[Federal Register Volume 59, Number 50 (Tuesday, March 15, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-5920]


[[Page Unknown]]

[Federal Register: March 15, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-33737; File No. SR-NASD-93-48]

 

Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Approving a Proposed Rule change to the By-Laws 
and Rules of Fair Practice Relating to Rule Approval Procedures

March 8, 1994.

I. Introduction

    On September 17, 1993, the National Association of Securities 
Dealers, Inc. (``NASD'' or ``Association'') filed with the Securities 
and Exchange Commission (``SEC'' or ``Commission'') a proposed rule 
change pursuant to section 19(b)(1) of the Securities Exchange Act of 
1934 (``Act'')\1\ and Rule 19b-4 thereunder.\2\ The rule change amends 
the NASD By-Laws and Rules of Fair Practice to make uniform all rule 
approval and amendment procedures under the NASD's By-Laws and to 
convert certain appendices of Rules of Fair Practice into Rules of Fair 
Practice themselves.
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    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\17 CFR 240.19b-4 (1993).
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    Notice of the proposed rule change appeared in the Federal Register 
on September 28, 1993.\3\ The Commission received four comment letters 
opposing the proposal.\4\ This order approves the rule change.\5\
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    \3\Securities Exchange Act Release No. 32942 (Sept. 22, 1993), 
58 FR 50609 (Sept. 28, 1993).
    \4\Letter from Merle I. Hoch, Executive Director, Securities 
Traders Association of New York, to Jonathan G. Katz, Secretary, SEC 
(Oct. 15, 1993) (``STANY Comment Letter''); letter from Dennis 
Marion, President and Chief Executive Officer, Sherwood Securities, 
to Jonathan G. Katz, Secretary, SEC (Oct. 15, 1993) (``Sherwood 
Comment Letter''); letter from David E. Rosendahl, Chairman, Federal 
Regulation Committee, Securities Industry Association (``SIA''), and 
Mark T. Commander, Chairman, Self-Regulatory and Supervisory 
Practices Committee, SIA, to Jonathan Katz, Secretary, SEC (Nov. 4, 
1993) (``SIA Comment Letter''); and letter from Kenneth S. Spirer, 
General Counsel, Private Client Group, Merrill Lynch, to Jonathan G. 
Katz, Secretary, SEC (Oct. 25, 1993) (``Merrill Lynch Comment 
Letter'').
    \5\The rule change was approved for filing with the Commission 
at a meeting of the NASD Board of Governors (``Board'') on November 
13, 1992. The change was submitted to a vote of the NASD membership 
in NASD Notice to Members 93-15 (Mar. 1993), and was approved by the 
membership, as required by Article XII, Section 1, and Article XVII, 
Section 1 of the NASD By-Laws by a vote of 1,683 in favor, 478 
opposed, and 11 not voting out of 2,172 ballots received.
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II. Description of the Rule Change

    The NASD is proposing to amend the NASD By-Laws and Rules of Fair 
Practice to make all rule approval and amendment procedures under the 
NASD's By-Laws uniform\6\ and, thus, eliminate the requirement that 
certain rules be submitted to the membership for their approval as part 
of the rulemaking process.\7\ The rule change conforms the NASD's 
procedure to those of other securities industry self-regulatory 
organizations (``SRO''), which do not require member vote for rule 
changes.\8\ The rule change is effective immediately and applies only 
to proposed rule changes approved by the Board or the Executive 
Committee\9\ after the effective date of the rule change.\10\ Thus, 
rule changes currently pending before the Commission or approved by the 
Board prior to the date of effectiveness of this order will not be 
affected by the rule change.
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    \6\In addition, the rule change converts certain appendices of 
Rules of Fair Practice into Rules of Fair Practice themselves.
    \7\Currently, the NASD By-Laws and Rules of Fair Practice 
require Board and membership approval to amend Rules of Fair 
Practice while amendment to other NASD rules only requires Board 
approval. Thus, the NASD By-Laws currently provide that the Board 
may adopt Rules of Fair Practice for submission to NASD members. 
NASD Manual, By-Laws, Art. XII, Sec. 1 (CCH)  1251. Certain Rules 
of Fair Practice adopted by the Board and approved by the 
membership, however, authorize the Board to establish rules, 
regulations and/or procedures concerning NASD members without 
recourse to the membership for approval. NASD Manual, Rule of Fair 
Practice, Art. III, Secs. 30(b) (Margin accounts), 31 (Securities 
``failed to receive'' and ``failed to deliver''), 32(b) (Fidelity 
bonds), 33(c) (Options), 34(c) (Direct participation programs) & 37 
(Operating rules for ITS/CAES and CAES), (CCH)  2180, 2181, 2182, 
2183, 2191 & 2197.
    \8\See, e.g., Amex, Const., Art. II, Sec. 2; Chicago Stock 
Exchange, Const., Art. XI, Sec. 2; Midwest Clearing Corp., By-Laws, 
Art. VII, Sec. 1; NYSE, Const., Art. VIII, Sec. 1.
    \9\Between Board meetings, the Executive Committee has authority 
to act on behalf of the Board during emergency or extraordinary 
market conditions. NASD Manual, By-Laws, Art. VII, Sec. 3, (CCH)  
1182A.
    \10\Letter from Suzanne Rothwell, Associate General Counsel, 
NASD, to Selwyn Notelovitz, Branch Chief, SEC (Jan. 27, 1994).
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A. Amendments to the By-Laws

    Article VII, Section 1(a) of the By-Laws sets forth certain 
authority of the Board. The rule change amends this section with 
respect to the Board's authority to amend the NASD rules; to amend its 
Certificate of Incorporation or By-Laws, the NASD will continue to be 
required to obtain membership approval. To reflect this distinction, 
Article VII, section 1(a)(1) of the By-Laws has been divided into two 
subsections. Amended section 1(a)(1) provides that amendments to the 
By-Laws require membership approval and new section 1(a)(2) specifies 
that the Board has the authority to adopt and amend Rules of Fair 
Practice. This new section also provides that the Board may, in its 
discretion, still choose to submit certain rule changes or additions to 
Rules of Fair Practice to the membership for consideration.
    Redesigned section 1(a)(3) (formerly section 1(a)(9)) generally 
provides broad authority to the Board to exercise the action necessary 
or appropriate to implement the provisions of the Act. The rule change 
deletes from redesignated section 1(a)(3) language referencing the 
Government Securities Act of 1986 because the pertinent provisions of 
the Government Securities Act of 1986 are incorporated in the Act, as 
amended.\11\
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    \11\The rule change also amends redesignated sections 1(a) (5), 
(6) and (8) (formerly sections 1(a) (3), (4) and (6)) because the 
language in these sections specifying that no member vote is needed 
is now superfluous. In addition, redesignated sections 1(a) (9) and 
(10) (formerly sections 1(a) (7) and (8)) have been amended 
stylistically, with no substantive implications.
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    Article XII, Section 1 of the By-Laws is also amended to delete the 
reference to the member vote procedure for adoption and amendment of 
Rules of Fair Practice, and to remove references to emergency rules. 
Because the NASD may now amend Rules of Fair Practice without 
membership vote, the procedures for member vote and references to 
emergency rules are no longer.

B. Amendments to Rules of Fair Practice

    Currently, the text of Rules of Fair Practice, Article III, 
Sections 30 through 34 contain general Rules of Fair Practice and set 
forth the procedures for adopting the specific requirements underlying 
these general rules, which procedures include that the Board may adopt 
or amend these rules without recourse to the membership.12 The 
specific requirements underlying these general rules appear in 
appendices to each of these rules, which include a reiteration of the 
general rule. As noted above, the rule change amends Article VII of the 
By-Laws to provide the Board authorization to and the procedure for 
amending all Rules of Fair Practice without recourse to the membership. 
Accordingly, the rule change deletes the text of Sections 30 through 
34, which are now superfluous, and converts the substantive provisions 
found in the appendices to each of these rules into their respective 
sections. To conform the former appendices to the format of Rules of 
Fair Practice, the appropriate numbering, lettering and cross 
referencing, changes have been made.13
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    \1\2NASD Manual, Rule of Fair Practice, Art. III, Secs. 30(b), 
31, 32(b), 33(c), 34(c) & 37, (CCH)  2180, 2181, 2182, 2183, 2191 
& 2197.
    \1\3The numbering convention for former Appendix A, however, is 
not changed at this time because, as explained in SR-NASD-92-35, the 
NASD's new margin rule is based on rules of the NYSE and, for 
purposes of comparison, the NASD considers using the same numbering 
scheme for the NASD's and NYSE's rules useful. See Securities 
Exchange Act Release No. 31918 (Feb. 24, 1993), 58 FR 12286 (Mar. 3, 
1993) (order approving File No. SR-NASD-92-35).
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    Finally, the rule change deletes Rules of Fair Practice, Section 
37, which provided the Board authority to adopt and amend CAES 
Operating Rules and ITS/CAES Operating Rules without seeking membership 
approval. As amended, redesignated Sections 1(a) (3), (8) and (9) 
(formerly sections 1(a) (9), (6) and (7)) generally provide the Board 
authority to adopt rules and operate systems such as CAES and ITS/CAES 
without membership approval; thus, section 37 is unnecessary.

III. Comment Letters

    The Commission received four comment letters opposing the rule 
change. Commentators noted, among other things, that it violated the 
traditionally democratic process of the NASD14 and is unnecessary 
given the Board's authority to adopt rules in the event of an 
emergency.15 One commenter opposed the NASD's rule change because 
it believed that member vote provides a mechanism for NASD members to 
give careful consideration to rule changes.16 In addition, this 
commenter argued that the NASD should establish a uniform comment 
period for all rule changes.
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    \1\4STANY and Sherwood Comment Letters.
    \1\5STANY and SIA Comment Letters.
    \1\6Merrill Lynch Comment Letter.
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    In response, the NASD noted that its members have access to the 
NASD's rulemaking process through means other than membership 
vote.17 In particular, the NASD noted, members participate in this 
process through their representatives on Standing and District 
committees and through the election of a Board member from their 
district. In addition, the NASD noted, the Board has reserved the 
option of submitting to its members for consideration proposed changes 
to Rules of Fair Practice. Moreover, the NASD reiterated its 
representation that it will continue to notify its members of proposed 
rule changes through regular publication of Notice to Members and 
periodic summaries of Board meetings and noted that it will still 
respond to member comments.
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    \1\7Letter from T. Grant Callery, Vice President and General 
Counsel, NASD, to Selwyn Notelovitz, Branch Chief, SEC (Nov. 29, 
1993).
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IV. Discussion

    The Commission believes that the NASD's rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to the NASD and, therefore, has determined to 
approve the rule change. Specifically, the Commission believes that the 
rule change is consistent with the provisions of sections 15A(b)(4) and 
(6) of the Act.18 These sections require, in part, that the NASD's 
rules assure fair representation in the selection of its directors and 
the administration of its affairs and be designed to foster cooperation 
and coordination of securities transactions, to remove impediments to a 
free and open market, and to protect investors and the public interest.
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    \1\815 U.S.C. 78o-3(b)(4) and (6).
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    By eliminating the need for member vote prior to amending certain 
of the Rules of Fair Practice, the rule change simplifies the NASD's 
ability to amend its rules. With the change, the NASD's procedures for 
amending its rules will be consistent with those of other SROs in the 
securities industry, which do not require member vote for rule changes. 
According to the NASD, the change will not only reduce delays in making 
rule changes effective, but will also result in administrative cost 
savings. A member vote will, however, continue to be required for 
amendments to the NASD's By-Laws. Further, the Board has specifically 
provided that it may seek a member vote on any rule change if it 
considers such a vote appropriate.
    The rule change does not alter the substance of the NASD's Rules of 
Fair Practice. Rather, it simplifies the NASD's ability to amend its 
rules by eliminating the requirement for member vote. Nonetheless, 
mechanisms for members to participate in the formulation of and comment 
on NASD proposed rule changes remain. As noted above, members will 
continue to be able to participate in this process through the election 
of a Board member from their district and through representation on 
more than twenty Standing and District committees.19 Each Standing 
committee consists of at least one Board member and of members from 
across the country with expertise in the committee's business. In 
addition, section 19(b) of the Act provides NASD members the mechanism 
to comment in writing directly to the Commission on all NASD rule 
changes.20
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    \1\9NASD Manual, By-Laws, Sec. 4(a), (CCH) 1183; By-Laws, Art. 
III., Secs. 1-12, (CCH) 1191-1202; By-Laws, Art. XI, Secs. 1-4, 
(CCH) 1241-44.
    \2\015 U.S.C. 78s(b)(1).
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    To facilitate access to its committees, in addition to publishing 
the names and titles of all its officers, the NASD provides in the 
front of its manual a list of its committees and the names of the 
committee members. Each committee has a mission statement which 
provides it authority to make recommendations to the Board concerning 
specific areas of concentration. When the jurisdiction for an issue 
overlaps, all the relevant committees are presented an opportunity to 
provide input before a final recommendation is presented to the Board.
    The NASD's current process of electing Board members and selecting 
committee members provides fair representation of local, regional and 
national firms on the Board and on committees. To provide greater 
representation to each board member, in 1990, the NASD decreased the 
size of the Board.21 Finally, the Commission notes that an 
overwhelming majority (77%) of the members voting on the NASD's 
proposal voted to approve the rule change.
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    \2\1Securities Exchange Act Release No. 28406 (Sept. 4, 1990), 
55 FR 37782 (Sept. 13, 1990).
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    Recognizing that some rule changes will engender more debate than 
others, the Board has reserved the option of submitting to its members 
for consideration proposed changes to Rules of Fair Practice. 
Furthermore, the NASD has reiterated its representation that it will 
continue to notify its members of proposed rule changes through regular 
publication of Notice to Members and periodic summaries of Board 
meetings.
    Section 15A(b)(4) requires the NASD's rules assure fair 
representation of its members in the selection of its directors and 
administration of its affairs. This can be accomplished in several 
ways, not just by requiring member votes on specific rules. 
Accordingly, the Commission encourages the NASD not to underestimate 
the benefits derived from membership comment. In the Commission's 
experience, this provides members the opportunity to review proposals 
carefully, and often members provide useful comments which may lead to 
changes in the proposal.\22\ Committee members, therefore, should be 
encouraged to obtain the views of all interested members and committee 
chairman should be reminded of the NASD's obligation to provide fair 
representation to a cross-section of members pursuant to section 
15A(b)(4) of the Act.
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    \22\See, e.g., SR-NASD-93-3 (amendment to Section 34, Appendix 
F, Rules of Fair Practice to limit member participation in unfair 
roll-up transactions); SR-NASD-92-46 (amendment to Schedule E, 
Schedule to the By-Laws concerning conflicts of interest).
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V. Conclusion

    For the reasons stated above, the Commission believes the rule 
change is consistent with the Act and, therefore, has determined to 
approve it. The rule change will provide the NASD greater flexibility 
to amend its rules. This will enable the NASD to respond quickly to the 
needs of its members and to protect investors and the public interest 
in this era of rapidly changing market conditions.
    The Commission does not believe that the rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act, as amended.
    It is therefore ordered, Pursuant to section 19(b)(2) of the Act, 
that the rule change SR-NASD-93-48 be, and hereby is, approved.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\23\
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    \23\17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-5920 Filed 3-14-94; 8:45 am]
BILLING CODE 8010-01-M