[Federal Register Volume 59, Number 129 (Thursday, July 7, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-16419]


[[Page Unknown]]

[Federal Register: July 7, 1994]


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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34284; File No. SR-BSE-93-19]

 

Self-Regulatory Organizations; Order Approving a Proposed Rule 
Change by the Boston Stock Exchange Inc., Relating to the Insider 
Trading and Securities Fraud Enforcement Act of 1988

June 30, 1994.

I. Introduction

    On November 8, 1993, the Boston Stock Exchange Inc. (``BSE'' or 
``Exchange'') submitted to the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'')\1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to adopt a new BSE Rule--Chapter 
II, Section 37(a), ITSFEA Procedures--relating to the establishment, 
maintenance and enforcement of procedures designed to prevent the 
misuse of material, non-public information. On January 13, 1994, the 
BSE submitted to the Commission an amendment to the proposed rule 
change.\3\ Notice of the proposal appeared in the Federal Register on 
February 14, 1994. No comments were received on the proposal.
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    \1\15 U.S.C. 78s(b)(1) (1988).
    \2\17 CFR Sec. 240.19b-4 (1991).
    \3\See letter from Karen A. Aluise, assistant Vice President, 
Boston Stock Exchange, to Sandy Sciole, Branch Chief, Commission, 
dated January 13, 1994. The BSE letter made a similar change in nine 
places that clarifies member obligations with respect to 
``securities transactions which they reasonably believe may have 
involved the misuse of material, non-public information.'' Exhibit 4 
of the proposal requires associated persons to submit a list of 
securities accounts in which they either have a direct or indirect 
financial interest or make investment decisions. Associated persons 
with the firm are under a continuous obligation to update the list. 
The BSE's letter deleted a sentence that resulted in confusion on 
this matter. The letter also added ``trade confirmations'' to 
Exhibit 4, paragraph 1a, so that associated persons must submit to 
the member organization duplicate trade confirmations and monthly 
account statements for each relevant account. Finally, the letter 
changed the date in the Exhibit 3, Sample Membership Bulletin, from 
March 31, 1994, to April 30, 1994.
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II. Description of the Proposal

A. Background

    In November 1988, Congress enacted the Insider Trading and 
Securities Fraud Enforcement Act of 1988 (``ITSFEA''), designed 
primarily to prevent, deter, and prosecute insider trading.\4\ ITSFEA 
created a new Section 15(f) of the Act\5\ to require broker-dealers to 
maintain procedures designed to prevent the misuse of material, non-
public information by such Broker-dealers or any person associated with 
such broker-dealers. ITSEFEA also granted the Commission broad rule-
making authority concerning so-called ``Chinese Wall'' procedures 
developed by broker-dealers to deter and prevent insider trading.\6\ 
Pursuant to this grant of rule-making authority, the Division undertook 
a comprehensive review of broker-dealer policies and procedures and, in 
March of 1990, issued a report of its findings, conclusions and 
recommendations.\7\ In the Report, the Division stated that, among 
other things, it was concerned about the need for firms to ``maintain 
documentation sufficient to recreate actions taken pursuant to Chinese 
Wall procedures.''\8\ Accordingly, the Division urged the self-
regulatory organizations (``SRO'') to develop standards of 
documentation for their member firms as well as effective examination 
programs.
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    \4\4 Pub. L. No. 100-704.
    \5\15 U.S.C. 78o (f) (1988).
    \6\``Chinese Walls'' are broker-dealer policies and procedures 
designed as information barriers to segment the flow and prevent the 
misuse of material, non-public information.
    \7\See Report on Broker-Dealer Policies and Procedures Designed 
to Segment the Flow and Prevent the Misuse of material Non-public 
Information (``Report''), Division of Market Regulation, Commission, 
March 1990.
    \8\Id. at 26.
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B. The Proposal

    The proposed rule change was designed to supplement Section 15(f) 
of the Act and ITSFEA, by requiring every member organization of the 
Exchange to establish, maintain, and enforce written policies and 
procedures reasonably designed to prevent the misuse of material, non-
public information by such member and any person associated with the 
member. The proposal establishes minimum standards for compliance with 
the record-keeping requirements of the Rule and the Act. It mandates 
that all members that are required to file SEC Form X-17A-5 (``FOCUS 
Reports'') with the Exchange on an annual basis submit with their FOCUS 
Reports signed statements by such members that the procedures mandated 
by this rule have been established, enforced and maintained. The 
proposal requires members and associated persons to promptly notify the 
Exchange's Market Surveillance Department of any securities transaction 
that the firm reasonably believes may have involved the misuse of 
material, non-public information. Finally, the proposal provides that 
when BSE members adopt written supervisory procedures relating to 
ITSFEA in connection with requirements of another designated examining 
authority (``DEA''), that member organization shall not be subject to 
the ITSFEA requirements of this Rule.
    The proposal adds four Supplementary Material provisions to Chapter 
II, ITSFEA Procedures, Section 37(a) of the BSE Rules. Supplementary 
Material .01 describes conduct that would constitute the misuse of 
material, non-public information. This conduct includes, but is not 
limited to: (a) Trading in any securities, or in any related securities 
issued by a corporation, in any related securities or related options 
on other derivative securities while knowingly in possession of 
material non-public information concerning that issuer; (b) trading in 
a security or related option or other derivative security while in 
possession of material, non-public information concerning imminent 
transactions in the security or related securities; or (c) disclosing 
to another person or entity any material, non-public information 
involving a corporation whose shares are publicly traded or an imminent 
transaction in an underlying security or related securities for the 
purpose of knowingly facilitating the possible misuse of material, non-
public information.
    The Exchange states that the scope of the aforementioned definition 
is intended to be consistent with the goals of Section 15(f) of the Act 
and ITSFEA to prevent the misuse of material, non-public information. 
The Exchange believes that this definition should be broad enough to 
encompass frontrunning, trading on the basis of material corporate 
inside information, tipping, and misappropriating material corporate 
inside information.
    Supplementary Material .02 defines the terms ``associated person'' 
or ``person associated with a member.'' These terms shall mean any 
partner, officer, director, or branch manager of a member (or any 
person occupying a similar status or performing similar functions), any 
person directly or indirectly controlling, controlled by, or under 
common control with a member, or any employee of a member.
    Supplementary Material .03 requires, at a minimum, that each member 
establish, maintain and enforce certain policies and procedures. This 
provision specifically requires, first, that members must advise all 
associated persons in writing of the prohibition against the misuse of 
material, non-public information. Second, each member organization and 
all persons associated with that member organization must sign 
statements affirming their awareness of and agreement to abide by the 
prohibitions of the ITSFEA Rule. These signed statements must be 
maintained for at least three years, the first two years in an easily 
accessible place. Third, each member organization must maintain copies 
of trade confirmations and monthly account statements for each account 
in which an associated person has a direct or indirect interest or 
makes investment decisions. These trade confirmations and monthly 
account statements must be maintained for at least three years, the 
first two years in an easily accessible place. In addition, such 
brokerage accounts must be reviewed at least quarterly by the member 
organization for the purpose of detecting the possible misuse of 
material, non-public information. Fourth, an associated person must 
disclose to the member organization whether he, or any person in whose 
account he has a direct or indirect financial interest, is an officer, 
director or 10% shareholder in a company whose shares are publicly 
traded. Any transaction in the stock (or option thereon) of such 
company shall be reviewed to determine whether the transaction may have 
involved a misuse of material, non-public information.
    The Exchange states that the aforementioned policies and procedures 
may not, in all cases, satisfy the requirements of this rule. The 
adequacy of each member's policies and procedures will depend upon the 
nature of such member's business.
    Supplementary Material .04 and the Sample Membership Bulletin\9\ 
(Exhibit 3 to the proposal) describe a set of forms, denominated as the 
``ITSFEA Compliance Procedures'' (Exhibit 4 to the proposal), which may 
be used by certain eligible member organizations to facilitate their 
compliance with the recordkeeping and filing requirements of Chapter 
II, Section 37 (a) and (b). The Exchange states that the Sample ITSFEA 
Compliance Procedures are intended to constitute the minimum policies 
and procedures required by the Act and this rule. Their use, however, 
does not ensure compliance with the recordkeeping and filing 
requirements.
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    \9\A copy of the BSE's ``Sample Membership Bulletin'' and a 
``Summary of the ITSFEA Compliance Procedures'' were filed with the 
proposed rule change.
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    The Sample ITSFEA Compliance Procedures require identification of 
securities accounts as described in ITSFEA Form 1 (``Form 1''). Form 1 
requires each associated person to submit a list of each securities 
accounts in which he/she either has a direct or indirect financial 
interest, or makes investment decisions. This list is to include not 
only the accounts of associated persons, but also the accounts of 
relatives of such persons to the extent that an associated person has 
an interest in such accounts or makes investment decisions with respect 
thereto. Form 1 further requires all associated persons to transmit to 
the member organization duplicate trade confirmations and monthly 
account statements for each account in which they have a direct or 
indirect financial interest, or for which they make investment 
decisions. These account statements must be maintained by the member 
organization for at least three years. In addition, Form 1 requires all 
associated persons to disclose to the member organization if they, or 
any persons in whose account they have a direct or indirect financial 
interest, or over whose account they make investment decisions, is an 
officer, director or 10% shareholder in the company whose shares are 
publicly traded. Any transaction in the stock of any company shall be 
reviewed to determine whether the transaction may have involved a 
misuse of material, non-public information.
    The Sample ITSFEA Compliance Procedures requires a ``Statement of 
Compliance by Associated Persons'' as described in ITSFEA Form 2 
(``Form 2'').\10\ Form 2 outlines a sample ``Statement of Compliance'' 
which should be read and signed by all associated persons at the time 
they join the member organization and at least annually thereafter.
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    \10\A copy of the BSE's ``Statement of Compliance by Associated 
Persons'' was filed with the proposed rule change.
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    The Sample ITSFEA Compliance Procedures also require a ``Statement 
of Compliance by Senior Reporting Member'' as described in ITSFEA Form 
3 (``Form 3'').\11\ Form 3 provides that each member organization must 
designate a Senior Reporting Member to be responsible for implementing 
all necessary policies and procedures on behalf of the member 
organization.\12\ This person shall sign a Statement of Compliance on 
behalf of the member organization and submit such certification to the 
Exchange at the time the firm files its year-end FOCUS Report (Form X-
17A-5).
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    \11\A copy of the BSE's ``Statement of Compliance by Senior 
Reporting Members'' was filed with the proposed rule change.
    \12\This includes, inter alia, the filing of all appropriate 
information and the review of all employee accounts.
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    The Sample ITSFEA Compliance Procedures provide additional guidance 
regarding account review and review of proprietary or associated person 
trading. For example, under the Sample ITSFEA Compliance Procedures, a 
member organization shall review, at least quarterly, all account 
statements and/or trade confirmations for accounts in which associated 
persons have a direct or indirect financial interest or make investment 
decisions and a written record of such review shall be maintained for 
three years. The Sample ITSFEA Compliance Procedures also provide, 
inter alia, that when conducting a review of proprietary or associated 
person trading, the timing or unusual nature of a transaction shall be 
considered.

III. Discussion and Conclusion

    The Commission believes that the proposed rule change is consistent 
with section 6(b) of the Act, in general, and section 6(b)(5) of the 
Act, in particular,\13\ in that it is designed to prevent fraudulent 
and manipulative acts and practices and promote just and equitable 
principles of trade. The proposal will accomplish this by setting 
standards and bringing consistency to member practices to prevent the 
misuse of material, non-public information.
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    \13\15 U.S.C. 78f(b)(5) (1988).
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    Broker-dealer Chinese Walls predate section 15(f) of the Act and 
have evolved to include policies and physical apparatus designed to 
prevent the improper or unintended dissemination of market sensitive 
information from one division of a multi-service firm to another. The 
Chinese Wall procedures also have developed trading reviews designed to 
prevent and detect illegal trading. Prior to the existence of section 
15(f), however, the policies and procedures varied from one broker-
dealer to the next, ranging from very tight, centralized control of 
information and review to little or no review or follow-up. The 
Division, in its Report, stated that broker-dealer oversight with 
regard to section 15(f) is an important issue and is best effectuated 
by SRO examinations and regulation subject to Commission oversight.\14\ 
The Commission believes that the BSE's proposal adequately addresses 
the concerns raised in the Division's Report and that it should help to 
prevent the misuse of material, non-public information by brokers and 
dealers.
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    \14\See Report, supra note 8 at 23.
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    Specifically, the Commission believes that the policies and 
procedures set forth in Chapter II, Section 37(a) of the BSE Rules and 
the corresponding Supplementary Material provisions will serve to 
ensure that BSE members establish, maintain and enforce policies to 
prevent the misuse of material, non-public information, thereby helping 
to assure that BSE members are in compliance with section 15(f) of the 
Act. First, the requirement that all associated persons be advised in 
writing of the prohibition against the misuse of material, non-public 
information as defined in the Rule, and the requirement that member 
organizations and persons associated with them sign attestations 
affirming their awareness of, and agreement to abide by, the 
aforementioned prohibitions will serve to heighten awareness of 
associated persons of this prohibition. Second, the requirements that 
member organizations maintain copies of trade confirmations and monthly 
account statements for each account in which an associated person has a 
direct or indirect financial interest or makes investment decisions and 
that such brokerage accounts be reviewed by the member organization 
will assist Exchange and Commission review of those records and make 
any fraudulent acts easier to deter and detect. Third, the requirement 
that an associated person disclose to the member organization whether 
he, or any person in whose account he has a direct or indirect 
financial interest, or for which he makes investment decisions, is an 
officer, director or 10% shareholder in a company whose shares are 
publicly traded, and the requirement that transactions in the stock (or 
option thereon) of such company be reviewed to determine whether the 
transaction may have involved a misuse of material, non-public 
information, will assist the Exchange and the Commission in the 
detection and deterrence of the misuse of material, non-public 
information.
    The Commission believes that it is consistent with the Act for the 
BSE Rules to require that only members who file their FOCUS reports 
annually with the Exchange submit, along with their FOCUS Reports, an 
attestation of their compliance with the BSE Rule. In this regard, the 
Commission notes that members that file FOCUS Reports on a more 
frequent basis are subject to more frequent periodic audits by the 
Exchange. During these audits, the Exchange will review the procedures 
maintained by such members pursuant to the BSE's Rule. Members who file 
FOCUS Reports on an annual basis, however, are subject to audits on a 
more infrequent basis. Accordingly, the Commission believes that the 
requirement that these members file an annual attestation that they are 
in compliance with the BSE Rule will serve as a continuing reminder of 
the obligations of this rule. This should result in more internal 
compliance checks by members and, therefore, assist the Exchange in the 
administration of the BSE Rule without compromising the effectiveness 
of the rule or adherence to section 15(f) of the Act.
    The Commission believes that Supplementary Material .02 of Chapter 
II, Section 37 of the BSE Rule, which defines ``associated persons'' or 
``person associated with a member'' is consistent with the Act. 
Currently, the Exchange, in enforcing its rules, applies the definition 
of ``person associated with a member'' or ``associated person of a 
member'' contained in section 3(a)(21) of the Act. The proposal adopts 
this definition into the Exchange's rules.
    Finally, the Commission believes that the designation of a senior 
reporting member to be responsible for implementing all necessary 
ITSFEA policies and procedures is appropriate to help ensure member 
firm compliance with the ITSFEA requirements of the Act.
    For the reasons stated above, it is therefore ordered, pursuant to 
section 19(b)(2) of the Act,\15\ that the proposed rule change (SR-BSE-
93-19) is hereby approved.
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    \15\15 U.S.C. 78s(b)(2) (1988).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\16\
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    \16\17 CFR 200.30-3(a)(12) (1991).
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Jonathan G. Katz,
Secretary.
[FR Doc. 94-16419 Filed 7-6-94; 8:45 am]
BILLING CODE 8010-01-M