365 days will be eligible for dissemination pursuant to Rule 6250. The enhancement to the TRACE System will be supported in CTCI and TRACE WEB reporting. However, at this time, the Depository Trust Clearing Corporation's (DTCC) Real Time Trade Matching (RTTM) system is not able to accept reports for transactions having trade dates more than T+365 days prior to the report date.2


      1 "T" means the trade date or the date of execution.

      2 If members that ordinarily use RTTM to report to TRACE identify transactions executed more than T+365 days from the date the member tries to report the transactions, the member must use one of the alternative reporting methods that will enable the member to make such late reports electronically to the TRACE System.

    • 07-20 NASD Amends Rules 1012 and 1013 to Require Applicants for Membership to Submit Applications Using Online Form NMA; Implementation Date: May 7, 2007; Compliance Date: May 31, 2007

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      GUIDANCE

      SUGGESTED ROUTING

      KEY TOPICS

      Legal and Compliance
      Operations
      Senior Management
      Service Bureaus/Providers
      Form NMA
      New Member Applications
      Rule 1012
      Rule 1013
      Standardized Online Application Form

      New Member Applications

      Executive Summary

      NASD is issuing this Notice to inform members and applicants for membership of amendments to Rules 1012 (General Provisions) and 1013 (New Member Application and Interview) to require that applicants submit Form NMA electronically.

      The rule change, which was filed with the Securities and Exchange Commission (SEC), became effective upon filing.1 The implementation date of the amendment and the date upon which applicants may begin using the online Form NMA to apply for NASD membership is May 7, 2007. All applicants must begin using the online Form NMA by May 31, 2007.

      Questions/Further Information

      Questions regarding this Notice may be directed to J. Barron Knight, Special Counsel, Office of Regulation Policy, NASD Department of Member Regulation, at (202) 728-8070.

      Background and Discussion

      To streamline the membership application process and outline clearly the information that must be submitted with the application, NASD previously amended Rule 1013 (New Member Application and Interview) to require applicants to use a standardized form, Form NMA, to submit their membership applications.2 The Form NMA is organized according to the 14 individual standards for membership enumerated in Rule 1014 (Department Decision) and assists applicants in compiling a complete application package by identifying the information and supporting documentation required by Rule 1013. Applicants currently submit Form NMA in hard copy to NASD, along with the required forms and supporting documentation, via hand delivery, courier or first-class mail.

      NASD is now implementing Online Form NMA and the new electronic application submission process.3 This new process does not change the information applicants must submit pursuant to Rule 1013 or the standards set forth in Rule 1014 for granting an applicant's membership application.

      To effect this change to an electronic application system, NASD has amended Rules 1012 and 1013 to require applicants to file an application in the manner prescribed by NASD and today is prescribing that an application for member be filed electronically.4 NASD has also amended Rule 1012(a) (Filing by Applicant or Service by NASD) to reflect that the electronic filing of a new member application will be deemed complete on the date specified on the confirmation page generated by the electronic filing system (EFS).5 In addition, NASD has amended Rule 1013 (a) to require new member applicants to include the completed online Form NMA as part of the contents of a membership application.6 This move away from a paper new member application to an electronic application will further streamline and make the new member application process more efficient.7

      Form NMA Participant Guide

      NASD has published the "New Membership Application Form NMA Participant Guide" (Guide), which applicants can access on NASD's Web site at www.nasd.com/OnlineFormNMA/instructions. The Guide has been developed to provide applicants with detailed instructions necessary to input information and electronic documents into the online Form NMA. The Guide will not instruct, give guidance to or advise the applicant regarding the sufficiency of the information entered into the online Form NMA. Questions regarding technical requirements may be directed to NASD's Gateway Call Center at (301) 590-6500.

      Electronic Filing System (EFS)

      Applicants can access the online Form NMA and EFS directly at www.nasd.com/OnlineFormNMA. Before entering the EFS, the applicant will have to create an account through the self-registration process. The EFS will allow the applicant to upload documents into the online Form NMA, print out the online Form NMA and save the online Form NMA in draft form and return to it later. The EFS will also allow the applicant to review the completed online Form NMA before it is submitted to ensure completeness and accuracy. The EFS will not allow applicants to submit the online Form NMA until all parts of the application have been completed.

      Additional Application Materials

      Applicants should be aware that some mandatory items, such as the Form BD, fingerprint cards, new member assessment report and CRD entitlement forms cannot be submitted through EFS. Those items and the membership application fee will still need to be submitted via first class mail, overnight courier or hand delivery.8 Information and/or forms for the above-mentioned items can be obtained either through the links in the online Form NMA or on the NASD Web site, as indicated below:

      •  Form BD: www.nasd.com/CRD/formBD
      •  New Member Assessment Report: via online Form NMA under Standard 2, Number 7, or at www.nasd.com/becomeamember/assessment
      •  CRD Entitlement Forms: via online Form NMA under Standard 2, Number 13, or at www.nasd.com/entitlementagree and www.nasd.com/entitlementforms
      •   Fingerprint cards: via online Form NMA under Standard 2, Number 5, or at www.nasd.com/CRD/e-fingerprint_vendors

      After an applicant has completed the online Form NMA and has submitted all the items that can be submitted electronically, EFS will generate a confirmation page that will provide the address of where to submit the membership fees and those items that cannot be submitted electronically. The fees and items must be submitted via first-class mail, overnight courier or hand delivery.

      The implementation date of the rule amendment is May 7, 2007. Accordingly, all new membership applications submitted on or after that date can be submitted via the EFS using the online Form NMA. The compliance date is May 31, 2007. Accordingly, all new membership applications submitted on or after May 31 must be submitted via the EFS using the online Form NMA.


      1 See Securities Exchange Act Release No. 55412 (March 7, 2007), 72 FR 11414 (March 13, 2007) (SR-NASD-2007-015).

      2 See Securities Exchange Act Release No. 53564 (March 29, 2006), 71 FR 16847 (April 4, 2006) (SR-NASD-2006-038); see also Notice to Members 06-16 (May 2006).

      3 See Securities Exchange Act Release No. 53564 (March 29, 2006), 71 FR 16847 (April 4, 2006) (SR-NASD-2006-038).

      4 See Rule 1012(a)(1) and Rule 1013(a)(1).

      5 Rule 1012(a)(4)(E).

      6 Rule 1013(a)(1)(A).

      7 Cf. Securities Exchange Act Release No. 54654 (October 26, 2006), 71 FR 64326 (November 1, 2006) (SR-NASD-2006-60) (order approving new NASD Rule 3170 (Mandatory Electronic Filing Requirements) giving NASD the authority to require members to file or submit electronically any regulatory notice or other document that a member is required to file with (or otherwise submit to) NASD).

      8 See Rule 1012(a)(4)(A) through (4)(C).


      ATTACHMENT A

      New language is underlined, deletions are in brackets.

      * * * * *

      1011. Definitions

      Unless otherwise provided, terms used in the Rule 1010 Series shall have the meaning as defined in Rule 0120.

      (a) through (g) No Change.
      (h) "Interested [Association]NASD Staff"

      The term "Interested [Association]NASD Staff" means an employee who directly participates in a decision under Rule 1014 or 1017, an employee who directly supervises an employee with respect to such decision, an employee who conducted an investigation or examination of a member that files an application under Rule 1017, the District Director for the relevant district, and the head of the Department.
      (i) through (n) No Change.

      1012. General Provisions

      (a) Filing by Applicant or Service by [the Association]NASD
      (1) An Applicant for membership [may]shall file an application in the manner prescribed in Rule 1013.
      (2) Except where NASD has otherwise prescribed an electronic or alternative filing process, an Applicant may file an application or any document or information requested under the Rule 1010 Series by first-class mail, overnight courier, or hand delivery. If the Department and the Applicant agree, the Applicant also may file a requested document or information by facsimile.
      [(2) The Association](3) NASD shall serve a notice or decision issued under he Rule 1010 Series by first-class mail on the Applicant or its counsel, unless a Rule specifies a different method of service.
      [(3)](4) For purposes of the Rule 1010 Series, [S]service by [the Association] NASD or filing by an Applicant shall be deemed complete as follows:
      (A) Service or filing by first-class mail shall be deemed complete on the date of postmark;
      (B) Service or filing by overnight courier shall be deemed complete on the date of delivery to the overnight courier as specified in the airbill;
      (C) Service or filing by hand delivery shall be deemed complete on the date of receipt as evidenced by a date stamp;[ and]
      (D) Service or filing by facsimile shall be deemed complete on the date specified in the document and on the written confirmation of transmission[.]; and
      (E) Filing by an electronic system shall be deemed complete on the date specified on the confirmation page generated by the electronicfiling system.
      (b) Lapse of Application
      (1) No Change.
      (2) If an Applicant wishes to continue to seek membership or approval of a change in ownership, control, or business operations, then the Applicant shall be required to submit a new application and fee under Rule 1013 or 1017, respectively. [The Association]NASD shall not refund any fee for a lapsed application.
      (c) Ex Parte Communications
      (1) The prohibitions against ex parte communications shall become effective when [Association] NASD staff has knowledge that an Applicant intends to file a written request for review by the National Adjudicatory Council under Rule 1015.
      (2) Unless on notice and opportunity for an Applicant and Interested [Association]NASD Staff to participate, or to the extent required for the disposition of ex parte matters as authorized by [the]NASD Rules[ of the Association]:
      (A) an Applicant, a counsel or representative of an Applicant, or an Interested [Association]NASD Staff shall not make or knowingly cause to be made an ex parte communication relevant to the merits of a membership proceeding under the Rule 1010 Series to a Governor, a member of the National Adjudicatory Council or a Subcommittee thereof, or an [Association] NASD employee who is participating or advising in a decision of such a person with respect to that proceeding; and
      (B) a Governor, a member of the National Adjudicatory Council or a Subcommittee thereof, or an [Association]NASD employee who is participating or advising in the decision of such a person with respect to a membership proceeding shall not make or knowingly cause to be made to an Applicant, a counsel or representative of the Applicant, or an Interested [Association]NASD Staff an ex parte communication relevant to the merits of that proceeding.
      (3) A Governor, a member of the National Adjudicatory Council or a Subcommittee thereof, or an [Association]NASD employee participating or advising in the decision of such a person, who receives, makes, or knowingly causes to be made a communication prohibited by this paragraph shall place in the record of the membership proceeding:
      (A) through (C) No Change.
      (d) through (e) No Change.

      * * * * *

      1013. New Member Application and Interview

      (a) Filing of Application

      (1) [Where]How to File

      An Applicant for NASD membership shall file its application in the manner prescribed by NASD 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). An Applicant shall submit an application that includes:
      [(2) Contents]

      [An Applicant shall submit an application using NASD Form NMA The application shall include:]
      (A) Form NMA;

      Existing (A) through (R) relabeled (B) through (S).
      [(3)](2) [Electronic Filings]Uniform Registration Forms

      Upon approval of the Applicant's NASD Member Firm Account Administrator Entitlement 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, and any Form U5 electronically via Web CRD.
      [(4)](3) Rejection of Application That Is Not Substantially Complete

      If the Department determines within 30 days after the filing of an application that the application is not substantially complete, the Department may reject the application and deem it not to have been filed. In such case, within the 30 day period, the Department shall serve a written notice on the Applicant of the Department's determination and the reasons therefor. [The Association]NASD shall refund the application fee, less $350, which shall be retained by [the Association]NASD as a processing fee. If the Applicant determines to continue to seek membership, the Applicant shall submit a new application and fee under this Rule.
      [(5)](4) Request For Additional Documents Or Information

      Within 30 days after the filing of an application, the Department shall serve an initial request for any additional information or documents necessary to render a decision on the application. The Department may serve subsequent requests for additional information or documents at any time during the membership application process.

      Unless otherwise agreed by the Department and the Applicant, the Applicant shall file any additional information and documents with the Department within 60 days after service of the Department's initial request and 30 days after service of any subsequent request.
      (b) No Change.

      * * * * *

      (b) Not applicable.
      (c) Not applicable.

      * * * * *

    • 07-19 SEC Approves Amendments to Expand IM-2110-2 to Include OTC Equity Securities; Effective Date: July 26, 2007

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      GUIDANCE

      SUGGESTED ROUTING

      KEY TOPICS

      Internal Audit
      Legal & Compliance
      Operations
      Senior Management
      Systems
      Trading
      IM-2110-2
      Limit Orders
      Limit Order Protection
      Manning Rule
      Rule 6541

      Trading Ahead of Customer Limit Orders

      Executive Summary

      On February 26, 2007, the Securities and Exchange Commission (SEC) approved amendments to Interpretive Material (IM) 2110-2, Trading Ahead of Customer Limit Order, to apply to over-the-counter (OTC) equity securities.1 The amendments also modify the minimum price-improvement standards set forth in IM-2110-2 with respect to both NMS stocks and OTC equity securities. IM-2110-2, as amended, is set forth in Attachment A of this Notice. The amendments become effective on July 26, 2007.

      Questions/Further Information

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

      Background and Discussion

      IM-2110-2 generally prohibits a member from trading for its own account in an NMS stock2 at a price that is equal to or better than an unexecuted customer limit order in that security, unless the member immediately thereafter executes the customer limit order at the price at which it traded for its own account or a better price.3 The legal underpinnings for IM-2110-2 are a member's basic fiduciary obligations and the requirement that it must, in the conduct of its business, "observe high standards of commercial honor and just and equitable principles of trade."4

      Currently, the requirements in IM-2110-2 apply only to NMS stocks. However, Rule 6541 (Limit Order Protection), which is similar but not identical to IM-2110-2, applies the general principles of IM-2110-2 to a subset of OTC equity securities—those that are quoted on the OTC Bulletin Board (OTCBB). On February 26, 2007, the SEC approved amendments that expand the scope of IM-2110-2 to apply to all OTC equity securities and delete Rule 6541, as those requirements are now subsumed inIM-2110-2.5

      Members should be aware that the limit order protection requirements under IM-2110-2 differ from those under Rule 6541 in several ways.6 Upon implementation of the amendments described in this Notice, members must comply with the requirements of IM-2110-2 for those limit orders previously covered by Rule 6541.

      First, both IM-2110-2 and Rule 6541 provide that a member is not deemed to have traded ahead of a customer limit order if the member provides a contemporaneous execution of the customer's order. Rule 6541 currently provides a maximum time limit of five minutes, within which an execution of a customer order will be deemed contemporaneous with an execution for a member firm's account. IM-2110-2 prescribes a shorter maximum time limit (as soon as possible, but absent reasonable and documented justification, within one minute) within which an execution of a customer order will be deemed contemporaneous with an execution for the firm's account.7 In addition, Rule 6541 requires that the customer limit order be executed at the limit price, while IM-2110-2 requires that the customer limit order be executed at the price of the firm's execution if better than the limit price. Accordingly, upon implementation of the amendments, members must comply with the IM-2110-2 standard for all securities.

      Second, IM-2110-2 contains a higher dollar value threshold for the order size at which firms may negotiate terms and conditions to permit them to continue to trade along side of, or ahead of, the limit order, if the customer agrees. Rule 6541 requires that an order be 10,000 shares or more and greater than $20,000 in value, while IM-2110-2 requires that an order be 10,000 shares or more and greater than $100,000 in value. Upon implementation of the amendments, members must comply with the higher dollar value threshold for all securities.

      Third, IM-2110-2 applies from 9:30 a.m. to 6:30 p.m. Eastern Time (ET),8 whereas Rule 6541 currently applies only during the normal market hours of 9:30 a.m. to 4:00 p.m. ET.

      Finally, IM-2110-2 and Rule 6541 contain different standards relating to the minimum level of price improvement that a member must provide to trade ahead of an unexecuted customer limit order.9 Rule 6541 requires that for customer limit orders priced at or inside the current inside spread, the minimum price improvement must be a minimum of the lesser of $.01 or one-half (1/2) of the current inside spread. IM-2110-2 currently requires a minimum price improvement of a $.01 for limit orders priced at or inside the best inside market. For customer limit orders priced outside the best inside market, IM-2110-2 currently requires minimum price improvement at a price at least equal to the next superior minimum quotation increment, while Rule 6541 does not set a minimum price level (although it does require price improvement in such circumstances).

      The amendments revise the price-improvement standards for both NMS stocks and OTC equity securities, making them uniform depending on the price of the customer limit order and whether it is priced inside or outside the best inside market. Specifically, for customer limit orders priced greater than or equal to $1.00 that are at or inside the best inside market, the minimum amount of price improvement required is $0.01. For customer limit orders priced less than $1.00 that are at or inside the best inside market, the minimum amount of price improvement required is the lesser of $0.01 or one-half (1/2) of the current inside spread. For customer limit orders priced outside the best inside market, the member is required to execute the incoming order at a price at or inside the best inside market for the security. Lastly, for customer limit orders in securities for which there is no published inside market, the minimum amount of price improvement required is $0.01.

      NASD is providing 90 days from publication of this Notice for implementation to provide members with adequate time to comply with the amended requirements. As such, the amendments become effective July 26, 2007.


      1 See Securities Exchange Act Release No. 55351 (February 26, 2007), 72 FR 9810 (March 5, 2007) (order approving SR-NASD-2005-146).

      2 IM-2110-2 currently uses the term "exchange-listed security." The amendments to IM-2110-2 replace the term "exchange-listed security" with the term "NMS stock," consistent with the terminology used in Regulation NMS. See SEC Rule 600(b)(47) of Regulation NMS.

      3 For example, if a member buys 100 shares of a security at $10 per share when holding customer limit orders in the same security to buy at $10.01 per share equaling, in aggregate, 1,000 shares, the member is required to fill 100 shares of the customer limit order at $10 per share.

      4 See NASD Rule 2110. See also NASD Rule 2320(a).

      5 For purposes of the amendments, OTC equity securities are defined as any non-exchange-listed security and certain exchange-listed securities that do not otherwise qualify for real-time trade reporting. This definition does not include options.

      6 For a more expansive discussion of the differences between IM-2110-2 and Rule 6541, members also should review the rule filing, SR-NASD-2005-146. See Securities Exchange Act Release No. 55351 (February 26, 2007), 72 FR 9810 (March 5, 2007) (order approving SR-NASD-2005-146).

      7 See Notices to Members 95-67 (August 1995) and 98-78 (September 1998).

      8 A member may generally limit the life of a customer limit order to the period of 9:30 a.m. to 4 p.m. ET. If a customer does not formally assent to processing of the customer's limit order(s) during the extended hours period commencing after the normal close of the market, limit order protection will not apply to that customer's order. See footnote 1 to IM-2110-2.

      9 In connection with the approval of the amendments to IM-2110-2, the price-improvement standards, which previously were operating on a pilot basis, became permanent.


      ATTACHMENT A

      Below is the text of the rule change. New language is underlined; deletions are in brackets.

      IM-2110-2. Trading Ahead of Customer Limit Order

      (a) General Application

      To continue to ensure investor protection and enhance market quality, NASD's Board of Governors is issuing an interpretation to NASD Rules dealing with member firms' treatment of their customer limit orders in NMS stocks and OTC equity[exchange-listed] securities. This interpretation, which is applicable from 9:30 a.m. to 6:30 p.m. Eastern Time, will require members to handle their customer limit orders with all due care so that members do not "trade ahead" of those limit orders. Thus, members that handle customer limit orders, whether received from their own customers or from another member, are prohibited from trading at prices equal or superior to that of the limit order without executing the limit order. In the interests of investor protection, NASD is eliminating the so-called disclosure "safe harbor" previously established for members that fully disclosed to their customers the practice of trading ahead of a customer limit order by a market-making firm.1 For purposes of this interpretation, (1) "NMS stock" shall have the meaning set forth in SEC Rule 600(b)(47) of Regulation NMS and (2) "OTC equity security" shall have the meaning set forth in Rule 6610(d).

      Rule 2110 states that:

      A member, in the conduct of his business, shall observe high standards of commercial honor and just and equitable principles of trade.

      Rule 2320, the Best Execution Rule, states that:

      In any transaction for or with a customer, a member and persons associated with a member shall use reasonable diligence to ascertain the best inter-dealer market for the subject security and buy or sell in such a market so that the resultant price to the customer is as favorable as possible to the customer under prevailing market conditions.

      Interpretation

      The following interpretation of Rule 2110 has been approved by the Board:

      A member firm that accepts and holds an unexecuted limit order from its customer (whether its own customer or a customer of another member) in an NMS stock or OTC equity[exchange-listed] security and that continues to trade the subject security for its own account at prices that would satisfy the customer's limit order, without executing that limit order, shall be deemed to have acted in a manner inconsistent with just and equitable principles of trade, in violation of Rule 2110, provided that a member firm may negotiate specific terms and conditions applicable to the acceptance of limit orders only with respect to limit orders that are: (a) for customer accounts that meet the definition of an "institutional account" as that term is defined in Rule 3110(c)(4); or (b) 10,000 shares or more, unless such orders are less than $100,000 in value. In the event that a member trades ahead of an unexecuted customer limit order at a price that is better than the unexecuted limit order, such member is required to execute the limit order at the price received by the member or better. Nothing in this interpretation, however, requires members to accept limit orders from any customer.

      By rescinding the safe harbor position and adopting this interpretation, NASD wishes to emphasize that members may not trade ahead of their customer limit orders even if the member had in the past fully disclosed the practice to its customers prior to accepting limit orders. NASD believes that, pursuant to Rule 2110, members accepting and holding unexecuted customer limit orders owe certain duties to their customers and the customers of other member firms that may not be overcome or cured with disclosure of trading practices that include trading ahead of the customer's order. The terms and conditions under which institutional account or appropriately sized customer limit orders are accepted must be made clear to customers at the time the order is accepted by the firm so that trading ahead in the firm's market-making capacity does not occur.

      [As outlined in NASD Notice to Members 97-57, the minimum amount of price improvement necessary in order for a member to execute an incoming order on a proprietary basis when holding an unexecuted limit order for a Nasdaq security trading in fractions, and not be required to execute the held limit order, is as follows:]
      •  [If actual spread is greater than 1/16 of a point, a firm must price improve an incoming order by at least a 1/16. For stocks priced under $10 (which are quoted in 1/32 increments), the firm must price improve by at least 1/64.]
      •  [If actual spread is the minimum quotation increment, a firm must price improve an incoming order by one-half the minimum quotation increment.]
      [For Nasdaq securities authorized for trading in decimals pursuant to the Decimals Implementation Plan For the Equities and Options Markets, t]The minimum amount of price improvement necessary in order for a member to execute an incoming order on a proprietary basis [in a security trading in decimals] when holding an unexecuted limit order in that same security, and not be required to execute the held limit order, is as follows:
      1) For customer limit orders priced greater than or equal to $1.00 that are at or inside the best inside market [displayed in Nasdaq], the minimum amount of price improvement required is $0.01; [and]
      2) For customer limit orders priced less than $1.00 that are at or inside the best inside market, the minimum amount of price improvement required is the lesser of $0.01 or one-half (1/2) of the current inside spread;
      3) For customer limit orders priced outside the best inside market [displayed in Nasdaq], the member must price improve the incoming order by executing the incoming order at a price at or inside the best inside market for the security; and[at least equal to the next superior minimum quotation increment in Nasdaq (currently $0.01)]
      4) For customer limit orders in securities for which there is no published inside market, the minimum amount of price improvement required is $0.01.
      NASD also wishes to emphasize that all members accepting customer limit orders owe those customers duties of "best execution" regardless of whether the orders are executed through the member or sent to another member for execution. As set out above, the Best Execution Rule requires members to use reasonable diligence to ascertain the best inter-dealer market for the security and buy or sell in such a market so that the price to the customer is as favorable as possible under prevailing market conditions. NASD emphasizes that order entry firms should continue to monitor routinely the handling of their customers' limit orders regarding the quality of the execution received.
      (b) through (c) No change.

      * * * * *

      6541. [Limit Order Protection]Reserved.

      [(a) Members shall be prohibited from "trading ahead" of customer limit orders that a member accepts in securities quoted on the OTCBB. Members handling customer limit orders, whether received from their own customers or from another member, are prohibited from trading at prices equal or superior to that of the customer limit order without executing the limit order. Members are under no obligation to accept limit orders from any customer.]
      [(b) Members may avoid the obligation specified in paragraph (a) through the provision of price improvement. If a customer limit order is priced at or inside the current inside spread, however, the price improvement must be for a minimum of the lesser of $0.01 or one-half (1/2) of the current inside spread. For purposes of this rule, the inside spread shall be defined as the difference between the best reasonably available bid and offer in the subject security.]
      [(c) Notwithstanding subparagraph (a) of this rule, a member may negotiate specific terms and conditions applicable to the acceptance of limit orders only with respect to such orders that are:]
      [(1) for customer accounts that meet the definition of an "institutional account" as that term is defined in Rule 3110(c)(4); or]
      [(2) for 10,000 shares or more, and greater than $20,000 in value.]
      [(d) Contemporaneous trades]
      [A member that trades through a held limit order must execute such limit order contemporaneously, or as soon as practicable, but in no case later than five minutes after the member has traded at a price more favorable than the customer's price.]
      [(e) Application]
      [(1) This rule shall apply, regardless of whether the subject security is additionally quoted in a separate quotation medium.]
      [(2) This rule shall apply from 9:30 a.m. to 4:00 p.m. Eastern Time.]

      1 For purposes of the operation of certain [Nasdaq] transaction and quotation reporting systems and facilities during the period from 4 p.m.to 6:30 p.m. Eastern Time, members may generally limit the life of a customer limit order to the period of 9:30 a.m. to 4 p.m. Eastern Time. If a customer does not formally assent ("opt-in") to processing of the customer's limit order(s) during the extended hours period commencing after the normal close of the [Nasdaq] market, limit order protection will not apply to that customer's order(s).

    • 07-18 SEC Approves Amendments to TRACE Reporting Exempting Trades in TRACE-Eligible Securities Conducted on a Facility of, and Reported to, the New York Stock Exchange; Effective Date: January 9, 2007

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      SUGGESTED ROUTING

      KEY TOPICS

      Legal and Compliance
      Operations
      Registered Representatives
      Senior Management
      Technology
      Tradingand Markets
      Training
      Debt Securities
      Operations
      Rule 6200 Series
      TRACE Rules
      Transaction Reporting

      GUIDANCE

      Transaction Reporting

      Executive Summary

      On November 16, 2006, the Securities and Exchange Commission approved an amendment to Rule 6230 (Transaction Reporting). Effective January 9, 2007, these amendments provide, on a pilot basis, a reporting exemption for corporate debt securities subject to both NASD's and NYSE's trade reporting requirements. The rules, as amended, are set forth in Attachment A.

      Questions/Further Information

      Questions concerning this Notice should be directed to Elliot Levine, Chief Counsel, Transparency Services, Markets, Services and Information, at (202) 728-8405; Ola Persson, Director, TRACE Data, Transparency Services, at (212) 858-4796; and James L. Eastman, Assistant General Counsel, Office of General Counsel, at (202) 728-6961.

      Background and Discussion

      On November 16, 2006, the SEC approved on an accelerated basis an amendment to Rule 6230(e) to exempt from Trade Reporting and Compliance Engine (TRACE) requirements, for a pilot period of two years, transactions in TRACE-eligible securities executed on a facility of the New York Stock Exchange (NYSE) in accordance with NYSE Rules 1400 and 1401.1 The pilot period began January 9, 2007.2

      To qualify for this new exemption, Rule 6230(e)(4), the transaction must be reported to NYSE pursuant to applicable NYSE trade reporting rules and disseminated publicly by NYSE. A transaction in a TRACE-eligible security executed on and reported to an exchange other than NYSE that is disseminated publicly still would qualify for an exemption from reporting under Rule 6230(e)(2). However, as was the case prior to the recent amendments, the exemption in Rule 6230(e)(2) is limited to transactions in securities that are listed on a national securities exchange.

      NASD amended Rule 6230 to address concerns regarding duplicative trade reporting of corporate debt securities subject to both NASD's and NYSE's trade reporting requirements.


      1 See Securities Exchange Act Release No. 54768 (November 16, 2006), 71 FR 67673 (November 22, 2006) (SR-NASD-2006-110). The SEC also approved technical changes to NASD Rule 6210 to remove references to "NASDAQ" and the "Nasdaq Stock Market, Inc." and to remove references to "NASDAQ" in NASD Rule 6230 to reflect The NASDAQ Stock Market LLC's registration as a national securities exchange.

      2 Unlike virtually every Notice to Members pertaining to a rule change that has a prospective effective date in order to allow member firms time to comply, the effective date of this Transaction Reporting rule change (SEC Release No. 54768) was scheduled to become effective upon either (1) SEC approval of the rule change or (2) execution by NASD and NYSE of a data sharing agreement addressing data related to the transactions covered by the rule change—whichever came later. The effective date of the NASD and NYSE data sharing agreement was the later of these two dates and, therefore, triggered the rule's effectiveness, even though it pre-dates this Notice. The first transactions covered by the rule change—and not subject to TRACE reporting—occurred the week of April 23, 2007.


      ATTACHMENT A

      New language is underlined; deletions are in brackets

      6200. TRADE REPORTING AND COMPLIANCE ENGINE (TRACE)

      * * * * *

      6210. Definitions

      The terms used in this Rule 6200 Series shall have the same meaning as those defined in NASD's By-Laws and Rules unless otherwise specified.

      (a) No Change.
      (b) No Change.
      (c) The term "reportable TRACE transaction" shall mean any secondary market transaction in a TRACE-eligible security except transactions in TRACE-eligible securities that are listed on a national securities exchange registered under Section 6 of the Securities Exchange Act of 1934, when such transactions are executed on, and reported to the exchange and the transaction information is disseminated publicly[, or transactions in TRACE-eligible securities that are listed and quoted on the Nasdaq Stock Market, Inc. (Nasdaq), when such transactions are reported to Nasdaq and the transaction information is disseminated publicly].
      (d)–(j) No Change.

      * * * * *

      6230. Transaction Reporting

      (a) through (d) No Change.
      (e) Transactions Exempt from Reporting

      The following types of transactions shall not be reported:

      (1) Transactions that are part of a primary distribution by an issuer.
      (2) Transactions in TRACE-eligible securities that are listed on a national securities exchange, when such transactions are executed on and reported to the exchange and the transaction information is disseminated publicly[, and transactions in TRACE-eligible securities that are listed and quoted on Nasdaq, when such transactions are reported to Nasdaq and the transaction information is disseminated publicly].
      (3) Transactions where the buyer and the seller have agreed to trade at a price substantially unrelated to the current market for the TRACE-eligible security (e.g., to allow the seller to make a gift).
      (4) For the duration of a two-year pilot program, effective upon the later of either: 1) approval of this rule by the Commission, or 2) execution by NASD and the New York Stock Exchange ("NYSE") of a data sharing agreement addressing data related to transactions covered by this Rule, transactions in TRACE-eligible securities that are executed on a facility of NYSE in accordance with NYSE Rules 1400 and 1401 and reported to NYSE in accordance with NYSE's applicable trade reporting rules and disseminated publicly by NYSE.

      (f) No Change.

    • 07-17 NASD and NYSE Joint Release Regarding Special Measures against Specified Banks Pursuant to Section 311 of the USA PATRIOT Act

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      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Operations
      Senior Management
      Anti-Money Laundering

      INFORMATIONAL

      Anti-Money Laundering

      Executive Summary

      This is to inform members1 that the Financial Crimes Enforcement Network (FinCEN) has issued a final rule imposing a special measure,2 effective April 18, 2007, against Banco Delta Asia SARL, including its subsidiaries Delta Asia Credit Limited and Delta Asia Insurance Limited (Banco Delta Asia or bank).3 Banco Delta Asia is a commercial bank in Macau, Special Administrative Region, China. This measure is comparable to that imposed against the Latvian bank VEF Banka and its subsidaries, including Veiksmes lizings.4

      Questions/Further Information

      NASD: Patricia Albrecht, Assistant General Counsel, OGC, at (202) 728-8026.
      NYSE: Stephen Kasprzak at 212-656-5226 or Cory Figman at (212) 656-4893.

      Background

      The factors described in USA PATRIOT Act Section 311 (Section 311) are considered in determining whether reasonable grounds exist to conclude there is a primary money laundering concern. In addition, Section 311 provides various options to effectively target specific money laundering and terrorist financing concerns. The Director is required by the Bank Secrecy Act to consult with the Secretary of State and the Attorney General prior to finding that reasonable grounds exist for concluding that a foreign financial institution is of primary money laundering concern. Furthermore, in determining that an institution is of primary money laundering concern, Section 311 requires the Director to consider relevant information, including: (1) whether the institution is used to promote or facilitate money laundering in or through the jurisdiction; (2) if the institution is used for a legitimate business purpose in its jurisdiction; and (3) whether the action contemplated to be taken will fulfill the purposes of the Bank Secrecy Act and will prevent the financial institution from engaging in international money laundering and other financial crimes.

      Appropriate special measures to address the money laundering risks must be applied if it is determined that reasonable grounds exist for concluding that a foreign financial institution is of primary money laundering concern. According to Section 311, the appropriate federal agencies and parties must be consulted and the following factors must be considered when imposing special measures:5 (1) whether other nations or multilateral groups have taken similar action; (2) if any special measure being imposed would create a significant competitive disadvantage for financial institutions organized or licensed in the United States; (3) the extent of any significant adverse systemic impact on the international payment, clearance and settlement system, or on the legitimate business activities of the institution; and (4) what effect there would be on the national security and foreign policy of the United States.

      Discussion

      FinCEN has issued a final rule that imposes special measures against Banco Delta Asia and its subsidiaries (the Specified Banks) in response to findings that the Specified Banks are financial institutions of primary money laundering concern. Under the special measures, covered financial institutions, which include broker-dealers, are subject to the following requirements with respect to the Specified Banks:

      Prohibition of the Direct Use of Correspondent Accounts by the Specified Banks

      Covered financial institutions are prohibited from opening or maintaining a correspondent account6 in the United States for, or on behalf of, the Specified Banks. This prohibition requires all covered financial institutions to review their account records to ensure that they maintain no accounts directly for, or on behalf of, the Specified Banks.

      Due Diligence to Prevent Indirect Use

      As a corollary to the prohibition on the opening or maintaining of correspondent accounts directly for the Specified Banks, each covered financial institution is required to apply due diligence to its correspondent accounts that is reasonably designed to guard against their indirect use by the Specified Banks. At a minimum, such due diligence must include two elements:

      1) Notification to Correspondent Accountholders

      A covered financial institution must notify its correspondent accountholders that their account(s) may not be used to provide the Specified Banks with access to the covered financial institution. The purpose of the notice requirement is to help ensure that the Specified Banks are denied access to the United States financial system, as well as to increase awareness within the international financial community of the risks and deficiencies of the Specified Banks. However, the final rules emphasize that FinCEN is not requiring or expecting financial institutions to obtain a certification from their correspondent accountholders that indirect use will not be provided.

      Although FinCEN makes clear that covered financial institutions have flexibility in choosing their method of notification, sample notification language which may be used for this purpose is provided, as follows:

      "Notice: Pursuant to U.S. regulations issued under section 311 of the USA PATRIOT Act, 31 CFR 103.192, we are prohibited from opening or maintaining a correspondent account for, or on behalf of, [the Specified Banks]. The regulations also require us to notify you that your correspondent account with our financial institution may not be used to provide [the Specified Banks] with access to our financial institution. If we become aware that [the Specified Banks] are indirectly using the correspondent account you hold at our financial institution, we will be required to take appropriate steps to prevent such access, including terminating your account."

      Methods of compliance with the notice requirement could include, for example, transmitting a one-time notice by mail, fax or email, or including such information in the next regularly occurring transmittal from the covered financial institution to its correspondent accountholders. Each covered financial institution must document its compliance with the requirement that it notify its correspondent accountholders that the accounts may not be used to provide the Specified Banks with access to the covered financial institution.

      2) Identification of Indirect Use

      A covered financial institution must take reasonable steps in order to identify any indirect use of its correspondent accounts by the Specified Banks, to the extent that such indirect use can be determined from transactional records maintained by the covered financial institution in the normal course of business. A covered financial institution must take a risk-based approach when deciding what, if any, additional due diligence measures it should adopt to guard against the indirect use of correspondent accounts by the Specified Banks, based on risk factors such as the type of services offered by, and geographic locations of, its correspondents. Unlike the duties imposed under the one-time notification requirement, covered financial institutions have an ongoing obligation to take reasonable steps to identify all correspondent account services they may directly or indirectly provide to the Specified Banks.

      Members are urged to consult the following links for further details:

      •  www.fincen.gov/bda_final_rule.pdf (for additional information regarding the final rule issued against Banco Delta Asia and its subsidiaries);
      •  www.fincen.gov/vef_final_rule_070706.pdf; and
      •  www.fincen.gov/reg_section311.html (for information on all special measures issued by FinCEN and to sign up for email notifications when Section 311 special measures are updated).

      1 For purposes of this joint release, the term "member" refers to NYSE member organizations and NASD members.

      2 The rule was issued pursuant to the authority contained in 31 U.S.C. 5318A. Section 311 of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA PATRIOT Act) added Section 5318A to the Bank Secrecy Act and granted the Secretary of the Treasury, in consultation with the Departments of Justice and State and appropriate federal financial regulators, the authority, after finding that reasonable grounds exist for concluding that a foreign jurisdiction, foreign financial institution, international class of transactions or type of account is of "primary money laundering concern," to require domestic financial institutions and domestic financial agencies to take certain "special measures" against the primary money laundering concern.

      3 See 72 FR 12730 (March 19, 2007).

      4 See 71 FR 39554 (July 13, 2006) available at www.fincen.gov/vef_final_rule_070706.pdf.

      5 See 31 U.S.C. 5318(c)(1).

      6 For purposes of these final rules, a "correspondent account" is defined as an account established to receive deposits from, or make payments or other disbursements on behalf of, a foreign bank, or handle other financial transactions related to the foreign bank (see 31 U.S.C. 5318A(e)(1)(B) as implemented in 31 C.F.R. 103.175(d)(1)(ii)).

    • 07-16 Frequently Asked NASD Financial and Operational Questions

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      GUIDANCE

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Regulatory
      Senior Management
      Financial and Operational Principals (FINOPs)
      SEC Rule 15c3-1 (Net Capital Rule)
      SEC Rule 15c3-3 (Customer Protection Rule)
      SEC Rule 17a-5 (Reports to Be Made by Certain Brokers and Dealers)

      Executive Summary

      NASD is issuing this Notice to Members (NTM) to provide member firms with answers to many of the frequently asked questions NASD receives on financial and operational issues. Much of the information is also available on NASD's Web site at www.nasd.com or through a firm's NASD Liaison. Additionally, NASD's Weekly Update emails sent to the Executive Representative of each NASD member firm contain valuable information about important topics of interest to NASD members, including select financial and operational information.

      Questions/Further Information

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

      SEC's Net Capital Rule (SEC Rule 15c3-1)

      QA-1. Are members required to maintain an appropriate amount of net capital only as of the close of each business day?
      A. No. SEC Rule 15c3-1(a), which governs net capital requirements, requires a broker or dealer to maintain its required net capital continuously.1 Broker-dealers must be able to demonstrate moment-to-moment compliance with SEC Rule 15c3-1 (the Net Capital Rule). While perpetual computations are not required, broker-dealers must be able to demonstrate compliance with the Net Capital Rule consistent with the firm's business activities as of the date and time of the computation when requested to do so by any of its regulators.
      QA-2. What is the net capital treatment for unmet maintenance margin calls for "pattern day traders"?2
      A. When a "pattern day trader" fails to meet special maintenance margin calls, as required (i.e., within five business days from the date the margin deficiency occurs), on the sixth business day only, a member is required to deduct from net capital the amount of unmet maintenance margin calls for its pattern day traders.3 The application of such charges is provided for in SEC Rule 15c3-1(c)(2)(xii) (Deduction From Net Worth For Certain Undermargined Accounts).4
      QA-3. Do unmet minimum equity requirements for customers meeting the definition of "pattern day traders" have any impact on a firm's net capital?
      A. No. The minimum equity requirement for the accounts of customers meeting the definition of "pattern day trader" is $25,000. This minimum equity must be deposited in the customer's account before he or she may day trade and must be maintained in the customer's account at all times. Unlike unmet maintenance margin calls, broker-dealers are not subject to any additional net capital deductions if a pattern day trader does not meet the minimum equity requirement. However, once the customer's minimum equity has declined below $25,000, the firm can no longer permit day trading in that customer's account until such time as the account meets the $25,000 minimum equity requirement.
      QA-4. What is the net capital treatment for payment for order flow fees receivable?
      A. Payment for order flow fees receivables are deemed to be unsecured receivables. As a result, these receivables must be treated as non-allowable assets pursuant to SEC Rule 15c3-1(c)(2)(iv) (Assets Not Readily Convertible Into Cash).5
      QA-5. When a broker-dealer enters into a reverse repurchase agreement (the purchase of securities with an agreement to sell them on a future, specified date) for its own account with a non-affiliated entity, is the contract value permitted to be treated as an allowable asset for net capital purposes?
      A. A broker-dealer should treat the entire amount of the reverse repurchase agreement contract as a non-allowable asset unless the securities subject to a reverse repurchase agreement are in the possession or control of the broker-dealer and are outside the control of the counterparty.6 To the extent the broker-dealer has possession and control of the securities subject to the reverse repurchase agreement, the broker-dealer generally must deduct from net capital the amount of the reverse repurchase agreement deficit (which is the difference between the contract price for resale of the securities and the market value of the securities (if less than the contract price)).7 The broker-dealer may reduce the reverse repurchase deficit by any margin or other deposits held by the broker-dealer on account of the reverse repurchase agreement; any excess market value of the securities over the contract price for resale of those securities held by the broker-dealer under any other reverse repurchase agreement with the same party; the difference between the contract price for resale and the market value of securities subject to repurchase agreements with the same party (if the market value of the securities is less than the contract price); and calls for margin, marks to market or other required deposits that are outstanding one business day or less.8 In addition, members should remember that, to the extent a broker-dealer engages in reverse repurchase agreements, it must maintain additional net capital in accordance with SEC Rule 15c3-1(a)(9).
      QA-6. If a broker-dealer has been the subject of an adverse arbitration award, when should the award be deducted from the firm's net capital?
      A. A broker-dealer that is the subject of an adverse award in an arbitration proceeding should, for net capital purposes, deduct the award at the time the award is made, even though the appeal process has not been exhausted and no judgment has been rendered, because grounds for revision on appeal are very limited. In addition, the award would be included in Aggregate Indebtedness, as there is no exclusion for adverse arbitration awards under SEC Rule 15c3-1(c)(1).9
      QA-7. When does the undue concentration haircut apply to equity securities?
      A. An undue concentration haircut applies to equity securities upon the initial recognition of the securities as an asset. If, however, the broker-dealer acquired the securities in connection with its capacity as an underwriter in the distribution of the securities, the undue concentration charge is applied on the eleventh business day following the date that the securities are first available for sale.10
      QA-8. What documentation is a broker-dealer required to maintain with respect to capital contributions or distributions?
      A. At a minimum, broker-dealers are required to record the date(s) and amount(s) of all capital contributions or distributions on their general ledger, and have readily available bank statements and other documentation supporting the transfer of assets that describe the source and purpose of the infusion or distribution. The main purpose of this requirement is to assist the SEC and the firm's designated examining authority (DEA) in determining if a capital withdrawal is a reportable event under SEC Rule 15c3-1(e). All capital infusions and distributions must be reflected in the quarterly Statement of Changes in Ownership Equity section of the FOCUS II or IIA Reports. All agreements between broker-dealers and their investors should be in writing.
      QA-9. The definition of "dealer" for purposes of determining a firm's minimum net capital requirements includes "any broker or dealer that effects more than 10 transactions in any one calendar year for its own investment account."11 Are corrections, cancellations and errors included in determining the 10-transactions total?
      A. Corrections, cancellations and errors generally are not included in the 10-transactions limitation described under Dealers in SEC Rule 15c3-1(a)(2)(iii)(B). However, because there have been instances, for example, where broker-dealers have attempted to circumvent the dealer requirement of the net capital rule by trading in their error account, as opposed to the error account containing legitimate corrections, the 10-transactions total must be determined on a case-by-case basis.
      QA-10: Do proprietary transactions involving the sale of shares of one mutual fund and the purchase of shares of another mutual fund that are part of the same fund family count toward the "more than 10 transactions in any one calendar year" that would make a firm a "dealer" (and impose a $100,000 net capital requirement) under the net capital rule?
      A. Yes. Transactions involving mutual funds (excluding money market mutual funds) within the same family of funds count toward the 10-transactions limitation described under Dealers in SEC Rule15c3-1(a)(2)(iii)(B). A sale and a purchase count as two transactions.12
      QA-11: Should monthly investments into a mutual fund by a member firm be counted in determining the "more than 10 transactions in any one calendar year" that would make a firm a "dealer" under the net capital rule?
      A. In general, yes. However, SEC staff has advised that a single monthly investment of $1,000 or less into a proprietary mutual fund account does not have to be counted in determining whether a firm has exceeded the 10-transactions limitation described under Dealers in SEC Rule 15c3-1(a)(2)(iii)(B).13
      QA-12: If a broker-dealer guarantees an obligation of a subsidiary or an affiliate, what is the impact to the broker-dealer's net capital?
      A. Where the broker-dealer is guaranteeing the financial obligations of a subsidiary or an affiliate, it must consolidate into a single computation all assets and liabilities of the guaranteed entity (Paragraph (a) of Appendix C of the Net Capital Rule). If the broker-dealer is guaranteeing a particular obligation or set of financial obligations of a subsidiary or affiliate, the broker-dealer needs to deduct the notional value of the guarantee when computing its net capital, in accordance with paragraph (d) of same appendix.
      QA-13. For net capital purposes, what is the proper treatment of an amount offered by a broker-dealer to settle a formal disciplinary action with NASD?
      A. The broker-dealer must record the loss and related liability when the offer is accepted by NASD's Office of Disciplinary Affairs or is otherwise deemed final under NASD's Code of Procedure.
      QA-14. NASD NTM 03-47114 provides guidelines for firms to follow when calculating refunds to customers and accounting for their anticipated refund liabilities. Firms determined their probable or estimated liability based upon currently available information in accordance with generally accepted accounting principles. Firms needed to reflect the balance of the breakpoint refund liability and fund such balances (by segregating funds in a reserve bank account or a "(k)(2)(i)" account) until they believed that all customers who did not receive applicable breakpoint discounts had been compensated, or until the time limit for customers to present claims had expired in accordance with applicable law. Since three years have passed since the issuance of the Notice, assuming a firm has satisfactorily communicated to its customers the possibility of the overcharge, at what point may a firm discontinue reserving for possible refunds?
      A. The current absence of customers' claims does not on its own support removal of the liability. Prior to reducing or removing this liability, a firm should determine, to the satisfaction of (1) those responsible for the financial management of, and reporting for, the firm and (2) the firm's outside auditors, that such a reduction of the current balance/value, with respect to the firm's securities business and operating practices, is accurate. Firms reducing or removing the liability should maintain workpapers and make such documentation available to NASD staff for review, if requested. Also, firms that reduce or remove the liability may not rely on the reduction/removal as a justification for failing to compensate a customer upon presentation of a bona fide claim, simply because the claim was presented after the reduction/removal of the liability/funds segregation.

      Financial Reporting

      QB-1. What is the filing due date for a broker-dealer's annual audited financial statements?
      A. Pursuant to SEC Rule 17a-5(d)(5), the annual audit report shall be filed not more than sixty (60) days from the broker-dealer's fiscal year end. SEC Rule 17a-5(d)(6) further states that one copy of the annual audit report shall be filed at the regional or district office of the Commission for the region or district in which the broker or dealer has its principal place of business and the principal office of the designated examining authority for said broker or dealer. Two copies of the annual audit report must be filed at the Commission's principal office in Washington, DC. Copies must also be provided to all self-regulatory organizations of which the broker or dealer is a member.
      QB-2. What address should a broker-dealer use to submit its annual audited financial statements to the principal office of NASD?
      A. The annual audit must be filed in hard copy with the NASD Systems Support Department at 9509 Key West Avenue, Rockville, MD 20850. Copies of the annual audited financial statements must also be submitted to the SEC in Washington, DC, and to the appropriate Regional/District Office of the SEC.15
      QB-3. Is my broker-dealer required to have its annual audit prepared by an accounting firm registered with the Public Company Accounting Oversight Board (PCAOB)?
      A. On December 12, 2006, the SEC extended the deadline by which non-public broker-dealers must file financial statements that have been certified by a registered public accounting firm. As a result, all non-public broker-dealers may file with the SEC a balance sheet and income statement and may send to their customers a balance sheet that has been certified by an independent public accountant, instead of by a registered public accounting firm, for fiscal years ending before January 1, 2009.16
      QB-4. What is an oath or affirmation that is attached to the annual audit report?17
      A. As described in SEC Rule 17a-5(e)(2), the oath or affirmation attached to the annual audit report is an acknowledgement by the broker-dealer that to the best knowledge and belief of the person making such oath or affirmation: (1) the financial statements and schedules are true and correct, and (2) neither the broker or dealer, nor any partner, officer or director, as the case may be, has any proprietary interest in any account classified solely as that of a customer. The oath or affirmation must be made by a person authorized to administer such oaths or affirmations. If the broker or dealer is a sole proprietorship, the oath or affirmation must be made by the proprietor; if a partnership, by a general partner; and if a corporation, by a duly authorized officer.
      QB-5. When and where should a request for an extension of time for filing a FOCUS II/IIA Report, including Schedule I, or an annual audit be sent?
      A. A member firm must submit its written request for an extension to its local NASD District Office. Such requests must be received by the local NASD District Office no later than three business days prior to the required filing date for each such FOCUS Report or annual audit. Extensions will only be granted for delays outside the control of the member, e.g. technical difficulties, third-party contractor delays, and auditor delays.18
      QB-6. Is there a late fee if a FOCUS II/IIA Report, including Schedule I, or annual audit is received by NASD after the due date (or the revised due date, if the firm requested and was granted an extension)?
      A. Yes. An administrative fee of $100 for late filings will be imposed for each day that each report was late. The fee will be assessed for a period not to exceed 10 business days.19 Additionally, a member firm could be subject to formal or informal disciplinary proceedings and fines depending on the circumstances.20
      QB-7. Does NASD recommend specific independent public accountants, service bureaus, clearing firms, consulting firms or law firms?
      A. No. NASD does not recommend or endorse individuals or entities that provide professional services.
      QB-8. What are the appropriate fields on the FOCUS II and IIA Reports to reflect haircut deductions pursuant to SEC Rule 15c3-1(c)(2)(iv)(J) (All Other Securities)?
      A. Haircut deductions pursuant to SEC Rule 15c3-1(c)(2)(iv)(J) must be reflected in field 3720 for FOCUS II fliers and 3734 for FOCUS IIA fliers in the Computation of Net Capital section.
      QB-9. Who should a broker-dealer contact regarding technical problems in submitting a FOCUS Report and/or the annual Schedule I?
      A. Members should contact the NASD Technical Help Desk at (800) 321-6273.

      Miscellaneous

      QC-1. Where may a firm locate interpretative issues relating to financial and operational matters?
      A. NASD provides guidance on NASD and SEC rule interpretations on its Web site through the Publications and Guidance > Rules and Interpretations path, which may be directly accessed at www.nasd.com/RulesRegulation/PublicationsGuidance/index.htm. Additionally, NASD routinely sponsors educational programs, webcasts and compliance conferences that are announced on the NASD Web site. As previously noted, NASD also issues weekly update emails to all NASD executive representatives. NASD encourages member firms to use these resources.
      QC-2. Where can a firm locate contact information for NASD and SEC offices?
      A. The addresses, telephone numbers and facsimile numbers for NASD and SEC offices are at www.nasd.com/ContactUs/index.htm and www.sec.gov/contact.shtml.
      QC-3. How can a member firm remit payment for its CRD/IARD account?
      A. Payments can be made through Electronic Payment via Web CRD/IARD E-Pay, Wire Transfer or check. Checks must be made payable to "NASD." Please include the firm's CRD number on the check.21

      1 See NASD Interpretation of Financial Operational Rules, Net Capital Rule, SEC Rule 15c3-1, Minimum Net Capital Requirement, "Moment-to-Moment Net Capital Requirement," available at: www.nasd.com/finops/moment

      2 NASD Rule 2520(f)(8)(B)(ii) defines the term "pattern day trader" as "any customer who executes four or more day trades within five business days. However, if the number of day trades is 6% or less of total trades for the five business day period, the customer will not be considered a pattern day trader...."

      3 See NASD Rule 2520(f)(8)(C).

      4 SEC Rule 15c3-1(c)(2)(xii) reads as follows: "Deducting the amount of cash required in each customer's or non-customer's account to meet the maintenance margin requirements of the Examining Authority for the broker or dealer, after application of calls for margin, marks to the market or other required deposits which are outstanding five business days or less."

      5 See NASD Regulatory & Compliance Alert, April 1995.

      6 See SEC Letter to Chicago Board Options Exchange (CBOE), August 21, 1981.

      7 See SEC Rule 15c3-1(c)(2)(iv)(F)(2)(i). With respect to reverse repurchase agreements with Government Securities Clearing Corporation (GSCC); see also SEC Letter to GSCC, April 1998.

      8 See SEC Rule 15c3-1(c)(2)(iv)(F)(2)(ii).

      9 See also Fox & Co., Inc., Exchange Act Release No. 52697, 2005 SEC LEXIS 2822 (October 28, 2005) at www.sec.gov/litigation/opinions/34-52697.pdf.

      10 See SEC Rule 15c3-1(c)(2)(vi)(M)(1).

      11 See SEC Rule 15c3-1(a)(2)(iii)(B).

      12 See NASD NTM 93-30 (NASD Provides SEC-Approved Clarifications and Interpretations to Recent Net Capital Rule Amendments).

      13 See NASD NTM 93-46 (SEC Provides Additional Clarifications and Interpretations to Recent Net Capital Rule Amendments).

      14 Styled 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.

      15 See www.sec.gov/contact/addresses.htm.

      16 See SEC Order at www.sec.gov/rules/other/2006/34-54920.pdf.

      17 See www.sec.gov/about/forms/formx-17a-5_3.pdf.

      18 See NASD NTM 01-54 (Minor Violations of Rules and Late Fees).

      19 See NASD By-Laws, Schedule A, Section 4(g).

      20 See NASD Rule 9216 and NASD NTM 01-54 (Minor Violations of Rules and Late Fees).

      21 See www.nasd.com/crd/payments.

    • 07-15 SEC Approves Amendments to TRACE Rules to Reflect the Availability of TRACE "Snapshot" Data for a Reduced Monthly Fee; Effective Date: May 1, 2007

      View PDF File

      GUIDANCE

      Trade Reporting and Compliance Engine (TRACE)

      SUGGESTED ROUTING

      KEY TOPICS

      Legal and Compliance
      Operations
      Registered Representatives
      Senior Management
      Trading and Markets
      Debt Securities
      Operations
      Rule 7000 Series
      TRACE Rules

      Executive Summary

      On March 6, 2007, the Securities and Exchange Commission approved an amendment to Rule 7030 relating to the availability of TRACE Snapshot data, which is real-time TRACE transaction data that is available once per day, for a reduced monthly fee. The rules, as amended, are set forth in Attachment A.

      The amendments become effective May 1, 2007.

      Questions/Further Information

      Questions concerning this Notice should be directed to Ola Persson, Director, TRACE Data, Transparency Services, at (212) 858-4796; Elliot Levine, Chief Counsel, Transparency Services, Markets, Services and Information, at (202) 728-8405; and James L. Eastman, Assistant General Counsel, Office of General Counsel, at (202) 728-6961.

      Background and Discussion

      On March 6, 2007, the SEC approved amendments to Rule 7030 (until recently Rule 7010(k)), which sets forth certain fees related to NASD's Trade Reporting and Compliance Engine (TRACE).1 Specifically, the rule changes lower the fee related to the receipt of real-time TRACE transaction data by persons opting to receive the data once a day (Snapshot TRACE data), which will be limited to one TRACE price per security per day rather than made available on a continuous basis. A person choosing to receive Snapshot TRACE data (a Snapshot TRACE data subscriber) will pay $250 per month for the receipt of Snapshot TRACE data rather than paying $1,500 per month to receive TRACE data continuously throughout the day.

      A Snapshot TRACE data subscriber will be able to choose the specific time of day it will receive Snapshot TRACE data each day; however, it is expected that certain market participants will choose to receive Snapshot TRACE data at or shortly after 4:00 p.m. each day and use it to value certain positions held in their investment portfolios. The reduced fee for Snapshot TRACE data is intended to be better aligned with the more tailored information requirements of a subset of market participants that today are foregoing TRACE data at the higher costs per month for continuous TRACE data. For example, to date, no institutional buy-side participants have subscribed for the receipt of TRACE data continuously throughout the day for portfolio valuation purposes. As is the case today with the distribution of TRACE desktop data, NASD will work with third-party re-transmission vendors to distribute Snapshot TRACE data to market participants.

      Frequently asked questions regarding the new Snapshot TRACE data program are available on NASD's Web site at www.nasd.com/trace.


      1 See Securities Exchange Act Release No. 55409 (March 6, 2007), 72 FR 11416 (March 13, 2007) (SR-NASD-2007-004). Amendment No. 1 to SR-NASD-2007-004 was filed on March 2, 2007, to reflect renumbering of the Rule 7000 Series, which became immediately effective on March 1, 2007. See SR-NASD-2007-018 (available at www.nasd.com/RulesRegulation/RuleFilings/2007RuleFilings/NASDW_018722. Attachment A to this Notice reflects changes made to the text of the Rule 7000 Series by SR-NASD-2007-004 and is marked to show changes against the newly renumbered rules of the Rule 7000 Series. For example, former Rule 7010(k) has been renumbered as Rule 7030 and the changes initially made to the text of Rule 7010(k) have been reflected in the newly renumbered Rule 7030.


      ATTACHMENT A

      New language is underlined; deletions are in brackets

      * * * * *

      7010. OTC Reporting Facility No change.

      7020. OTC Bulletin Board Service No change.

      7030. Trade Reporting and Compliance Engine (TRACE)

      The following charges shall be paid by participants for the use of the Trade Reporting and Compliance Engine ("TRACE"):

      System Fees Transaction Reporting Fees Market Data Fees
      Level I Trade Report Only Web Browser Access—$20/month per user ID
      Level II Full Service Web Browser Access—$80/month per user ID, except that the charge for the first such user ID shall be $50/month
      Trades up to and including $200,000 par value—$0.475/trade;
      Trades between $201,000 and $999,999 par value—$0.002375 times the number of bonds traded/trade;
      Trades of $1,000,000 par value or more—$2.375/trade
      BTDS Professional Real-Time Data Display—$60/month per terminal, or a flat fee of $7,500/month entitling Professionals to make unlimited internal use of Real-Time TRACE transaction data on any number of interrogation or display devices
      CTCI/Third Party—$25/month/ per firm Cancel/Correct—$1.50/trade Vendor Real-Time Data Feed—$1,500/ month for receipt of continuous Real-Time TRACE transaction data except for qualifying Tax-Exempt Organizations, or $250/month for daily receipt of Snapshot Real-Time TRACE transaction data
        "As of" Trade Late—$3/trade Vendor Real-Time Data Feed—$400/month for Real-Time TRACE transaction data for qualifying Tax-Exempt Organizations
          BTDS TRACE Non-Professional Real-Time Data Display—No charge
      (a) through (b) No change.
      (c) Market Data Fees

      Professionals and Non-Professionals may subscribe to receive Real-Time TRACE transaction data disseminated by NASD in one or more of the following ways for the charges specified, as applicable. Members, vendors and other redistributors shall be required to execute appropriate agreements with NASD.

      (1) Professional Fees

      Professionals may subscribe for the following:

      (A) Bond Trade Dissemination Service ("BTDS") Professional Real-Time Data Display Fee of $60 per month, per terminal charge for each interrogation or display device receiving Real-Time TRACE transaction data, or a flat fee of $7,500 per month entitling Professionals to make unlimited internal use of Real-Time TRACE transaction data on any number of interrogation or display devices.
      (B) Vendor Real-Time Data Feed Fee of $1,500 per month for receipt of continuous Real-Time TRACE transaction data for any person or organization (other than a Tax-Exempt Organization) that receives a Real-Time TRACE transaction data feed, or $250 per month for daily receipt of Snapshot Real-Time TRACE transaction data which shall consist of one TRACE price per security per day. These fees entitles use in one or more of the following ways: internal operational and processing systems, internal monitoring and surveillance systems, internal price validation, internal portfolio valuation services, internal analytical programs leading to purchase/sale or other trading decisions, and other related activities, and the repackaging of market data for delivery and dissemination outside the organization, such as indices or other derivative products. (Th[is]ese fees do[es] not include per terminal charges for each interrogation or display device receiving Real-Time TRACE transaction data.)
      (C)–(D) No change.
      (2) through (4) No change.

    • 07-14 Portfolio Margin Risk Disclosure Statement and Written Acknowledgement to be Furnished to Customers Using a Portfolio Margin Account

      View PDF File

      GUIDANCE

      Portfolio Margin Risk Disclosure Statement

      SUGGESTED ROUTING

      KEY TOPICS

      Legal and Compliance
      Margin
      Operations
      Senior Management
      Margin Requirements
      Options
      Portfolio Margin
      Portfolio Margin Risk Disclosure Statement
      Rule 2520
      Rule 2860

      Executive Summary

      As announced in Notice to Members (NTM) 07-11 (February 2007), recent amendments to NASD Rule 2520 (Margin Requirements) permit members to margin certain products according to a prescribed portfolio margin methodology on a pilot basis. Related amendments to Rule 2860 (Options) require that a disclosure statement and written acknowledgement for use with the proposed portfolio margin program be furnished to customers using a portfolio margin account.1 This Notice sets forth the language required for the written disclosure statement and acknowledgment pursuant to Rule 2860(c).

      Member firms participating in, or planning to participate in, the Portfolio Margin Risk pilot program should refer to Attachment A of this Notice for sample disclosure and acknowledgement statements.

      Questions/Further Information

      Questions regarding this Notice may be directed to Susan M. DeMando, Associate Vice President, Financial Operations, Member Regulation, at (202) 728-8411; or Kathryn M. Moore, Assistant General Counsel, Office of General Counsel, at (202) 974-2974.

      Background and Discussion

      On February 12, 2007, NASD filed with the Securities and Exchange Commission (SEC) for immediate effectiveness a rule change to amend Rule 2520 (Margin Requirements) to permit members, on a pilot basis, to margin certain products according to a prescribed portfolio margin methodology. NASD also amended Rule 2860 (Options) to require that a disclosure statement and written acknowledgement for use with the proposed portfolio margin program be furnished to customers using a portfolio margin account.

      The portfolio margin program will operate on a pilot basis starting on April 2, 2007 and ending on July 31, 2007, unless the SEC approves an extension of the pilot or adoption of the program on a permanent basis.2 Details of these rule amendments and the related pilot program can be found in NTM 07-11.

      As noted in 07-11, Rule 2860(c) requires member firms to provide every portfolio margin customer with a written risk disclosure statement at, or prior to, the initial transaction in a portfolio margin account. The disclosure must be in a format prescribed by NASD or in a format developed by the member, provided it contains substantially similar information as in the prescribed NASD format and has received the prior written approval of NASD. Attachment A of this Notice sets forth the language required in the written disclosure statement and acknowledgement.3

      Members seeking approval to participate in the portfolio margining pilot should refer to 07-11 for details on the program and the application submission and approval process. As a reminder, applications should be submitted to Susan M. DeMando, Associate Vice President, Financial Operations, 1735 K Street, NW, Washington, DC 20006.


      1 See SR-NASD-2007-013 filed on February 12, 2007. Under Section 19(b) of the Securities Exchange Act of 1934, the SEC has the authority to summarily abrogate this type of rule change within 60 days of filing.

      2 The pilot period conforms to the time periods of substantially similar portfolio margin pilot programs of the New York Stock Exchange (NYSE) and the Chicago Board Options Exchange (CBOE), which were approved by the SEC. See Notice to Members 07-11.

      3 The NYSE and CBOE also have adopted the disclosure document and acknowledgement set forth in Attachment A in connection with their respective portfolio margin programs.


      ATTACHMENT A

      Sample Portfolio Margining Risk Disclosure Statement to Satisfy Requirements of NASD Rule 2520(g)

      OVERVIEW OF PORTFOLIO MARGINING

      1. Portfolio margining is a margin methodology that sets margin requirements for an account based on the greatest projected net loss of all positions in a "security class" or "product group" as determined by an options theoretical pricing model using multiple pricing scenarios. These pricing scenarios are designed to measure the theoretical loss of the positions given changes in both the underlying price and implied volatility inputs to the model.
      2. The goal of portfolio margining is to set levels of margin that more precisely reflect actual net risk. The customer benefits from portfolio margining in that margin requirements calculated on net risk are generally lower than alternative "position" or "strategy" based methodologies for determining margin requirements. Lower margin requirements allow the customer more leverage in an account.

      CUSTOMERS ELIGIBLE FOR PORTFOLIO MARGINING

      3. To be eligible for portfolio margining, customers (other than broker-dealers or members of a national futures exchange) must be approved for writing uncovered options. If a customer (other than a broker-dealer or member of a national futures exchange) wishes to trade in unlisted derivatives, the customer must have and maintain at all times account equity of not less than five million dollars, aggregated across all accounts under identical ownership at the clearing broker. This identical ownership requirement excludes accounts held by the same customer in different capacities (e.g., as a trustee and as an individual) and accounts where ownership is overlapping but not identical (e.g., individual accounts and joint accounts). In addition to the requirements of the self-regulatory organization rule, carrying broker-dealers may have their own minimum equity requirement and possibly other eligibility requirements.

      POSITIONS ELIGIBLE FOR A PORTFOLIO MARGIN ACCOUNT

      4. All margin equity securities (as defined in Section 220.2 of Regulation T of the Board of Governors of the Federal Reserve System), warrants on equity securities or on indices of equity securities, equity-based or equity-index based listed options, and security futures products (as defined in Section 3(a)(56) of the Securities Exchange Act of 1934) are eligible for a portfolio margin account. In addition, a customer that has an account with equity of at least five million dollars may establish and maintain positions in unlisted derivatives (e.g., OTC swaps, options) on an equity security or index of equity securities that can be priced by a theoretical pricing model approved by the Securities and Exchange Commission ("SEC").

      SPECIAL RULES FOR PORTFOLIO MARGIN ACCOUNTS

      5. A portfolio margin account may be either a separate account or a sub-account of a customer's standard margin account. In the case of a sub-account, equity in the standard account will be available to satisfy any margin requirement in the portfolio margin sub-account without transfer to the sub-account.
      6. A portfolio margin account or sub-account will be subject to a minimum margin requirement of $.375 for each listed option, unlisted derivative and security futures product, multiplied by the contract's or instrument's multiplier, carried long or short in the account. Other eligible products are not subject to a minimum margin requirement.
      7. A margin deficiency in the portfolio margin account or sub-account, regardless of whether due to new commitments or the effect of adverse market movements on existing positions, must be met within three business days. Failure to meet a portfolio margin deficiency prior to the end of the third business day will result in a prohibition on entering any new orders, with the exception of new orders that reduce the margin requirement. Failure to meet a portfolio margin deficiency by the end of the third business day will result in immediate liquidation of positions on the fourth business day, to the extent necessary to eliminate the margin deficiency.
      8. Any shortfall in aggregate equity across accounts, when required, must be met within three business days. Failure to meet a minimum equity deficiency prior to the end of the third business day will result in a prohibition on entering any new orders, with the exception of new orders that reduce the margin requirement, beginning on the fourth business day and continuing until such time as the minimum equity requirement is satisfied or all unlisted derivatives are liquidated or transferred out of the portfolio margin account to the appropriate securities account.
      9. When a broker-dealer carries a standard cash account or margin account for a customer, the broker-dealer is limited by rules of the SEC and of the Options Clearing Corporation ("OCC") to the extent to which the broker-dealer may permit the OCC to have a lien against long option positions in those accounts. In contrast, the OCC will have a lien against all long option positions that are carried by a broker-dealer in a portfolio margin account, and this could, under certain circumstances, result in greater losses to a customer having long option positions in such an account in the event of the insolvency of the customer's broker. Furthermore, the carrying broker-dealer has a lien on all long positions in a portfolio margin account, including margin equity securities, even if fully paid. Accordingly, to the extent that a customer does not borrow against long options and margin equity positions in a portfolio margin account or have margin requirements in the account against which the long options or margin equity securities can be credited, there is no advantage to carrying the long options and margin equity securities in a portfolio margin account and the customer should consider carrying them in an account other than a portfolio margin account.
      10. Customers participating in portfolio margining will be required to sign an agreement acknowledging that their security positions and property in the portfolio margin account will be subject to the customer protection provisions of Rule 15c3-3 under the Securities Exchange Act of 1934 and the Securities Investor Protection Act.

      SPECIAL RISKS OF PORTFOLIO MARGIN ACCOUNTS

      11. Portfolio margining generally permits greater leverage in an account, and greater leverage creates greater losses in the event of adverse market movements.
      12. Because the maximum time limit for meeting a margin deficiency is shorter than in a standard margin account, there is increased risk that a customer's portfolio margin account will be liquidated involuntarily, possibly causing losses to the customer.
      13. Because portfolio margin requirements are determined using sophisticated mathematical calculations and theoretical values that must be calculated from market data, it may be more difficult for customers to predict the size of future margin deficiencies in a portfolio margin account. This is particularly true in the case of customers who do not have access to specialized software necessary to make such calculations or who do not receive theoretical values calculated and distributed periodically by an approved vendor of theoretical values.
      14. For the reasons noted above, a customer that carries long eligible positions in a portfolio margin account could, under certain circumstances, be less likely to recover the full value of those positions in the event of the insolvency of the carrying broker.
      15. Trading of margin equity securities, warrants on equity securities or on indices of equity securities, listed options, unlisted derivatives, and security futures products in a portfolio margin account is generally subject to all the risks of trading those same products in a standard securities margin account. Customers should be thoroughly familiar with the risk disclosure materials applicable to those products, including the booklets entitled "Characteristics and Risks of Standardized Options" and "Security Futures Risk Disclosure Statement". Because this disclosure statement does not disclose the risks and other significant aspects of trading in security futures and options, customers should review those materials carefully before trading in a portfolio margin account.
      16. Customers should consult with their tax advisers to be certain that they are familiar with the tax treatment of transactions in margin equity securities, warrants on equity securities or on indices of equity securities, listed options, unlisted derivatives, and security futures products, including tax consequences of trading strategies involving both security futures and option contracts.
      17. The descriptions in this disclosure statement relating to eligibility requirements for portfolio margin accounts, and minimum equity and margin requirements for those accounts, are minimums imposed under the self-regulatory organization rules. Time frames within which margin and equity deficiencies must be met are maximums imposed under the self-regulatory organization rules. Broker-dealers may impose their own more stringent requirements.
      18. Customers should bear in mind that the discrepancies in the cash flow characteristics of security futures and certain options are still present even when those products are carried together in a portfolio margin account. In addition, discrepancies in the cash flow characteristics of certain unlisted derivatives may also be present when those products are carried in a portfolio margin account. Both security futures and options contracts are generally marked to the market at least once each business day. Similarly, certain unlisted derivatives may also be marked to the market on a daily basis. However, there may be incongruity between each eligible product in that marks may take place with different frequency and at different times within the day. For example, when a security futures contract is marked to the market, the gain or loss is immediately credited to or debited from, respectively, the customer's account in cash. While a change in the value of a long option contract may increase or decrease the equity in the account, the gain or loss is not realized until the option is liquidated, exercised, or assigned. Accordingly, a customer may be required to deposit cash in the account in order to meet a variation payment on a security futures contract even though the customer is in a hedged position and has experienced a corresponding (but yet unrealized) gain on an option. Alternatively, a customer who is in a hedged position and would otherwise be entitled to receive a variation payment on a security futures contract may find that the cash is required to be held in the account as margin collateral on an offsetting option position.

      * * * * *

      Sample Portfolio Margining Acknowledgement

      ACKNOWLEDGEMENT FOR CUSTOMERS

      UTILIZING A PORTFOLIO MARGIN ACCOUNT

      As discussed in the Portfolio Margining Risk Disclosure Statement, portfolio margining must be conducted in a margin account dedicated exclusively to portfolio margining. Portfolio margin accounts are treated as securities accounts carried with broker-dealers. As such, positions in portfolio margin accounts are covered by Rule 15c3-3 under the Securities Exchange Act of 1934, which protects customer accounts.

      Rule 15c3-3 under the Securities Exchange Act of 1934 requires that a broker or dealer promptly obtain and maintain physical possession or control of all fully-paid securities and excess margin securities and maintain a special reserve account for the benefit of their customers. Fully-paid securities are securities carried in a cash account and margin equity securities carried in a margin or special account (other than a cash account) that have been fully paid for. Excess margin securities are a customer's margin securities having a market value in excess of 140% of the total of the debit balances in the customer's non-cash accounts. For the purposes of Rule 15c3-3, securities held subject to a lien to secure obligations of the broker-dealer are not within the broker-dealer's physical possession or control. The Securities and Exchange Commission ("SEC") staff has taken the position that all long option positions in a customer's portfolio margining account may be subject to such a lien by the Options Clearing Corporation ("OCC") and will not be deemed fully-paid or excess margin securities under Rule 15c3-3.

      The hypothecation rules under the Securities Exchange Act of 1934 (Rules 8c-1 and 15c2-1) prohibit broker-dealers from permitting the hypothecation of customer securities in a manner that allows those securities to be subject to any lien or liens in an amount that exceeds the customer's aggregate indebtedness. However, all long option positions in a portfolio margining account will be subject to the OCC's lien, including any positions that exceed the customer's aggregate indebtedness. Furthermore, all long positions, including margin equity securities, in a portfolio margin account are held subject to a lien by the carrying broker-dealer, even if fully paid. The SEC staff has taken a position that would allow customers to carry positions in portfolio margining accounts even when those positions exceed the customer's aggregate indebtedness. Accordingly, within a portfolio margin account, to the extent that you have long option and/or margin equity securities positions that do not operate to offset your aggregate indebtedness and thereby reduce your margin requirement, you receive no benefit from carrying those positions in your portfolio margin account and incur the additional risk of the OCC's lien on your long option position(s) and the carrying broker-dealer's lien on all of your long positions.

      Additionally, the Securities Investor Protection Corporation insures customer accounts against the financial insolvency of a broker-dealer in the amount of up to $500,000 to protect against the loss of registered securities and cash maintained in the account for purchasing securities or as proceeds from selling securities (although the limit on cash claims is $100,000).

      BY SIGNING BELOW YOU AFFIRM THAT YOU HAVE READ AND UNDERSTOOD THE PORTFOLIO MARGINING RISK DISCLOSURE STATEMENT AND ACKNOWLEDGE AND AGREE THAT:

      LONG POSITIONS IN A PORTFOLIO MARGINING ACCOUNT WILL BE EXEMPTED FROM CERTAIN CUSTOMER PROTECTION RULES OF THE SECURITIES AND EXCHANGE COMMISSION AS DESCRIBED ABOVE AND WILL BE SUBJECT TO A LIEN BY THE CARRYING BROKER-DEALER, AS WELL AS BY THE OPTIONS CLEARING CORPORATION WITH RESPECT TO LONG OPTION POSITIONS, WITHOUT REGARD TO SUCH RULES.

      CUSTOMER NAME: ________________
      BY:_____________ DATE: _______________
      (Signature/title)  

    • 07-13 SEC Approves Amendments to NASD Code of Arbitration Procedure Concerning Subpoenas and Payment of Arbitrators; Effective Date: April 2, 2007

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      GUIDANCE

      Code of Arbitration Procedure

      SUGGESTED ROUTING

      KEY TOPICS

      Legal and Compliance
      Registered Representatives
      Senior Management
      Training
      Arbitration
      Code of Arbitration Procedure
      Dispute Resolution
      Subpoenas

      Executive Summary

      The Securities and Exchange Commission (SEC) has approved amendments to the subpoena rule as set forth in Rule 10322 of the NASD Code of Arbitration Procedure (Code)1 to allow only arbitrators to issue subpoenas, whether for discovery in arbitration or for appearance at a hearing before the arbitrators.2 The SEC also approved an amendment to the payment of arbitrators rule as set forth in IM-10104 to provide for the payment of a $200 honorarium per case for each arbitrator who considers contested motions for the issuance of subpoenas.3

      The text of Rule 10322 and IM-10104, as approved, are set forth in Attachment A of this Notice. The changes to Rule 10322 will become effective on April 2, 2007, and will apply to subpoenas issued on or after that date, regardless of when the case was filed. The changes to IM-10104 will apply to decisions rendered on a contested subpoena request on or after April 2, 2007.

      Questions/Further Information

      Questions regarding this Notice may be directed to Jean I. Feeney, Vice President and Chief Counsel, Dispute Resolution, at (202) 728-6959; or Mignon McLemore, Assistant Chief Counsel, Dispute Resolution, at (202) 728-8151.

      Background and Discussion

      Under current Rule 10322(a) of the Code of Arbitration Procedure (Code), both arbitrators and counsel of record to the arbitration have the power to issue a subpoena, as provided by law. In the course of preparing their cases, attorneys sometimes issue subpoenas to non-parties requesting the production of documents in advance of an arbitration hearing. Disputes regarding the propriety or scope of these subpoenas to non-parties occasionally arise, raising the question of whether the subpoenaed materials should be produced. Currently, the Code does not contain any rules that specifically address the issuance of subpoenas to non-parties or the resolution of disputes involving such subpoenas. Thus, parties may bring their disputes to the arbitrators or, if arbitrators have not yet been appointed, then they may resort to litigation in court. This process may be expensive and confusing to parties.

      Under amended Rule 10322, only arbitrators will be permitted to issue subpoenas for both parties and non-parties, whether for discovery or for appearance at a hearing. Parties will send their requests for issuance of a subpoena to the NASD Director of Arbitration and to all other parties at the same time and in the same manner. The request must be in the form of a written motion and must include a draft subpoena.4 The requesting party may not serve the motion or draft subpoena on a non-party.

      If another party objects to the scope or propriety of the subpoena, that party must— within 10 calendar days of service of the motion—file written objections with the Director, with an additional copy for the arbitrator, and must serve copies on all other parties at the same time and in the same manner as on the Director. The party that requested the subpoena may respond to the objections within 10 calendar days of receipt of the objections. After considering timely objections, the arbitrator responsible for deciding discovery-related motions will rule promptly on the issuance and scope of the subpoena.5 Arbitrators will use their discretion to determine whether or not to issue a subpoena, and whether or not to limit the scope of a subpoena before it is issued.

      After the requesting party receives subpoenaed documents from a non-party, the requesting party must notify all other parties within five calendar days of receipt. If another party requests copies of documents that were received in response to a non-party subpoena, the party that requested the documents must provide the copies within ten calendar days. The arbitration panel has authority to determine the amount of costs incurred as a result of subpoenaed documents and by whom such costs should be borne.

      NASD believes that providing arbitrators with greater control over the issuance of subpoenas will help to protect investors, associated persons and other parties from abuse in the discovery process. In addition, the establishment of a uniform, nationwide rule will reduce potential confusion for parties and their counsel regarding whether they have the ability to issue subpoenas, minimize gamesmanship in the subpoena process and make the rule easier to administer.

      Payment of Arbitrators for Deciding Contested Subpoena Requests

      In 2005, NASD amended IM-10104 to provide arbitrators with an honorarium of $200 to decide discovery-related motions without a hearing session. The revised rule did not discuss whether a contested motion concerning a subpoena constitutes a discovery-related motion. NASD recognizes that arbitrators may spend a significant amount of time and effort deciding contested subpoena motions and believes that arbitrators should be compensated for this work. Therefore, NASD has amended the payment of arbitrators rule to provide a $200 honorarium for each arbitrator who decides contested motions for subpoenas.

      Under most circumstances, the chairperson will be the only arbitrator to consider the subpoena requests based on the documents supplied by the parties. If a party requests that the entire panel decide the contested motion, each arbitrator who participates in the decision on the subpoena will receive an honorarium of $200. The honorarium will be paid on a per case basis, regardless of the number of contested subpoena motions considered by an arbitrator or panel during the case. Furthermore, the maximum amount that will be paid by the parties for any one case will be $600, irrespective of any changes to the composition of the panel.6 NASD believes that structuring the honorarium in this manner will limit the arbitration costs for parties while at the same time compensating arbitrators for the time that they spend considering contested subpoena requests.


      1 Rule 10322 will be renumbered as Rule 12512 in the NASD Code of Arbitration Procedure for Customer Disputes (Customer Code) and Rule 13512 in the NASD Code of Arbitration Procedure for Industry Disputes (Industry Code) when those Codes become effective on Apr. 16, 2007. Similarly, IM-10104 will be renumbered as Rules 12214 and 13214. See Notice to Members 07-07 (Feb. 2007).

      2 Exchange Act Release No. 55038 (Jan. 3, 2007), 72 FR 1353 (Jan. 11, 2007) (File No. SR-NASD-2005-079).

      3 Exchange Act Release No. 55108 (Jan. 16, 2007), 72 FR 2914 (Jan. 23, 2007) (File No. SR-NASD- 2006-101).

      4 Motions are not required to be in any particular format. They may take the form of a letter, legal motion or any other format that the panel decides is acceptable. NASD anticipates that the motion accompanying a subpoena will provide the panel with relevant information that would not be obvious from the draft subpoena itself, such as the rationale for the request.

      5 Normally, the chair will issue subpoenas. In customer cases, the parties are given an opportunity to agree on their chairperson, who is almost always a public arbitrator, and if they cannot agree, then the highest-ranked public arbitrator is appointed as the chairperson. See NASD Rule 10308(c)(5). In intra-industry cases, the chair may be a public or non-public arbitrator, as appropriate to the type of case. Under the amendments to the Code that will be effective on April 16, 2007, parties will select their chair from a list of chair-qualified arbitrators; see the Rule 12400 and 13400 Series.

      6 If more than three arbitrators decide contested subpoena motions in a particular case because of changes in the panel, NASD will absorb the cost of any honorarium that exceeds $600.


      ATTACHMENT A

      New language is underlined. Deleted language is in brackets.

      * * * * *

      NASD Code of Arbitration Procedure1

      IM-10104. Arbitrators' Honorarium

      (a)–(e) No change
      (f) Payment for Deciding Contested Subpoena Requests Without a Hearing Session
      (1) The honorarium for deciding one or more contested motions requesting the issuance of a subpoena without a hearing session shall be $200. The honorarium shall be paid on a per case basis to each arbitrator who decides the contested motion(s). The parties shall not be assessed more than $600 in fees under this paragraph in any arbitration proceeding. The honorarium shall not be paid for cases administered under Rules 10203 or 10302.
      (2) For purposes of paragraph (f)(1), a contested motion requesting the issuance of a subpoena shall include a motion requesting the issuance of a subpoena, the draft subpoena, a written objection from the party opposing the issuance of the subpoena, and any other documents supporting a party's position.
      (3) The panel will allocate the cost of the honorarium under paragraph (f)(1) to the parties pursuant to Rules 10205(c) and 10332(c).

      * * *

      10322. Subpoenas and Power to Direct Appearances

      (a) [Subpoenas

      The arbitrators and any counsel of record to the proceeding shall have the power of the subpoena process as provided by law. All parties shall be given a copy of a subpoena upon its issuance. Parties shall produce witnesses and present proofs to the fullest extent possible without resort to the subpoena process.] To the fullest extent possible, parties should produce documents and make witnesses available to each other without the use of subpoenas. Arbitrators shall have the authority to issue subpoenas for the production of documents or the appearance of witnesses.
      (b) A party may make a written motion requesting that an arbitrator issue a subpoena to a party or a nonparty. The motion must include a draft subpoena and must be filed with the Director, with an additional copy for the arbitrator. The requesting party must serve the motion and draft subpoena on each other party, at the same time and in the same manner as on the Director. The requesting party may not serve the motion or draft subpoena on a non-party.
      (c) If a party receiving a motion and draft subpoena objects to the scope or propriety of the subpoena, that party shall, within 10 calendar days of service of the motion, file written objections with the Director, with an additional copy for the arbitrator, and shall serve copies on all other parties at the same time and in the same manner as on the Director. The party that requested the subpoena may respond to the objections within 10 calendar days of receipt of the objections. After considering all objections, the arbitrator responsible for deciding discoveryrelated motions shall rule promptly on the issuance and scope of the subpoena .
      (d) If the arbitrator issues a subpoena, the party that requested the subpoena must serve the subpoena at the same time and in the same manner on all parties and, if applicable, on any non-party receiving the subpoena.
      (e) Any party that receives documents in response to a subpoena served on a non-party shall provide notice to all other parties within five days of receipt of the documents. Thereafter, any party may request copies of such documents and, if such a request is made, the documents must be provided within 10 calendar days following receipt of the request.
      (f) [Power to Direct Appearances and Production of Documents An arbitrator] The arbitrator(s) shall be empowered without resort to the subpoena process to direct the appearance of any person employed by or associated with any member of the Association and/or the production of any records in the possession or control of such persons or members. Unless an arbitrator directs otherwise, the party requesting the appearance of a person or the production of documents under this Rule shall bear all reasonable costs of such appearance and/or production.

      1 The text of these rules as renumbered by the Customer and Industry Codes can be found on the NASD Web site. While the new Codes generally apply to claims filed on or after April 16, 2007, amended Rules 12214 and 13214 will apply to decisions rendered on a contested subpoena request on or after April 2, 2007; and the changes to Rules 12512 and 13512 are effective on April 2, 2007, for subpoenas issued on or after that date.

    • 07-12 NASD Requests Comment on Proposed Amendments to Rules 3010(g) and 2711 in Connection with the Rule Harmonization Project with the NYSE; Comment Period Expires April 9, 2007

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      REQUEST FOR COMMENT

      Rule Harmonization

      SUGGESTED ROUTING

      KEY TOPICS

      Corporate Financing Legal & Compliance
      Registration
      Senior Management
      Branch Office
      Initial Public Offering
      Office of Supervisory Jurisdiction
      Registration
      Rule 2711 (Research Analysts and
      Research Reports)
      Rule 3010 (Supervision)
      Rule Harmonization
      Supervision

      Executive Summary

      NASD is issuing this Notice to Members to solicit comments from members and other interested parties on a proposal to amend Rule 3010(g) (Supervision—Definition of "Office of Supervisory Jurisdiction") and Rule 2711 (Research Analysts and Research Reports—Definition of "Initial Public Offering").

      Early last year, the New York Stock Exchange (NYSE) and NASD announced a plan to work jointly to harmonize their rulebooks in an effort to eliminate duplicative rules and streamline regulation. Further, on November 28, 2006, NASD and the NYSE announced a plan to consolidate their member regulation operations into a new organization that will be the single self-regulatory organization (SRO) for all securities firms doing business with the public in the U.S. The consolidation plan sets forth a more sensible and less complex regulatory system that will make securities regulation more efficient and effective.

      The new SRO will work diligently toward the creation of single rulebook; however, the rule harmonization plan discussed in this NTM is a separate endeavor from the rulebook consolidation project. NASD believes that continuation of the rule harmonization project at this time remains a critical step toward ending duplication and reducing regulatory inefficiency.

      Accordingly, NASD is issuing this Notice to Members to solicit comments from members and interested persons on the first round of proposed rules changes as part of the harmonization effort. NASD is proposing to amend Rule 3010(g)(2) to eliminate the definition of "Office of Supervisory Jurisdiction" and adopt definitions for a "supervisory branch office," a "limited supervisory branch office," a "non-supervisory branch office" and "non-branch office." NASD is also seeking comment on a proposal to amend Rule 2711 to define the term "initial public offering" consistent with the definition of such term in NYSE Rule 472.

      Action Requested

      NASD requests comment on the proposed amendments. Comments must be received by March 26, 2007. Members and interested persons can submit their comments using the following methods:

      •  Emailing comments to pubcom@nasd.com
      •  Mailing comments in hard copy to:
      Barbara Z. Sweeney
      NASD
      Office of the Corporate Secretary
      1735 K Street, NW
      Washington, D.C. 20006-1506

      Important Notes:

      The only comments that will be considered are those submitted pursuant to the methods set forth 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.1

      Before becoming effective, a proposed rule change must be authorized for filing with the Securities and Exchange Commission (SEC) by the NASD Board, and then must be approved by the SEC, following publication for public comment in the Federal Register.2

      Questions/Further Information

      As noted, hard copy comments should be submitted to Barbara Z. Sweeney. Questions concerning this Notice should be directed to Kosha K. Dalal, Associate General Counsel, Office of General Counsel, at (202) 728-6903.

      Background

      Rule Harmonization Project

      Early last year, NASD and the NYSE announced a plan to work jointly to harmonize their rulebooks in an effort to eliminate duplicative rules and streamline regulation. A series of industry committees was convened to assist in the detailed work required to bring the two rulebooks into line. The industry committees reviewed a wide range of rules, including all rules in the NASD and NYSE manuals covering sales practices, supervision, financial and operational obligations, registration, and qualification and continuing education requirements.

      Further, on November 28, 2006, NASD and the NYSE announced a plan to consolidate their member regulation operations into a new organization that will be the single SRO for all securities firms doing business with the public in the U.S. On January 19, 2007, NASD member firms approved By-Law changes necessary for the proposed consolidation. The consolidation plan sets forth a more sensible and less complex regulatory system that will make securities regulation more efficient and effective. The By-Laws amendments will be sent to the Securities and Exchange Commission (SEC) for approval. NASD currently expects to have all the necessary approvals and a final agreement with the NYSE completed in the second quarter of 2007.

      NASD believes that continuation of the rule harmonization project at this time remains a critical step toward ending duplication and reducing regulatory inefficiency. As part of an initial round of changes, NASD is soliciting comment on proposed amendments to Rules 3010(g)(1) and 2711.

      Discussion

      Rule 3010(g)(1)

      Rule 3010(g)(1) defines the term "Office of Supervisory Jurisdiction" to mean any office of a member at which any one or more of the following functions take place: (a) order execution and/or market making; (b) structuring of public offerings or private placements; (c) maintaining custody of customers' funds and/or securities; (d) final acceptance (approval) of new accounts on behalf of the member; (e) review and endorsement of customer orders, pursuant to paragraph (d) above; (f) final approval of advertising or sales literature for use by persons associated with the member, pursuant to Rule 2210(b)(1); or (g) responsibility for supervising the activities of persons associated with the member at one or more other branch offices of the member.

      One recommendation of the industry committee was that NASD consider eliminating its definition of OSJ to prevent locations where the only activity being conducted is principal review and approval of research reports from being classified as branch offices under Rule 3010(g).

      In July 2006, amendments to NASD's branch office definition under Rule 3010(g)(2) went into effect (Uniform Branch Office Definition). The Uniform Branch Office Definition was developed collectively by NASD, the NYSE and NASAA to establish a broad national standard. In conjunction with the new Uniform Branch Office Definition, a new Form BR was introduced to provide a more efficient, standardized method for members to register branch office locations.

      While the SROs have sought to adopt consistent interpretations of the new Uniform Branch Office Definition, NASD and the NYSE have different classifications of a location where final approval by a principal of research reports occurs. Under NASD's current rules, final review of advertising or sales literature (which includes research reports) makes a location an OSJ, and therefore a branch office. The NYSE, however, does not have an OSJ definition and stated in NYSE Information Memorandum 06-13 that it deems a location where a member stations a Series 16 qualified supervisory analyst solely to review research reports as a "non-sales location," which is an express exclusion from the Uniform Branch Office Definition.3 Because of NASD's OSJ definition, NASD could not permit such locations to qualify as "non-sales locations" under the Uniform Branch Office Definition.

      This inconsistency led the industry committee to recommend that NASD consider eliminating its OSJ definition to prevent such locations from being treated differently by the two SROs.

      As a result, NASD is proposing to eliminate the definition of OSJ from NASD's rulebook. In its place, NASD proposes to adopt express definitions for the terms "supervisory branch office," "limited supervisory branch office," "non-supervisory branch office," and "non-branch locations." NASD believes this proposal will simplify the current structure by clearly delineating, in one rule, four classifications for member offices and the supervisory and inspection obligations that attach to each. In addition, with the proposed elimination of the term "OSJ," locations that conduct only final review of research reports would no longer be classified as OSJs and thereby required to register as branch offices. Such locations would become "non-branch locations."

      The functions that currently make a location an OSJ would be captured in a proposed new definition of "supervisory branch office." A "supervisory branch office" would be any location that performs all the functions currently included in the OSJ definition, except for locations at which the only activity being conducted is the final review of research reports. A location that supervises one or more other supervisory branch offices, one or more limited supervisory branch offices, or one or more non-supervisory branch offices would be deemed a "supervisory branch office." A main office of a member may qualify as a supervisory branch office. Like the current system for OSJs, an appropriately registered principal would have to be on-site at a supervisory branch office as provided in Rule 3010(a)(4) and such location would be subject to an annual inspection cycle as provided in Rule 3010(c)(1)(A).

      A "limited supervisory branch office" would be any location of the member that supervises one or more non-branch locations and does not supervise any supervisory branch offices or any other limited supervisory branch offices. A main office of a member may qualify as a limited supervisory branch office. Like the current system, such location would be subject to branch office registration and would be subject to an annual inspection cycle as provided in Rule 3010(c)(1)(A). But, the office would not be required to have an appropriately registered principal on-site as provided in Rule 3010(a)(4).

      A "non-supervisory branch office" would be any location of the member that satisfies the definition of branch office, but does not qualify as a supervisory branch office or limited supervisory branch office. A main office of a member may qualify as a non-supervisory branch office. Like the current system for non-OSJ branch offices, a non-supervisory branch office would be subject to branch office registration, but would not be required to have an appropriately registered principal on-site, but must have one or more appropriately registered representatives or principals on-site with authority to carry out the supervisory responsibilities assigned to that office by the member ("person-in-charge") as provided in Rule 3010(a)(4), and such location would be subject to inspection at least every three years as provided in Rule 3010(c)(1)(B).

      A "non-branch location" would be any location of the member, including but not limited to a main office, that does not qualify as a supervisory branch office, a limited supervisory branch office, or a non-supervisory branch office. In addition, a "non-branch location" would include any of the following locations, provided such locations do not engage in any other activities that would require branch office registration: (A) a location that qualifies for an exclusion from the definition of "branch office" pursuant to Rule 3010(g)(2); (B) a location that engages solely in final approval of research reports by a person registered in a principal capacity (or equivalent NYSE registration category, e.g., Series 16) for use by persons associated with the member pursuant to Rule 2210(b)(1) provided no other sales functions are conducted and the location is not held out to the public as a branch office; (C) a location that engages solely in soliciting a member's "investment banking services" as defined in NASD Rule 2711 (and NYSE Rule 472.20) provided no other sales functions are conducted and the location is not held out to the public as a branch office; or (D) a location that engages solely in proprietary trading or securities lending provided no other sales functions are conducted and the location is not held out to the public as a branch office.4 A non-branch location would not be required to register as a branch office. Further, a non-branch location would be permitted to engage in a combination of the activities described above provided the location does not engage in any activities that would otherwise require branch office registration. Non-branch locations would not be required to have an appropriately registered principal on-site and would be subject to a regular inspection cycle established by the member as provided in Rule 3010(c)(1)(C).

      Rule 2711

      Rule 2711 (Research Analysts and Research Reports), among other things, imposes quiet periods after an initial public offering during which a member is prohibited from publishing or otherwise distributing research and also restricts research analysts from purchasing or owning certain securities issued before a company's initial public offering. NASD Rule 2711 does not, however, define the term "initial public offering."

      The industry committee recommended that NASD add an express definition of the term "initial public offering" for purposes of its research analyst rule to make it consistent with the NYSE research analyst rule. NYSE Rule 472 defines the term "initial public offering" for purposes of NYSE's research analyst rule as "the initial registered equity security offering by an issuer, regardless of whether such issuer is subject to the reporting requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, prior to the time of the filing of such issuer's registration statement."

      Specifically, Rule 2711(f)(1) provides that a member may not publish or otherwise distribute a research report and that a research analyst may not make a public appearance regarding a subject company for which the member has acted as manager or co-manager of, among other things, an initial public offering for 40 calendar days following the date of the offering. Rule 2711(f)(2) imposes a 25-day quiet period after an initial public offering on any other member that has agreed to participate or is participating as an underwriter or dealer in such offering.5 Further, Rule 2711(g)(1) restricts a research analyst from purchasing or receiving any securities before an issuer's initial public offering if the issuer is principally engaged in the same types of businesses as the companies that the research analyst follows.

      While Rule 2711 does not expressly define the term "initial public offering," NASD has interpreted the term as used in Rule 2711 to have the same meaning as in NYSE Rule 472. As a result, NASD is proposing to amend Rule 2711 to codify this interpretation.


      1 See Notice to Members 03-73 (November 2003) (NASD Announces Online Availability of Comments). Personal identifying information, such as names or email addresses, will not be edited from submissions. Submit only information that you wish to make publicly available.

      2 Section 19 of the Securities Exchange Act (Exchange Act) permits certain limited types of proposed rule changes to take effect upon filing with the SEC. The SEC has authority to summarily abrogate these types of rule changes within 60 days of filing. See Exchange Act Section 19 and the rules thereunder.

      3 See NYSE Information Memorandum 06-13 (March 22, 2006) Joint Interpretive Guidance from NYSE and NASD Relating to the Uniform Branch Office Definition, Question and Answer #5.

      4 Proposed subparagraphs (C) and (D) are currently excluded from the Uniform Branch Office Definition in Notice to Members 06-12 and NYSE Information Memorandum 06-13 as qualifying for the "non-sales location" exclusion. The proposal would amend the rule text to reflect these exclusions.

      5 A proposed rule change pending with the Commission would amend the rule to establish a unified 25-day quiet period for all underwriters and dealers, irrespective of whether a member acts as a lead or co-manager.

    • 07-11 Amendment to Margin Rules to Establish a Portfolio Margin Pilot Program; Effective Date: April 2, 2007

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      GUIDANCE

      Portfolio Margin Program

      SUGGESTED ROUTING

      KEY TOPICS

      Legal and Compliance
      Margin
      Operations
      Senior Management
      Margin Requirements
      Portfolio Margin
      Rule 2520
      Rule 2860

      Executive Summary

      On February 12, 2007, NASD filed with the Securities and Exchange Commission (SEC) for immediate effectiveness a rule change to amend Rule 2520 to permit members to margin certain products according to a prescribed portfolio margin methodology on a pilot basis. NASD also amended Rule 2860 to require that a disclosure statement and written acknowledgement for use with the proposed portfolio margin program be furnished to customers using a portfolio margin account.1

      Rules 2520 and 2860, as amended, are set forth in Attachment A of this Notice. The portfolio margin program will operate on a pilot basis starting on April 2, 2007, and ending July 31, 2007, unless the SEC approves an extension of the pilot or adoption of the program on a permanent basis.

      Questions/Further Information

      Questions regarding this Notice may be directed to Susan M. DeMando, Associate Vice President, Financial Operations, at (202) 728-8411, or Kathryn M. Moore, Assistant General Counsel, Office of General Counsel, at (202) 974-2974.

      Background and Discussion

      Section 7(a) of the Securities Exchange Act of 1934 (the Exchange Act) authorizes the Board of Governors of the Federal Reserve System to prescribe the rules and regulations regarding credit that may be extended by broker-dealers on securities to their customers as set forth in Regulation T. Currently, Rule 2520 (Margin Requirements) prescribes minimum maintenance margin requirements for customer accounts held by members based on position or strategy-based margin requirements. This methodology applies prescribed margin percentage requirements to each security position and/or strategy, either long or short, held in a customer's account. The Board of Governors of the Federal Reserve System, in its amendments to Regulation T in 1998, permitted self-regulatory organizations to implement portfolio margin rules, subject to SEC approval.2

      Accordingly, NASD has amended Rule 2520 to allow members on a pilot basis, subject to specified conditions, to elect to apply a portfolio margin methodology to all margin equity securities,3 listed options, security futures products,4 unlisted derivatives,5 warrants, index warrants and related instruments.6 In addition, a member, provided that it is a Futures Commission Merchant (FCM) and is either a clearing member of a futures clearing organization or has an affiliate that is a clearing member of a futures clearing organization, is permitted to combine an eligible participant's related instruments with listed index options, unlisted derivatives, options on exchange traded funds (ETF), index warrants and underlying instruments,7 and compute a margin requirement for such combined products on a portfolio margin basis.

      The rule change is substantially similar to recent margin rule amendments by the New York Stock Exchange (NYSE) and the Chicago Board Options Exchange (CBOE), which were approved by the SEC.8 Consistent with the NYSE and CBOE programs, the rule change is available as a pilot beginning on April 2, 2007, and ending on July 31, 2007, unless the SEC approves an extension of the pilot or adoption of the program on a permanent basis.

      Portfolio Margin

      Portfolio margining is a margin methodology that sets margin requirements for an account based on the greatest projected net loss of all positions in a product class or group9 using computer modeling to perform risk analysis using multiple pricing scenarios. These scenarios are designed to measure the theoretical loss of the positions given changes in both the underlying price and implied volatility inputs to the model. Accordingly, the margin required is based on the greatest loss that would be incurred in a portfolio if the value of its components move up or down by a predetermined amount.

      Margin Calculation

      Under the rule change, a gain or loss on each position in the portfolio is calculated on each of 10 equidistant points along a range representing a potential percentage increase and decrease in the value of the instrument or underlying instrument in the case of a derivative product. For portfolios of only highly capitalized broad-based indexes, the range is between a market increase of 6 percent and a decrease of 8 percent. For non-highly capitalized broad-based indexes, the range is +/- 10 percent. For portfolios of equity options, narrow-based index options and/or security futures, the risk-array for computing the portfolio margin requirement is up/down market moves of +/-15 percent.

      For options with the same underlying security (or index in the case of an index option), the underlying security itself and any related futures, options on futures or security futures products could be combined as a portfolio for purposes of computing a portfolio margin requirement. The SEC-approved theoretical options pricing model is used to derive position values at each valuation point for the purpose of determining the gain or loss.10 The gains and losses are netted to derive a potential portfolio gain or loss for the point. The margin requirement for the portfolio is the amount of the greatest loss among the calculation points. Certain portfolios are allowed offsets such that, at the same valuation point, a gain in one portfolio may reduce or offset the loss in another portfolio. The amount of offset allowed between portfolios is the same that is permitted under SEC Rule 15c3-1a for computing a broker-dealer's Net Capital. The margin requirement for each portfolio then is added together to calculate the total margin requirement for the portfolio margin account.

      In addition, the rule change prescribes a minimum margin requirement of $0.375 for each listed option, unlisted derivative, security futures product, and related instrument multiplied by the contract or instrument's multiplier.

      Generally, a customer benefits from portfolio margining in that margin requirements calculated on net position risk are generally lower than strategy-based margin methodologies currently in place. In permitting margin computation based on actual net risk, members no longer are required to compute a margin requirement for each individual position or strategy in a customer's account.

      Monitoring and Risk Management

      As a pre-condition to permitting portfolio margining, a member is required to establish a comprehensive written risk analysis methodology to assess the potential risk to the member's capital over a specified range of possible market movements. The written risk analysis methodology must include procedures and guidelines for (1) obtaining and reviewing account documentation and financial information to assess the amount of credit to be extended to eligible participants; (2) the determination, review and approval of credit limits to each eligible participant, and across all eligible participants, utilizing a portfolio margin account; (3) monitoring credit risk exposure to the member's capital, on both a intra-day and end of day basis, including the type, scope and frequency of reporting to senior management; (4) the use of stress testing of portfolio margin accounts in order to monitor market risk exposure from individual accounts and in the aggregate; (5) the regular review and testing of the procedures by an independent unit; (6) managing the impact of credit extended related to portfolio margin accounts on the member's overall risk exposure; (7) the appropriate response by management when credit extensions have been exceeded; and (8) determining when additional margin may need to be collected.

      A member is required to periodically review its credit extension activities for consistency with its guidelines and determine if the data necessary to apply portfolio margining is accessible on a timely basis, and information systems are available to adequately capture, monitor, analyze and report relevant data.

      Approval Required to Use Portfolio Margin Methodology

      A member that wishes to use a portfolio margin methodology must file an application with NASD, or the member's designated examining authority (DEA) if other than NASD, and receive approval from NASD or the member's DEA if other than NASD, prior to establishing a portfolio margin methodology for eligible participants. The application must be fully documented and should address, at minimum, the following:

      a. Opening of portfolio margin accounts;
      b. The profile of customers who will be eligible for portfolio margining, including the initial approval process to be applied by the firm;
      c. A description of minimum equity requirements for each customer;
      d. The determination, review and approval of credit limits for each customer and across all customers;
      e. A description of any internal model used to determine risk in individual customer accounts, including the documentation for such model;
      f. A description of correlation assumptions included in any internal models used for assessing the adequacy of margin in a customer's account;
      g. A description of the stress testing scenarios that are performed on the accounts, the frequency of such testing and the results of the most recent stress test;
      h. Monitoring of accounts to assess if the account contains a portfolio of hedged instruments;
      i. Identification of security concentrations within an account;
      j. Identification of concentrations in individual securities across customer accounts;
      k. Intra-day monitoring of exposure in customer accounts;
      l. Detection, prevention and circumvention of day trading requirements;
      m. Monitoring of limitation on credit extended on portfolio margin accounts to 10 times the member's Net Capital;
      n. A description of the process for obtaining the TIMS theoretical values and the process used to compute margin requirements in individual customer accounts;
      o. A description of house margin requirements if they differ from the TIMS requirement;
      p. A description of exception reports that will be used to monitor margin exposure;
      q. A description of the escalation procedures to alert senior management of unusual risks;
      r. The regular review and testing of the risk analysis procedures by an independent unit such as internal audit or other comparable group;
      s. If an organization would like to provide portfolio margin to customers in unlisted derivatives, the application should include a description of the products as well as a detailed description of the credit analysis and collateral management process that will be used to monitor any exposure that may result to the member. This information may be submitted to NASD at a later date if unlisted derivatives are not being offered to customers on the implementation date; and
      t. An organizational chart identifying those persons primary responsible for portfolio margin risk management and the person or persons to whom they report.

      Members seeking approval to participate in the portfolio margining pilot must submit the application providing the information set forth above to Susan M. DeMando, Associate Vice President, Financial Operations, 1735 K Street, NW, Washington, D.C. 20006. In order for members to be eligible for approval by the effective date of the pilot on April 2, 2007, the application must be submitted to NASD no later than March 2, 2007.

      Eligible Participants

      The rule change permits the following persons to engage in portfolio margining: (1) any broker or dealer registered pursuant to Section 15 of the Exchange Act; (2) any member of a national futures exchange to the extent that listed index options, unlisted derivatives, options on ETFs, index warrants or underlying instruments hedge the member's index futures; and (3) any person approved to engage in uncovered option contracts, and if security futures are to be included in the account, approval for such transactions is also required. However, an eligible participant under category (3) may not establish or maintain positions in unlisted derivatives unless minimum equity of at least five million dollars is established and maintained with the member. If the account of an eligible participant subject to the five million dollar requirement falls below such minimum requirement, it must be restored within three business days. A member is prohibited from accepting new opening orders beginning on the fourth business day, except for new opening orders entered solely for the purpose of reducing market risk, where the result would be to lower margin requirements.

      Margin Deficiencies

      Under the rule change, eligible participants are required to satisfy a margin deficiency in a portfolio margin account within three business days by the deposit of additional funds and/or securities, or by the establishment of a hedge that would reduce margin requirements. In the event the deficiency is not satisfied after three business days, the member must liquidate positions to eliminate the deficiency. A member is required to deduct from its Net Capital the amount of any margin deficiency not satisfied by the close of business on the next business day after the business day on which the deficiency arises, and continuing until the deficiency is satisfied. Members should not permit an eligible participant to make a practice of meeting a portfolio margin deficiency by liquidation and are required to identify accounts that periodically liquidate positions to eliminate margin deficiencies. However, liquidation to eliminate margin deficiencies that are caused solely by adverse price movements may be disregarded.

      Establishing Account

      Members are permitted to use a specific securities margin account or a sub-account of a margin account clearly identified as a portfolio margin account. The account must be separate from any other securities account. In the event a portfolio margin account is a subaccount of a regular margin account, a member is allowed to use excess equity in the regular margin account to meet a margin deficiency in the portfolio margin account. In addition, securities, including money market funds, that are not eligible for portfolio margin treatment are allowed to be carried in a portfolio margin account for their collateral value, subject to the margin requirement applicable in a regular securities margin account.

      Day Trading

      The day trading restrictions in Rule 2520 do not apply to a portfolio margin account that establishes and maintains at least five million dollars in equity, provided that a member has the ability to monitor the intra-day risk associated with day trading. A portfolio margin account that does not establish and maintain at least five million dollars in equity is otherwise subject to the day trading restrictions. However, if the position or positions day traded were part of a hedge strategy, the day trading restrictions do not apply. A "hedge strategy" for purposes of the rule means a transaction or a series of transactions reduces or offsets a material portion of the risk in a portfolio. Members are expected to monitor portfolio margin accounts to detect and prevent circumvention of the day trading requirements.

      Net Capital Treatment

      Under the rule change, the aggregate portfolio margin and maintenance requirements may not exceed ten times the member's Net Capital, as computed under SEC Rule 15c3-1. This requirement places a ceiling on the amount of portfolio margin a broker-dealer can extend to its customers.

      Disclosure Document

      NASD Rule 2860(b)(11) prescribes requirements for the delivery of options disclosure documents concerning the opening of customer accounts. Under the rule change, members are required to provide every portfolio margin customer with a written risk disclosure statement at or prior to the initial transaction in a portfolio margin account. The disclosure will be in a format prescribed by NASD or in a format developed by the member, provided it contains substantially similar information as in the prescribed NASD format and has received the prior written approval of NASD. NASD will issue a subsequent Notice to Members to set forth the language required in the written disclosure statement.

      Effective Date

      The rule change establishes a pilot program that begins on April 2, 2007, and ends on July 31, 2007, to conform to the time periods of the similar portfolio margin pilot programs of the NYSE and CBOE.

      As discussed above, members seeking approval to participate in the portfolio margining pilot must submit an application that includes the specified information to Susan M. DeMando, Associate Vice President, Financial Operations, 1735 K Street, NW, Washington, D.C. 20006. In order for members to be eligible for approval by the effective date of April 2, 2007, applications must be submitted to NASD no later than March 2, 2007.


      1 See SR-NASD-2007-013 filed on February 12, 2007. Under Section 19(b) of the Securities Exchange Act of 1934, the SEC has the authority to summarily abrogate this type of rule change within 60 days of filing.

      2 See Federal Reserve System, "Securities Credit Transactions; Borrowing By Broker and Dealers"; Regulations G, T, U and X; Dockets Nos. R-0905, R-0923 and R-0944, 63 FR 2806 (January 16, 1998).

      3 For purposes of the rule, the term "margin equity security" uses the definition at Section 220.2 of Regulation T of the Board of Governors of the Federal Reserve System.

      4 For purposes of the rule, "security futures product" uses the definition at Section 3(a)(56) of the Exchange Act.

      5 For purposes of the rule, the term "unlisted derivatives" is defined in Rule 2520(g)(2)(H).

      6 For purposes of the rule, the term "related instrument" is defined in Rule 2520(g)(2)(D).

      7 For purposes of the rule, the term "underlying instrument" is defined in Rule 2520(g)(2)(G).

      8 See Exchange Act Release No. 54918 (December 12, 2006), 71 FR 75790 (December 18, 2006) (SR-NYSE-2006-13, relating to further amendments to the NYSE's portfolio margin pilot program); Exchange Act Release No. 54125 (July 11, 2006), 71 FR 40766 (July 18, 2006) (SR-NYSE-2005-93, relating to amendments to the NYSE's portfolio margin pilot program); Exchange Act Release No. 52031 (July 14, 2005) 70 FR 42130 (July 21, 2005) (SR-NYSE-2002-19, relating to the NYSE's original portfolio margin pilot). See also Exchange Act Release No. 54919 (December 12, 2006), 71 FR 75781 (December 18, 2006) (SRCBOE- 2006-014, relating to amendments to the CBOE's portfolio margin pilot); Exchange Act Release No. 52032 (July 14, 2005) 70 FR 42118 (July 21, 2005) (SR-CBOE-2002-03, relating to the CBOE's original portfolio margin pilot).

      9 Products would be grouped into a single portfolio that is based on the same index or issuer.

      10 Currently, the only model that is approved by the SEC is The Options Clearing Corporation's Theoretical Intermarket Margining System (TIMS).


      ATTACHMENT A

      New language is underlined.

      * * * * *

      2520. Margin Requirements

      (a) through (f) No Change.
      (g) Portfolio Margin

      As an alternative to the "strategy-based" margin requirements set forth in paragraphs (a) through (f) of this Rule, members may elect to apply the portfolio margin requirements set forth in this paragraph (g) to all margin equity securities,1 listed options, security futures products (as defined in Section 3(a)(56) of the Exchange Act), unlisted derivatives, warrants, index warrants and related instruments, provided that the requirements of paragraph (g)(6)(B)(i) of this Rule are met.

      In addition, a member, provided that it is a Futures Commission Merchant ("FCM") and is either a clearing member of a futures clearing organization or has an affiliate that is a clearing member of a futures clearing organization, is permitted under this paragraph (g) to combine an eligible participant's related instruments as defined in paragraph (g)(2)(D), with listed index options, unlisted derivatives, options on exchange traded funds ("ETF"), index warrants and underlying instruments and compute a margin requirement for such combined products on a portfolio margin basis.

      The portfolio margin provisions of this Rule shall not apply to Individual Retirement Accounts ("IRAs").
      (1) Monitoring

      Members must monitor the risk of portfolio margin accounts and maintain a comprehensive written risk analysis methodology for assessing the potential risk to the member's capital over a specified range of possible market movements of positions maintained in such accounts. The risk analysis methodology shall specify the computations to be made, the frequency of computations, the records to be reviewed and maintained, and the person(s) within the organization responsible for the risk function. This risk analysis methodology must be filed with NASD, or the member's designated examining authority ("DEA") if other than NASD, and submitted to the Commission prior to the implementation of portfolio margining. In performing the risk analysis of portfolio margin accounts required by this Rule, each member shall include in the written risk analysis methodology procedures and guidelines for:
      (A) obtaining and reviewing the appropriate account documentation and financial information necessary for assessing the amount of credit to be extended to eligible participants;
      (B) the determination, review and approval of credit limits to each eligible participant, and across all eligible participants, utilizing a portfolio margin account;
      (C) monitoring credit risk exposure to the member from portfolio margin accounts, on both an intra-day and end of day basis, including the type, scope and frequency of reporting to senior management;
      (D) the use of stress testing of portfolio margin accounts in order to monitor market risk exposure from individual accounts and in the aggregate;
      (E) the regular review and testing of these risk analysis procedures by an independent unit such as internal audit or other comparable group;
      (F) managing the impact of credit extended related to portfolio margin accounts on the member's overall risk exposure;
      (G) the appropriate response by management when limits on credit extensions related to portfolio margin accounts have been exceeded; and
      (H) determining the need to collect additional margin from a particular eligible participant, including whether that determination was based upon the creditworthiness of the participant and/or the risk of the eligible product.
      Moreover, management must periodically review, in accordance with written procedures, the member's credit extension activities for consistency with these guidelines. Management must periodically determine if the data necessary to apply this paragraph (g) is accessible on a timely basis and information systems are available to adequately capture, monitor, analyze and report relevant data.
      (2) Definitions

      For purposes of this paragraph (g), the following terms shall have the meanings specified below:
      (A) The term "listed option" means any equity-based or equity index-based option traded on a registered national securities exchange or automated facility of a registered national securities association.
      (B) The term "portfolio" means any eligible product, as defined in paragraph (g)(6)(B)(i), grouped with its underlying instruments and related instruments.
      (C) The term "product group" means two or more portfolios of the same type (see table in paragraph (g)(2)(F)below) for which it has been determined by SEC Rule 15c3-1a that a percentage of offsetting profits may be applied to losses at the same valuation point.
      (D) The term "related instrument" within a security class or product group means broad-based index futures and options on broad-based index futures covering the same underlying instrument. The term "related instrument" does not include security futures products.
      (E) The term "security class" refers to all listed options, security futures products, unlisted derivatives, and related instruments covering the same underlying instrument and the underlying instrument itself.
      (F) The term "theoretical gains and losses" means the gain and loss in the value of individual eligible products and related instruments at ten equidistant intervals (valuation points) ranging from an assumed movement (both up and down) in the current market value of the underlying instrument. The magnitude of the valuation point range shall be as follows:
      Portfolio Type Up / Down Market Move
      (High & Low Valuation Points)
      High Capitalization, Broad-based Market Index2 +6% / -8%
      Non-High Capitalization, Broad-based Market Index3 +/- 10%
      Any other eligible product that is, or is based on, an equity security or a narrow-based index +/- 15%
      (G) The term "underlying instrument" means a security or security index upon which any listed option, unlisted derivative, security future, or broad-based index future is based.
      (H) The term "unlisted derivative" means any equity-based or equity index-based unlisted option, forward contract, or security-based swap that can be valued by a theoretical pricing model approved by the Commission.
      (3) Approved Theoretical Pricing Models

      Theoretical pricing models must be approved by the Commission.
      (4) Eligible Participants

      The application of the portfolio margin provisions of this paragraph (g) is limited to the following:
      (A) any broker or dealer registered pursuant to Section 15 of the Exchange Act;
      (B) any member of a national futures exchange to the extent that listed index options, unlisted derivatives, options on ETFs, index warrants or underlying instruments hedge the member's index futures; and
      (C) any person or entity not included in paragraphs (g)(4)(A) and (g)(4)(B) above approved for uncovered options and, if transactions in security futures are to be included in the account, approval for such transactions is also required. However, an eligible participant under this paragraph (g)(4)(C) may not establish or maintain positions in unlisted derivatives unless minimum equity of at least five million dollars is established and maintained with the member. For purposes of this minimum equity requirement, all securities and futures accounts carried by the member for the same eligible participant may be combined provided ownership across the accounts is identical. A guarantee pursuant to paragraph (f)(4) of this Rule is not permitted for purposes of the minimum equity requirement.
      (5) Opening of Accounts
      (A) Members must notify and receive approval from NASD, or the member's DEA if other than NASD, prior to establishing a portfolio margin methodology for eligible participants.
      (B) Only eligible participants that have been approved to engage in uncovered short option contracts pursuant to NASD Rule 2860, or the rules of the member's DEA if other than NASD, are permitted to utilize a portfolio margin account.
      (C) On or before the date of the initial transaction in a portfolio margin account, a member shall:
      (i) furnish the eligible participant with a special written disclosure statement describing the nature and risks of portfolio margining which includes an acknowledgement for all portfolio margin account owners to sign, attesting that they have read and understood the disclosure statement, and agree to the terms under which a portfolio margin account is provided (see NASD Rule 2860(c)); and
      (ii) obtain the signed acknowledgement noted above from the eligible participant and record the date of receipt.
      (6) Establishing Account and Eligible Positions
      (A) For purposes of applying the portfolio margin requirements prescribed in this paragraph (g), members are to establish and utilize a specific securities margin account, or sub-account of a margin account, clearly identified as a portfolio margin account that is separate from any other securities account carried for an eligible participant.

      A margin deficit in the portfolio margin account of an eligible participant may not be considered as satisfied by excess equity in another account. Funds and/or securities must be transferred to the deficient account and a written record created and maintained. However, if a portfolio margin account is carried as a sub-account of a margin account, excess equity in the margin account (determined in accordance with the rules applicable to a margin account other than a portfolio margin account) may be used to satisfy a margin deficit in the portfolio margin sub-account without having to transfer any funds and/or securities.
      (B) Eligible Products
      (i) For eligible participants as described in paragraphs (g)(4)(A) through (g)(4)(C), a transaction in, or transfer of, an eligible product may be effected in the portfolio margin account. Eligible products under this paragraph (g) consist of:
      (a) a margin equity security (including a foreign equity security and option on a foreign equity security, provided the foreign equity security is deemed to have a "ready market" under SEC Rule 15c3-1 or a "no-action" position issued thereunder, and a control or restricted security, provided the security has met the requirements in a manner consistent with SEC Rule 144 or a Commission "no-action" position issued thereunder, sufficient enough to permit the sale of the security, upon exercise or assignment of any listed option or unlisted derivative written or held against it, without restriction);
      (b) a listed option on an equity security or index of equity securities;
      (c) a security futures product;
      (d) an unlisted derivative on an equity security or index of equity securities;
      (e) a warrant on an equity security or index of equity securities; and
      (d) a related instrument as defined in paragraph (g)(2)(D).
      (7) Margin Required

      The amount of margin required under this paragraph (g) for each portfolio shall be the greater of:
      (A) the amount for any of the ten equidistant valuation points representing the largest theoretical loss as calculated pursuant to paragraph (g)(8) below; or
      (B) for eligible participants as described in paragraph (g)(4)(A) through (g)(4)(C), $.375 for each listed option, unlisted derivative, security future product, and related instrument, multiplied by the contract's or instrument's multiplier, not to exceed the market value in the case of long contracts in eligible products.
      (C) Account guarantees pursuant to paragraph (f)(4) of this Rule are not permitted for purposes of meeting margin requirements.
      (D) Positions other than those listed in Paragraph (g)(6)(B)(i) above are not eligible for portfolio margin treatment. However, positions not eligible for portfolio margin treatment (except for ineligible related instruments) may be carried in a portfolio margin account, provided the member has the ability to apply the applicable strategy-based margin requirements promulgated under this Rule. Shares of a money market mutual fund may be carried in a portfolio margin account, also subject to the applicable strategy-based margin requirement under this Rule provided that:
      (i) the customer waives any right to redeem shares without the member's consent;
      (ii) the member (or, if the shares are deposited with a clearing organization, the clearing organization) obtains the right to redeem shares in cash upon request;
      (iii) the fund agrees to satisfy any conditions necessary or appropriate to ensure that the shares may be redeemed in cash, promptly upon request; and
      (iv) the member complies with the requirements of Section 11(d)(1) of the Exchange Act and SEC Rule 11d1-2 thereunder.
      (8) Method of Calculation
      (A) Long and short positions in eligible products, including underlying instruments and related instruments, are to be grouped by security class; each security class group being a "portfolio." Each portfolio is categorized as one of the portfolio types specified in paragraph (g)(2)(F) above, as applicable.
      (B) For each portfolio, theoretical gains and losses are calculated for each position as specified in paragraph (g)(2)(F) above. For purposes of determining the theoretical gains and losses at each valuation point, members shall obtain and utilize the theoretical values of eligible products as described in this paragraph (g) rendered by an approved theoretical pricing model.
      (C) Offsets. Within each portfolio, theoretical gains and losses may be netted fully at each valuation point. Offsets between portfolios within the eligible product groups, as described in paragraph (g)(2)(F), may then be applied as permitted by SEC Rule 15c3-1a.
      (D) After applying the offsets above, the sum of the greatest loss from each portfolio is computed to arrive at the total margin required for the account (subject to the per contract minimum).
      (E) In addition, if a security that is convertible, exchangeable, or exercisable into a security that is an underlying instrument requires the payment of money or would result in a loss if converted, exchanged, or exercised at the time when the security is deemed an underlying instrument, the full amount of the conversion loss is required.
      (9) Portfolio Margin Minimum Equity Deficiency
      (A) If, as of the close of business, the equity in the portfolio margin account of an eligible participant as described in paragraph (g)(4)(C), declines below the five million dollar minimum equity required, if applicable, and is not restored to at least five million dollars within three business days by a deposit of funds and/or securities or through favorable market action, members are prohibited from accepting new opening orders beginning on the fourth business day, except that new opening orders entered for the purpose of reducing market risk may be accepted if the result would be to lower margin requirements. This prohibition shall remain in effect until,
      (i) equity of five million dollars is established, or
      (ii) all unlisted derivatives are liquidated or transferred from the portfolio margin account to the appropriate securities account.
      (B) Members will not be permitted to deduct any portfolio margin minimum equity deficiency amount from Net Capital in lieu of collecting the minimum equity required.
      (10) Portfolio Margin Deficiency
      (A) If, as of the close of business, the equity in the portfolio margin account of an eligible participant, as described in paragraph (g)(4)(A) through (g)(4)(C), is less than the margin required, the eligible participant may deposit additional funds and/or securities or establish a hedge to meet the margin requirement within three business days. After the three business day period, members are prohibited from accepting new opening orders, except that new opening orders entered for the purpose of reducing market risk may be accepted if the result would be to lower margin requirements. In the event an eligible participant fails to hedge existing positions or deposit additional funds and/or securities in an amount sufficient to eliminate any margin deficiency after three business days, the member must liquidate positions in an amount sufficient to, at a minimum, lower the total margin required to an amount less than or equal to the account equity.
      (B) If the portfolio margin deficiency is not met by the close of business on the next business day after the business day on which such deficiency arises, members will be required to deduct the amount of the deficiency from Net Capital until such time the deficiency is satisfied or positions are liquidated pursuant to paragraph (g)(10)(A) above.
      (C) Members will not be permitted to deduct any portfolio margin deficiency amount from Net Capital in lieu of collecting the margin required.
      (D) NASD, or the member's DEA if other than NASD, may grant additional time for an eligible participant to meet a portfolio margin deficiency upon written request, which is expected to be granted in extraordinary circumstances only.
      (E) Notwithstanding the provisions of subparagraph (B) above, members should not permit an eligible participant to make a practice of meeting a portfolio margin deficiency by liquidation. Members must have procedures in place to identify accounts that periodically liquidate positions to eliminate margin deficiencies, and the member is expected to take appropriate action when warranted. Liquidation to eliminate margin deficiencies that are caused solely by adverse price movements may be disregarded.
      (11) Determination of Value for Margin Purposes

      For the purposes of this paragraph (g), all eligible products shall be valued at current market prices. Account equity for the purposes of paragraphs (g)(9)(A) and (g)(10)(A) shall be calculated separately for each portfolio margin account by adding the current market value of all long positions, subtracting current market value of all short positions, and adding the credit (or subtracting the debit) balance in the account.
      (12) Net Capital Treatment of Portfolio Margin Accounts
      (A) No member that requires margin in any portfolio account pursuant to paragraph (g) of this Rule shall permit the aggregate portfolio margin requirements to exceed ten times its Net Capital for any period exceeding three business days. The member shall, beginning on the fourth business day, cease opening new portfolio margin accounts until compliance is achieved.
      (B) If, at any time, a member's aggregate portfolio margin requirements exceed ten times its Net Capital, the member shall immediately transmit telegraphic or facsimile notice of such deficiency to the principal office of the Commission in Washington, D.C., the district or regional office of the Commission for the district or region in which the member maintains its principal place of business; and to NASD, or the member's DEA if other than NASD. Notice to NASD shall be in such form as NASD may prescribe.
      (13) Day Trading Requirements

      The day trading restrictions promulgated under paragraph (f)(8)(B) of this Rule shall not apply to portfolio margin accounts that establish and maintain at least five million dollars in equity, provided that a member has the ability to monitor the intra-day risk associated with day trading. Portfolio margin accounts that do not establish and maintain at least five million dollars in equity will be subject to the day trading restrictions under paragraph (f)(8)(B) of this Rule, provided the member has the ability to apply the applicable day trading requirement under this Rule. However, if the position or positions day traded were part of a hedge strategy, the day trading restrictions will not apply. A "hedge strategy" for purposes of this Rule means a transaction or a series of transactions that reduces or offsets a material portion of the risk in a portfolio. Members are expected to monitor these portfolio margin accounts to detect and prevent circumvention of the day trading requirements.
      (14) Requirements to Liquidate
      (A) A member is required immediately either to liquidate, or transfer to another broker-dealer eligible to carry portfolio margin accounts, all portfolio margin accounts with positions in related instruments if the member is:
      (i) insolvent as defined in section 101 of title 11 of the United States Code, or is unable to meet its obligations as they mature;
      (ii) the subject of a proceeding pending in any court or before any agency of the United States or any State in which a receiver, trustee, or liquidator for such debtor has been appointed;
      (iii) not in compliance with applicable requirements under the Exchange Act or rules of the Commission or any self-regulatory organization with respect to financial responsibility or hypothecation of eligible participant's securities; or
      (iv) unable to make such computations as may be necessary to establish compliance with such financial responsibility or hypothecation rules.
      (B) Nothing in this paragraph (g)(14) shall be construed as limiting or restricting in any way the exercise of any right of a registered clearing agency to liquidate or cause the liquidation of positions in accordance with its by-laws and rules.
      (15) Members must ensure that portfolio accounts are in compliance with Rule 2860.

      1 For purposes of this paragraph (g) of the Rule, the term "margin equity security" utilizes the definition at Section 220.2 of Regulation T of the Board of Governors of the Federal Reserve System.

      2 In accordance with paragraph (b)(1)(i)(B) of SEC Rule 15c3-1a (Appendix A to SEC Rule 15c3-1), 17 CFR 240.15c3-1a(b)(1)(i)(B).

      3 See footnote 2.

      * * * * *


      2860. Options

      (a) through (b) No Change.
      (c) Portfolio Margining Disclosure Statement and Acknowledgement

      The special written disclosure statement describing the nature and risks of portfolio margining, and acknowledgement for an eligible participant signature, required by Rule 2520(g)(5)(C) shall be in a format prescribed by NASD or in a format developed by the member, provided it contains substantially similar information as in the prescribed NASD format and has received the prior written approval of NASD.

    • 07-10 SEC Approves Changes to NASD Interpretive Material 8310-2 Regarding the Release of Information through NASD BrokerCheck; Effective Date: March 19, 2007

      View PDF File

      GUIDANCE

      NASD BrokerCheck

      SUGGESTED ROUTING

      KEY TOPICS

      Legal & Compliance
      Operations
      Registered Representatives
      Registration
      Senior Management
      Training
      BrokerCheck
      Form BD (Uniform Application for Broker-Dealer Registration)
      Form BDW (Uniform Application for Broker-Dealer Withdrawal)
      Form U4 (Uniform Application for Securities Industry Registration or Transfer)
      Form U5 (Uniform Termination Notice for Securities Industry Registration) Form U6
      IM-8310-2
      IM-8310-3

      Executive Summary

      The Securities and Exchange Commission (SEC) has approved amendments to Interpretive Material 8310-2 (IM-8310-2), governing the release of information through NASD BrokerCheck (formerly known as NASD's Public Disclosure Program).1 These amendments expand the information NASD makes available through BrokerCheck and reflect NASD's commitment to strike a fair balance between investor protection and the privacy interests of member firms and their associated persons. Additionally, NASD is making BrokerCheck more user-friendly and improving its security and integrity by replacing the current method for the electronic delivery of BrokerCheck reports and by introducing a redesigned BrokerCheck Web site. NASD is also introducing an educational component of the BrokerCheck report and Web site that it believes will enable the reader to view disclosure events in the appropriate context and give appropriate weight to all disclosure events when evaluating a particular firm or broker. Upon request, subject to terms and conditions established by NASD and after execution of a licensing agreement prepared by NASD, NASD will also provide a compilation of selected data of NASD members. The amendments to IM-8310-2 and changes to NASD BrokerCheck are effective March 19, 2007. The amended text of IM-8310-2 and IM-8310-3 is attached to this Notice in Attachment A.

      Questions/Further Information

      Questions concerning this Notice may be directed to Richard E. Pullano, Chief Counsel and Associate Vice President, Registration and Disclosure, at (240) 386-4821; or Stefanie M. Watkins, Senior Counsel, Registration and Disclosure, at (240) 386-4824.

      Background

      NASD established its public disclosure program (now known as BrokerCheck) in 1988 to provide the public with information on the professional background, business practices and conduct of NASD member firms and their associated persons. In 1990, with NASD's support, Congress passed legislation requiring NASD to establish and maintain a toll-free telephone number to respond to inquiries about member firms and associated persons. In 1998, NASD began providing certain administrative information, such as registration and employment history, online via NASD's Web site (www.nasd.com). In 2000, NASD established a two-year period for disclosure of information about persons formerly registered with an NASD member, increased the amount of information disclosed to investors through BrokerCheck and refined the report delivery process.

      BrokerCheck currently processes over four million inquiries each year and gives investors an opportunity to obtain information essential to making an informed choice on whether to do business with a particular broker or securities firm. The changes to BrokerCheck, as described in this Notice, are the product of a comprehensive review of the information available through BrokerCheck and the way in which it is delivered to the public.

      Information NASD Will Release through BrokerCheck

      Subject to the exceptions described below, NASD will release through BrokerCheck the following information regarding current or former members, persons currently registered with an NASD member, or persons who were registered with an NASD member within the preceding two years, as reported on the most recently filed Form U4, Form U5, Form U6 (the form used by regulators to report actions), Form BD and Form BDW (collectively, Registration Forms).

      NASD will release:

      •   Currently approved registrations for brokers and member firms.
      •   Information about qualifications examinations passed by the broker and date passed.
      •  The name and succession history for current or former member firms.
      •   Summary information about certain arbitration awards against a member firm involving a securities or commodities dispute with a public customer.
      •   Information regarding control relationships, direct and indirect owners, and executive officers as provided on the Form BD.
      •   Information regarding the date of withdrawal from NASD registration and, if appropriate, details regarding funds owed customers or other firms, as provided on the Form BDW.
      •   In response to telephonic inquiries via the BrokerCheck toll-free telephone listing, whether a particular member firm is subject to the provisions of the Taping Rule (NASD Rule 3010(b)(2)).
      •   Historic Complaints (i.e., the information last reported on Registration Forms relating to customer complaints that are more than two (2) years old and that have not been settled or adjudicated, and customer complaints, arbitrations or litigations that have been settled for an amount less than $10,000 and are no longer reported on a Registration Form), provided that:
      (1) any such matter became a Historic Complaint on or after March 19, 2007;
      (2) the most recent Historic Complaint or currently reported customer complaint, arbitration or litigation is less than ten (10) years old; and
      (3) the person has a total of three (3) or more currently disclosable regulatory actions, currently reported customer complaints, arbitrations or litigations, or Historic Complaints (subject to the limitation that they became a Historic Complaint on or after March 19, 2007), or any combination thereof.
      In other words, only those disclosure events (i.e., customer complaints, arbitrations or litigations) that were archived on or after March 19, 2007 will be considered Historic Complaints for purposes of determining whether a person's Historic Complaints become eligible for disclosure through BrokerCheck.
      •   Broker Comments. As described below, currently registered persons and persons who are not currently registered with a member firm, but who were registered with an NASD member within the last two years (and who are, therefore, subject to BrokerCheck)2 will be given an opportunity to add context to or update information that may be disclosed through BrokerCheck.

      Persons No Longer Registered with a Member Firm May Submit Broker Comments

      Starting on March 19, 2007, NASD will give persons who are not currently registered with an NASD member, but who were registered within the last two years, an opportunity to submit a comment through the Broker Comment process. (As explained below, the Broker Comment process will not be available to currently registered persons.) Persons wishing to submit a Broker Comment must complete a Broker Comment Request Form, which may be found on NASD's Web site. The Request Form must be signed and notarized. NASD will also post Guidelines for Broker Comments on BrokerCheck on its Web site. NASD will review all submitted Request Forms to confirm relevance and compliance with the established instructions. Only Broker Comments that relate to the information provided through BrokerCheck will be accepted. If the person's Broker Comment meets NASD's criteria, NASD will add the Comment to the written report provided through BrokerCheck. The person submitting the Comment will be able to amend, replace or delete the Comment in the same way. These Comments will also be made available through the Central Registration Depository (CRD®) to participating regulators, and to any member firms with which the person who submitted the Comment seeks to be associated subject to the pre-registration protocols,3 so long as the person is subject to BrokerCheck.

      Registered Persons Continue to Provide Comments on Form U4

      Persons who are currently registered with a member firm will continue to have the opportunity to provide details in the appropriate Disclosure Reporting Page (DRP) of the Form U4. Currently, registered persons may provide details at the time a disclosure event is reported. Additionally, if the registered person wishes to add to his or her previously submitted filing, or provide comments for the first time, the person may, through his or her firm, amend the Form U4 to provide an additional statement relating to the reportable event.

      NASD will not edit these comments (whether submitted via Form U4 or a Broker Comment Form); however, consistent with current practice, NASD reserves the right to reject comments or redact information from comments, on a case-by-case basis, that contain confidential customer information, offensive or potentially defamatory language, or information that raises significant identity theft, personal safety or privacy concerns that are not outweighed by investor protection concerns. NASD will post Guidelines for Broker Comments on BrokerCheck on NASD's Web site.

      Additionally, NASD reminds all registered persons and persons registered within the last two years that customer complaints that become non-reportable may, at some future time, be eligible for disclosure through BrokerCheck. Therefore, all persons who are subject to BrokerCheck (whether registered or formerly registered) are responsible for ensuring that their comments about any customer complaint adequately reflect their views and concerns, in the event that the matter, although not currently disclosed through BrokerCheck, may be disclosed in the future as a Historic Complaint.

      Information NASD Will Not Release through BrokerCheck

      NASD will not release:

      •  Social Security numbers, residential history information, physical description information, information that NASD is otherwise prohibited from releasing under Federal law or information that is provided solely for use by regulators.
      •  Information about current or former members, registered persons or persons who were registered with an NASD member within the preceding two years that has been reported on registration forms relating to regulatory investigations or proceedings if the reported regulatory investigation or proceeding was vacated or withdrawn by the instituting authority.
      •  "Internal Review Disclosure" information reported by members, associated persons or regulators on Section 7 of the Form U5.4
      •  "Reason for Termination" information reported on Section 3 of the Form U5.
      •  Form U5 disclosure information for fifteen (15) days following the filing of such information. This will give persons on whose behalf the Form U5 was submitted an opportunity to file (or amend) a Form U4 or submit a separate Broker Comment to NASD for inclusion with the information released pursuant to BrokerCheck, regarding disclosure information reported on the Form U5 and any amendments thereto. NASD would then release both the Form U5 disclosure information and the person's comment, if any, to a requester.
      •   The most recent information reported on a Registration Form if:
      (1) NASD has determined that the information was reported in error by a firm, regulator or other appropriate authority; or
      (2) the information has been determined by regulators, through amendments to the Registration Forms, to be no longer relevant to securities registration or licensure, regardless of the disposition of the event or the date the event occurred.
      •   Information regarding branch offices provided on Schedule E of the Form BD.5

      In addition, NASD reserves the right to exclude, on a case-by-case basis, information that contains confidential customer information, offensive or potentially defamatory language, or information that raises significant identity theft, personal safety or privacy concerns that are not outweighed by investor protection concerns.

      Educational Component of BrokerCheck

      NASD has also developed an educational component of the BrokerCheck report and the BrokerCheck Web site that it believes will help the reader to view disclosure events in the appropriate context and give appropriate weight to all disclosure events when evaluating a particular firm or broker. These online educational materials consist of text and links to other resources and are designed to help the users of BrokerCheck better understand the content, context and source of the information provided through BrokerCheck and help investors in choosing a broker or firm.

      An introductory section immediately preceding the BrokerCheck report will explain that some reported items may involve pending actions or allegations that may be contested and have not been resolved or proven, and that these items may be withdrawn or dismissed, resolved in favor of the broker or concluded through a negotiated settlement with no admission or conclusion of wrongdoing. The report will also include certain status information on each type of disclosure event (provided the firm and/or regulator has reported the disposition on a Registration Form), so that the reader will know whether the complaint was resolved and, if so, how it was resolved. In addition, both the BrokerCheck report and the BrokerCheck Web site will advise the reader not to rely solely on the information available through the BrokerCheck program, but to learn as much as possible about the broker or firm from other sources.6

      Electronic Delivery of BrokerCheck Reports

      Prior to March 19, 2007, NASD delivered BrokerCheck reports via U.S. mail (when requested through NASD's toll-free number) or email (when requested online via BrokerCheck). NASD will continue to deliver BrokerCheck reports via U.S. mail, but will no longer send reports as file attachments in an email. Due to a number of practical issues that have arisen regarding email delivery, NASD will replace the current delivery approach with access to an online report through a secure Internet session in response to inquiries via its Web site or through the established toll-free number. The report will be in Portable Document Format (PDF) and will be viewable online within seconds after a request is made. This improved delivery method will result in more efficient and faster delivery of reports and will eliminate previous email file size limitations often encountered by users under the previous delivery methods. A requester also will be able to view investor education materials that will aid him or her in understanding the written report. NASD will continue to provide hard copy reports to those requesting hard copies.

      Compilation of Information

      Starting on March 19, 2007, upon written request, NASD will provide to the public (subject to terms and conditions established by NASD, and after execution of a licensing agreement prepared by NASD) a compilation of information selected by NASD from the Forms BD and BDW. The information provided under the licensing agreement will be limited to information that is otherwise publicly available from the SEC. NASD expects to charge a fee to commercial users. Interested persons should call the BrokerCheck Hotline ((800) 289-9999) for information on how to obtain a compilation.


      1 Securities Exchange Act Release No. 55127 (January 18, 2007), 72 FR 3455 (January 25, 2007) (SR-NASD-2003-168). These amendments also created IM-8310-3, which was formerly denominated as IM-8310-2(b). IM-8310-3 contains the rules regarding the release of disciplinary complaints, decisions and other information.

      2 Requesters may obtain information about brokers through BrokerCheck only during the time such persons are registered with NASD and for two years following the termination of their registration with an NASD member firm.

      3 NASD member firms are required to obtain an individual's written consent prior to reviewing his or her CRD record in connection with a firm's consideration of a potential employee.

      4 NASD will not release the response to the internal review question and related information reported on the associated DRP through BrokerCheck. However, if the matter that was the subject of the internal review is or becomes reportable under the investigation, termination or other disclosure questions, the disclosure information made pursuant to these other disclosure questions would be released.

      5 Branch office information formerly reported on Schedule E of the Form BD is now reported on the Form BR (Uniform Branch Office Registration Form).

      6 For example, NASD suggests that investors contact state securities regulators, local consumer and investment groups, or others who have established business relationships with a particular broker or firm.


      ATTACHMENT A

      Proposed new language is underlined; proposed deletions are in brackets.

      * * * * *

      IM-8310-2. [Release of Disciplinary and Other Information Through the Public Disclosure Program] NASD BrokerCheck Disclosure

      (a) In response to a written inquiry, electronic inquiry, or telephonic inquiry via a toll-free telephone listing, [the Association] NASD shall release certain information [contained in the Central Registration Depository] regarding a current or former member, an associated person, or a person who was associated with a member within the preceding two years, through [the Public Disclosure Program] NASD BrokerCheck. [Such information shall include:]
      [(1) the person's employment history and other business experience required to be reported on Form U-4;]
      [(2) currently approved registrations for the member or associated person;]
      [(3) the main office, legal status, and type of business engaged in by the member; and]
      [(4) an event or proceeding-]
      [(A) required to be reported under Item 14 on Form U-4;]
      [(B) required to be reported under Item 11 on Form BD; or]
      [(C) reported on Form U-6.]
      [The Association also shall make available through the Public Disclosure Program certain arbitration decisions against a member involving a securities or commodities dispute with a public customer. In addition, the Association shall make available in response to telephonic inquiries via the Public Disclosure Program's toll-free telephone listing whether a particular member is subject to the provisions of Rule 3010(b)(2). The Association shall not release through the Public Disclosure Program social security numbers, residential history information, or physical description information, or information that the Association is otherwise prohibited from releasing under Federal law.]
      (b) Except as otherwise provided in paragraph (c) below, NASD shall release:
      (1) any information reported on the most recently filed Form U4, Form U5, Form U6, Form BD, and Form BDW (collectively "Registration Forms");
      (2) currently approved registrations;
      (3) summary information about certain arbitration awards against a member involving a securities or commodities dispute with a public customer;
      (4) the most recently submitted comment, if any, provided to NASD by the person who is covered by BrokerCheck, in the form and in accordance with the procedures established by NASD, for inclusion with the information provided through BrokerCheck. Only comments that relate to the information provided through BrokerCheck will be included;
      (5) information as to qualifications examinations passed by the person and date passed. NASD will not release information regarding examination scores or failed examinations;
      (6) in response to telephonic inquiries via the BrokerCheck toll-free telephone listing whether a particular member is subject to the provisions of Rule 3010(b)(2) ("Taping Rule");
      (7) Historic Complaints (i.e., the information last reported on Registration Forms relating to customer complaints that are more than two (2) years old and that have not been settled or adjudicated, and customer complaints, arbitrations or litigations that have been settled for an amount less than $10,000 and are no longer reported on a Registration Form), provided that:
      (A) any such matter became a Historic Complaint on or after March 19, 2007;
      (B) the most recent Historic Complaint or currently reported customer complaint, arbitration or litigation is less than ten (10) years old; and
      (C) the person has a total of three (3) or more currently disclosable regulatory actions, currently reported customer complaints, arbitrations or litigations, or Historic Complaints (subject to the limitation that they became a Historic Complaint on or after March 19, 2007), or any combination thereof; and
      (8) the name and succession history for current or former members.
      (c) NASD shall not release:
      (1) information reported as a Social Security number, residential history or physical description, information that NASD is otherwise prohibited from releasing under Federal law, or information that is provided solely for use by regulators. NASD reserves the right to exclude, on a case-by-case basis, information that contains confidential customer information, offensive or potentially defamatory language or information that raises significant identity theft, personal safety or privacy concerns that are not outweighed by investor protection concerns;
      (2) information reported on Registration Forms relating to regulatory investigations or proceedings if the reported regulatory investigation or proceeding was vacated or withdrawn by the instituting authority;
      (3) "Internal Review Disclosure" information reported on Section 7 of the Form U5;
      (4) "Reason for Termination" information reported on Section 3 of the Form U5;
      (5) Form U5 information for fifteen (15) days following the filing of such information;
      (6) the most recent information reported on a Registration Form, if:
      (A) NASD has determined that the information was reported in error by a member, regulator or other appropriate authority;
      (B) the information has been determined by regulators, through amendments to the uniform Registration Forms, to be no longer relevant to securities registration or licensure, regardless of the disposition of the event or the date the event occurred;
      (7) information provided on Schedule E of Form BD.
      (d) Upon written request, NASD may provide a compilation of information about NASD members, subject to terms and conditions established by NASD and after execution of a licensing agreement prepared by NASD. NASD may charge commercial users of such information reasonable fees as determined by NASD. Such compilations shall consist solely of information selected by NASD from Forms BD and BDW and shall be limited to information that is otherwise publicly available from the Commission.

      IM-8310-3 Release of Disciplinary Complaints, Decisions and Other Information

      [(b)](a) [The Association] NASD shall, in response to a request, release to the requesting party a copy of any identified disciplinary complaint or disciplinary decision issued by [the Association] NASD or any subsidiary or Committee thereof; provided, h