[Federal Register Volume 60, Number 137 (Tuesday, July 18, 1995)]
[Notices]
[Pages 36838-36842]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-17582]
=======================================================================
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35956; File No. SR-NASD-95-16]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by National Association of Securities Dealers, Inc. Relating to
Amendment of the NASD Rules of Fair Practice Relating to a Customer
Complaint Reporting Rule
July 11, 1995.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on July 6,
1995,\1\ the National Association of Securities Dealers, Inc. (``NASD''
or ``Association'') filed with the Securities and Exchange Commission
(``SEC'' or ``Commission'') the proposed rule change as described in
Items I, II, and III below, which Items have been prepared by the NASD.
The Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
\1\ The proposed rule change was initially submitted on May 1,
1995, but was amended twice prior to publication of this Notice;
once on May 25, 1995, and again on July 6, 1995. The first amendment
was a technical amendment intended to clarify the scope of the rule
change. The second amendment added a time frame within which members
would be responsible to report certain information. Both amendments
are incorporated herein and are available for copying in the
Commission's Public Reference Room.
---------------------------------------------------------------------------
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The NASD is proposing to amend the NASD Rules of Fair Practice to
require NASD members to report to the NASD the occurrence of certain
specified events and quarterly summary statistics concerning customer
complaints. Below is the text of the proposed rule change. Proposed new
language is italicized and deleted language is bracketed.
Rules of Fair Practice
Article III
Reporting Requirements
Section
(a) Each member shall promptly report to the Association whenever
such member or person associated with the member:
(1) has been found to have violated any provision of any securities
law or regulation, any rule or standards of conduct of any governmental
agency, self-regulatory organization, or financial business or
professional organization, or engaged in conduct which is inconsistent
with just and equitable principles of trade; and the member knows or
should have known that any of the aforementioned events have occurred;
(2) is the subject of any written customer complaint involving
allegations of theft or misappropriation of funds or securities or of
forgery;
(3) is named as a defendant or respondent in any proceeding brought
by a regulatory or self-regulatory body alleging the violation of any
provision of the Securities Exchange Act of 1934, or of any other
federal or state securities, insurance, or commodities statute, or of
any rule or regulation thereunder, or of any provision of the By-laws,
rules or similar governing instruments of any securities, insurance or
commodities regulatory or self-regulatory organization;
(4) is denied registration or is expelled, enjoined, directed to
cease and desist, suspended or otherwise disciplined by any securities,
insurance or commodities industry regulatory or self-regulatory
organization or is denied membership or continued membership in any
such self-regulatory organization; or is barred from becoming
associated with any member of any such self-regulatory organization;
(5) is indicted, or convicted of, or pleads guilty to, or pleads no
contest to, any criminal offense (other than traffic violations);
(6) is a director, controlling stockholder, partner, officer or
sole proprietor of, or an associated person with, a broker, dealer,
investment company, investment advisor, underwriter or insurance
company which was suspended, expelled or had its registration denied or
revoked by any agency, jurisdiction or organization or is associated in
such a capacity with a bank, trust company or other financial
institution which was convicted of or pleaded no contest to, any felony
or misdemeanor;
(7) is a defendant or respondent in any securities or commodities-
related civil litigation or arbitration which has been disposed of by
judgement, award, or settlement for an amount exceeding $15,000.
However, when the member is the defendant or respondent, then the
reporting to the Association shall be required only when such
judgement, award, or settlement is for an amount exceeding $25,000;
(8) is the subject of any claim for damages by a customer, broker,
or dealer which is settled for an amount exceeding $15,000. However,
when the claim for damages is against a member, then the reporting to
the Association shall be required only when such claim
[[Page 36839]]
is settled for an amount exceeding $25,000;
(9) is associated in any business or financial activity with any
person who is subject to a ``statutory disqualification'' as that term
is defined in the Securities Exchange Act of 1934, and the member knows
or should have known of the association. The report shall include the
name of the person subject to the statutory disqualification and
details concerning the disqualification;
(10) is the subject of any disciplinary action taken by the member
against any person associated with the member involving suspension,
termination, the withholding of commissions or imposition of fines in
excess of $2,500, or otherwise disciplined in any manner which would
have significant limitation on the individual's activities on a
temporary or permanent basis.
(b) Each person associated with a member shall promptly report to
the member the existence of any of the conditions set forth in
paragraph (a) of this rule. Each member shall report to the Association
not later than 10 business days after the member knows or should have
known of the existence of any of the conditions set forth in paragraph
(a) of this rule.
(c) Each member shall report to the Association statistical and
summary information regarding customer complaints in such detail as the
Association shall specify by the 15th day of the month following the
calendar quarter in which customer complaints are received by the
member. For the purposes of this paragraph, ``customer'' includes any
person other than a broker or dealer with whom the member has engaged,
or has sought to engage, in securities activities, and ``complaint''
includes any written grievance by a customer involving the member or
person associated with a member.
(d) Nothing contained in paragraphs (a), (b) and (c) of this rule
shall eliminate, reduce, or otherwise abrogate the responsibilities of
a member or person associated with a member to promptly file with full
disclosure, required amendments to Form BD, Forms U-4 and U-5, or other
required filings, and to respond to the Association with respect to any
customer complaint, examination, or inquiry.
(e) Any member subject to substantially similar reporting
requirements of another self-regulatory organization of which it is a
member is exempt from the provisions of this rule.
* * * * *
Schedule C
Part V
[Disciplinary Actions]
[Every member shall promptly notify the Corporation in writing of any
disciplinary action, including the basis therefor, taken by any
national securities exchange or association, clearing corporation,
commodity futures market or government regulatory body against itself
or its associated persons, and shall similarly notify the Corporation
of any disciplinary action taken by the member itself against any of
its associated persons involving suspension, termination, the
withholding of commissions or imposition of fines in excess of $2,500,
or any other significant limitation on activities.]
II. Self-Regulatory Organization's Statement of the Purpose of and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the NASD included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. The NASD has prepared summaries, set forth in Sections
(A), (B), and (C) below, of the most significant aspects of such
statements.
(A) Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
The purpose of the proposed rule change is to adopt an enabling
rule which requires NASD members to report certain information on a
timely basis to the NASD so that the NASD can more aggressively detect
and investigate sales practice violations.
In furtherance of the NASD's varied initiatives to address sales
practice abuses and supervisory concerns, the NASD is proposing an
amendment to Article III of the Rules of Fair Practice (Rules) to
require members to report to the NASD the occurrence of specified
events and quarterly summary statistics concerning customer complaints.
The proposed rule would provide important new regulatory information
that will assist the NASD in the timely identification of problem
members, branch offices, and registered representatives in order to
more aggressively detect and investigate sales practice violations. If
adopted, the proposed rule would significantly parallel comparable
provisions of existing Rule 351 of the New York Stock Exchange (NYSE).
The NASD is concerned that critical material information identified
in the proposed rule, such as reports on statutory disqualifications,
internal disciplinary actions, and quarterly statistical data regarding
customer complaints received by a member is not now required by Form U-
4 or other forms to be reported to the NASD. As such, this information
is not available to the NASD staff on a routine, systematic, or timely
basis. In this regard, the NASD believes that the affirmative
obligation of members to provide the NASD with notice of certain events
concerning member firms or their associated persons will significantly
enhance the NASD's ability to quickly identify problem representatives
and appropriately respond in a timely manner.
The SEC supported the NASD adoption of a customer complaint
reporting rule similar to NYSE Rule 351 in its Large Firm Project
Report issued in conjunction with a cooperative effort involving the
NASD, SEC, and NYSE that examined the hiring and retention practices of
nine of the largest broker-dealers in the United States. Similarly, the
General Accounting Office (GAO) in its report titled Securities
Markets: Actions Needed to Better Protect Investors Against
Unscrupulous Brokers, recommended that member firms' customer complaint
information be computer captured and utilized as an additional tool by
regulators for identifying potentially problem firms.
As proposed, Subsection (a) of the rule requires member firms to
file a report with the NASD when any of 10 different specified events
occurs. These 10 events vary significantly, ranging from situations
where a court, government agency, or self-regulatory organization (SRO)
has determined there has been a violation of the securities laws, to
circumstances where a firm has received a written customer complaint
alleging theft or misappropriation of funds or securities, or forgery.
Subsection (b) of the proposed rule requires each person associated
with an NASD member to properly report to the member the existence of
any of the 10 conditions set forth in Subsection (a) of the proposed
rule. Subsection (b) also requires members to report to the NASD the
existence of any of the conditions set forth in Subsection (a) not
later than 10 business days after the member knows or should have known
of the existence of such conditions.
[[Page 36840]]
Subsection (c) of the rule further requires members to report to
the NASD statistical and summary information regarding written customer
complaints received by the member firm or relating to the firm or any
of its associated persons. Importantly, Subsection (e) of the proposed
rule eliminates the possibility of unnecessary regulatory duplication
by providing an exemption from filing with the NASD for members already
subject to similar reporting requirements of another SRO. NYSE Rule 351
is the only such rule in place at this time.
Currently, Part V of Schedule C to the NASD By-Laws requires
members to promptly notify the NASD in writing of any disciplinary
action that the member takes against any of its associated persons
involving suspension, termination, the withholding of commissions, or
imposition of fines in excess of $2,500, or any other significant
limitation on activities. As this existing disclosure requirement is
incorporated into the proposed rule in Subsection (a)(10), the NASD is
proposing to rescind this part of Schedule C with the adoption of the
new rule.
Members will file the information required by this rule through the
same data entry mechanism that is used for the electronic filing of
FOCUS reports. The NASD will distribute to the members the software
which will allow the members to file this information electronically.
The NASD believes that the proposed rule change is consistent with
the provisions of Section 15A(b)(6) of the Act in that the proposed new
Rule of Fair Practice will improve the NASD's ability to detect and
investigate sales practice violations. Pursuant to this statutory
obligations, the NASD has proposed this rule change in order to
establish a reporting mechanism for certain specified events which will
enhance the NASD's regulatory efforts.
(B) Self-Regulatory Organization's Statement on Burden on Competition
The NASD does not believe that the proposed 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.
(C) Self-Regulatory Organization's Statement on Comments on the
Proposed Rule Change Received From Members, Participants, or Others
The Association received 25 letters commenting on Notice to Members
94-95 (``the Notice''), the proposed amendment to the Rules of Fair
Practice. Below is a summary of the more significant and/or recurring
issues raised in the letters and the NASD's position in connection with
the same.
The NASD published Notice to Members 94-95 on December 15, 1994.
The Notice requested member comment on a new Rule of Fair Practice
which would require NASD members to report to the NASD the occurrence
of certain specified events and quarterly summary statistics concerning
customer complaints.
Twenty-five comment letters have been received. Twenty-four of
these are from NASD member firms or associations representing certain
industry segments; e.g., the Securities Industry Association. One
letter was received from a former registered person. Eight responses
were against the rule proposal with comment, fifteen responses were in
general agreement with the concept of the proposal, but with suggested
modifications, and one letter supported the proposal. The remaining
response requested a continuance to comment.
Overview of Comments
I. Form U-4 Reporting and the CRD System
The common general criticism was that the proposed rule is somewhat
duplicative of current reporting to the CRD through Form U-4. Also, a
majority of commenters questioned the manner in which the required
information would be collected and reported to the NASD. Similar
comments were also made that the proposal is premature in view of the
other ongoing initiatives involving the CRD redesign. As a result, some
commenters suggest that this rule proposal be postponed until such time
as the CRD redesign project is completed.
Additionally, one commenter suggested that it seems overburdensome
for members to provide another reporting channel for customer
complaints under the proposed rule. Another commenter was concerned
that the proposed rule would create a parallel database of the
disciplinary history of registered representatives separate and
distinct from the CRD system. Another commenter suggested that
quarterly statistical information be reported through CRD.
II. Filing Format and Content
Several commenters observed that the proposed rule fails to
disclose actual information to be filed by the member, to whom at the
NASD, and in what form. Further, several commenters asked how the
information should be transmitted to the NASD.
III. Separate Reporting Obligations on Members and Registered Persons
Several commenters noted that the proposed rule had separate
reporting obligations for the member and the registered person. A
number of commenters requested clarification on the member's obligation
to independently determine the existence of any of the cited provisions
regarding their registered persons, especially where the registered
person may be the only known source of this information. As a result,
one commenter suggested that the rule proposal should be modified to
require disclosure of reported events upon ``obtaining knowledge'' and
not the ``occurrence'' of the event.
IV. Public Versus Non-Public Availability of the Information
Several commenters were confused as to whether the information
submitted to the NASD would immediately, or at some future date, be
provided to the public. As a result consistent with their understanding
of the NYSE Rule 351 information, commenters suggested that the
information remain confidential.
V. Breadth and Scope of the Proposed Rule
Some commenters were concerned by the scope of the proposed rule
and opined that the requested information goes beyond the state
regulatory purposes.
Specific Comments
The following specific comments will highlight the comments with
respect to the various provisions of the proposed rule.
Section (a)(1)
Several commenters stated that this section is overly broad by
requiring reporting by any violation of ``rules or standards of
conduct'' of any governmental entity, SRO, or business or professional
organization. According to commenters, this would include violations of
rules and regulations that have no relationship to securities
activities or financial businesses. In this regard, one commenter
suggested that the proposed provision should be revised to state that
it only pertains to misconduct related to the financial services
industry.
Section (a)(2)
Most commenters on this provision were concerned that the proposed
rule required the reporting of ``allegations'' of misconduct. A general
view was that requiring a report based only on allegations, without
permitting some
[[Page 36841]]
initial evaluation or finding of reasonable cause, may lead to reports
that are based on false information. This allegedly could result in
damage to the reputation of members and associated persons who are
innocent of wrongdoing. Therefore, commenters suggested that members be
given an opportunity to screen customer complaints for veracity before
filing, or to permit the filing of later reports to correct previously
reported information after a member investigation.
Section (a)(3)
Four comments were made on this provision. Two commenters suggested
that the reporting of prospective legal action may lend underserved
credibility to the accusations and may be prejudicial. In addition, one
commenter stated that the proposal does not distinguish between minor
and major violations and ventures into areas that are not within the
jurisdiction of the NASD (i.e., insurance regulations, bank and trust
company regulations).
Lastly, one commenter suggested that the definition of
``proceedings'' be defined and suggested adopting portions of the
definition found on Form BD dealing with civil proceedings. The basis
for the comment was to account for the differences among the various
administrative procedures and regulatory processes of the 50 states,
their agencies, and federal agencies and SROs.
Section (a)(4)
Three commenters on this provision suggested that the member should
not have to report these matters to a second database when the
information is already reported through the CRD system. Another
commenter requested clarification of whether an action had to reach a
final order or adjudication before reporting to the NASD.
Section (a)(5)
The majority of commenters to this section suggested that the
proposed provision be revised to narrow the nature and range of
offenses to securities related activities and determine a level of
progression beyond arrest and arraignment before reporting to the NASD.
In addition, several commenters suggested that current reporting under
CRD system through Form U-4, question 22, is sufficient and was
designed to obtain information that has a direct bearing on an
individual's fitness to be employed in the securities industry.
Section (a)(6)
Five commenters submitted comments on this provision. Two
commenters suggested modifications to the proposed rule to restrict the
provision's application to persons with a ``control relationship'' with
the entity (i.e., director, controlling shareholder, partner, officer
or sole proprietor). According to the commenters, it is reasonable to
attribute some responsibility to the person if he or she is in a
control or principal relationship with the entity, not if the person is
solely ``associated'' with the entity. Another commenter suggested
that, unless the registered person notified the member of its
activities, it would be difficult to comply with this provision.
Sections (a)(7) and (a)(8)
The commenters suggested that this provision required clarification
for a number of specific fact situations. One commenter suggested that
the reporting thresholds are too low for both the individual and the
firm in today's litigious society and inflationary times, but did not
provide any suggestions for alternate amounts.
Section (a)(9)
Several commenters suggested that this proposed provision is too
broad and does not support its stated purpose. Comments included the
difficulty for registered persons and firms to make the required
determination of whether a person is ``subject'' to a statutory
disqualification. According to the commenters, a registered person may
enter into a business relationship with an individual without knowledge
that the person committed a felony, not involving securities or
investments, within the past ten years.
Other commenters suggested that the proposed provision should be
modified to require reporting when a member or registered person
``knows or learns'' of the relationship with a statutorily disqualified
person.
Two commenters suggested that it will be difficult for the member
to comply without actual knowledge conveyed to them from the registered
persons. One commenter suggested that the proposed provision is
inconsistent with the intent to obtain information for the timely
identification of problem broker-dealers and registered persons, in
that, the information requested involved de minimis securities
activities, non-securities business relationships, and similar
situations.
One commenter mentioned the proposed provision be expanded to
include the requirement to report detail about the associated person's
relationship with the statutorily disqualified person, such as, the
nature of their business relationship.
Response to Comments
The most significant concerns of the commenters focused on (1)
duplicative reporting; (2) public availability of the data to be
reported; (3) the reporting of unresolved customer complaints; (4) the
reporting protocol; (5) member obligations to ensure that their
associated persons disclose reportable events to them; (6) the
reporting of a broad array of violations; and (7) reporting arrests.
Duplicative Reporting
Many commenters did not recognize that existing reporting
obligations, particularly through Form U-4, do not cover some of the
most crucial information contained in the proposal. For example, Form
U-4 does not and will not collect data on statutory disqualifications,
internal disciplinary actions, or quarterly statistical data on
customer complaints. Also, Form U-4 information is presently collected
through the CRD system for registration and licensing purposes. That
data is not available to the NASD staff on a routine, systematic, or
timely basis for regulatory purposes and will not be available in the
foreseeable future. On the other hand, the proposed rule is designed to
separately collect data on a timely basis to substantially enhance
regulatory initiatives relating to the detection of sales practice
violations through the early identification of problem registered
representatives. Significantly, the proposed rule squarely responds to
SEC and GAO report recommendations. Those reports strongly urge the
NASD to adopt a rule similar to NYSE Rule 351 for the purpose of
enhancing sales practice initiatives and identifying problem registered
representatives through the analysis of customer complaint patterns and
other relevant information. Also responsive to concerns regarding
duplicative reporting is the provision of the proposed rule which
exempts members that have substantially similar reporting requirements
to another SRO (i.e.: the NYSE under Rule 351). Further, upon
implementation of the redesigned CRD which will provide more ready
access to registration information, the NASD will undertake to review
the proposed reporting rule to determine whether certain of the
duplicative requirements may be eliminated. To the degree that such
modifications are feasible, the NASD would intend to delete such
provisions from the proposed rule.
[[Page 36842]]
Public Availability of Data
A number of commenters clearly interpreted the proposed rule as
permitting public disclosure of the information to be reported.
However, the NASD collected data will not be made available to the
public. The data will be used solely for regulatory purposes, an
approach fully consistent with NYSE practices under Rule 351. This
would not be the case if, as one commenter suggested, CRD was used to
collect and store the customer complaint and other information. CRD
data is generally available to the public by state regulators pursuant
to disclosure statues. For this reason, it is imperative that a
separate and private regulatory database be developed to collect and
store the information.
Customer Complaint Reporting
The proposed rule is designed to act as an early warning system for
potential sales practice problems engaged in by identified registered
representatives. To achieve this result, the information collected will
be analyzed for, among other things, patterns of customer complaints
involving member firms and registered persons, whether or not all of
the complaints are ultimately substantiated. This data represents a
core feature of the new rule. As highlighted in the SEC's Large Firm
Project Report, identical data obtained through NYSE Rule 351 was a key
component in developing the Large Firm Project's special examination
list. Similar customer complaint data was also used extensively to
focus the new, ongoing joint regulatory problem representative sweep.
In this regard, the regulatory priorities relating to the collection of
written customer complaint data outweighs concerns about reporting
customer allegations of misconduct. Again, commenters are likely to be
comforted on this issue once they fully recognize that unsubstantiated
customer complaints will be solely used for regulatory purposes and not
be made available to the public.
Reporting Protocol
Concerns regarding the mechanics of the proposed rule will be
addressed in subsequent Notices to Members. The staff has developed the
specifications for electronic reporting that will facilitate the ease
of data transmission by members and data collection by the NASD. The
system specifications and the reporting protocol will be fully reported
to the members via the Notice to Members and appropriate software will
be provided.
Member Responsibility to Ensure Associated Person Disclosure
Commenters expressed concern about a member's obligation to ensure
compliance with the proposed rule where an associated person fails to
disclose to the member the occurrence of an event specified in
subsection (a)(9). A resolution surfaced in the comments by the
suggestion that the rule proposal be modified to require member
reporting under subsection (a)(9) only if the member obtains knowledge
of the reportable event. Extending this concept to ensure that members
do not intentionally avoid becoming aware of a reportable event, it was
suggested that proposed subsection (a)(9) be modified to obligate
member reporting under this item only if the member ``knows or should
have known'' of the existence of the reportable event.
Violation Reporting
Several commenters indicated that subsection (a)(1) information was
too broad and should require reporting only after a finding of
violation is made. Adopting this standard would add certainty to the
proposed reporting obligation and clarify that members are not expected
to launch independent inquiries to determine, for example, whether an
associated person violated a provision of a business or professional
organization. As a result, it was suggested that the rule proposal be
modified to include language that a ``finding of violation'' is
necessary before an occurrence needs to be reported under subsection
(a)(1).
Arrest Reporting
Comments arose under proposed subsection (a)(5) that included the
reporting of arrests. Analysis of this issue indicates that the NASD
may not have the authority to gain access to arrest records of an
individual. Similarly, ``arraignment'' carries a different meaning
among states and is not consistently an indication that a person has
been charged with a crime. For these reasons, it was suggested that the
proposal be modified to delete the term ``arrest'' and ``arraignment''
from the text.
With regard to some of the specific comments raised, the NASD Board
has amended the proposed rule in the following areas: (1) filings
required pursuant to subsection (a)(1) are to be made only when there
is a finding of violations; (2) ``arrest'' and ``arraignment'' are
deleted from subsection (a)(5); and (3) filings required under
subsection (a)(9) are to be made only where the member knows or should
have known of the information to be reported.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 35 days of the publication of this Notice in the Federal
Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
A. By order approve such proposed rule change, or
B. Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing. Persons making written submissions
should file six copies thereof with the Secretary, Securities and
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549.
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for inspection and copying in the
Commission's Public Reference Room. Copies of such filing will also be
available for inspection and copying at the principal office of the
NASD. All submissions should refer to file number SR-NASD-95-16 and
should be submitted by August 8, 1995.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\2\
\2\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-17582 Filed 7-17-95; 8:45 am]
BILLING CODE 8010-01-M