[Federal Register Volume 61, Number 92 (Friday, May 10, 1996)]
[Notices]
[Pages 21517-21521]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-11747]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37169; File No. SR-NASD-96-15]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by National Association of Securities Dealers, Inc. Relating to 
Schedule A to the By-Laws To Amend the Allowable Exclusions and 
Deductions From the Definition of Gross Revenue for Member Assessment 
Purposes

May 6, 1996.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on April 4, 1996, the 
National Association of Securities Dealers (``NASD'' or 
``Association'') filed with the Securities and Exchange Commission 
(``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.
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    \1\ 15 U.S.C. 78s(b)(1)
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    Following is the text of the proposed rule change. Proposed new 
language is italicized; deletions are in brackets.

NASD By-Laws

Schedule A

* * * * *
Section 5  Gross Revenue for Assessment Purposes
    (a) Gross revenue is defined for assessment purposes as total 
income as reported on FOCUS form Part II or IIA with the following 
exclusions:
    [  ] (1) Other income unrelated to the securities business;
    [  ] [Interest and dividends;]
    [  ] (2) Commodities income;
    [  ] (3) Advisory fees, investment management fees and 
finders' fees not directly involving the offering of securities; proxy 
fees; vault service fees; safekeeping fees; transfer fees; and fees for 
financial advisory services for municipalities;
    [  ] (4) Commissions derived from transactions executed on 
a registered national securities exchange or a foreign securities 
exchange (Note 1);
    [  ] (5) Profits or losses derived from transactions of 
which both the purchase and sale are executed on a registered national 
securities exchange, including arbitrage (Note 1); and
    [  ] (6) Profits and losses derived from transactions in 
certifications of deposit and commercial paper, which is defined to 
include drafts, bills of exchange, and bankers acceptances.
    (b) In addition, members may deduct:
    [  ] (1) Any commissions, concessions or other allowances 
paid to another member in connection with the execution or clearance of 
transactions included in reported revenue. For example, a member acting 
as a clearing agent for another member shall deduct net amounts allowed 
to the non-clearing member; [and]
    [  ] (2) 25% of gross wrap fees charged to and received 
from customers and paid or allocated to investment managers or 
advisors[.]; and
    [  ] (3) Interest and dividend expense but not in excess of 
related interest and dividend revenue or, alternatively, the member may 
deduct 40% of interest earned by the member on customer securities 
accounts; provided, however in addition the member may deduct the first 
$50,000 of net interest and dividend revenue.

Note 1: Income not subject to exclusion for members for whom the NASD 
is the designated examining authority.

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 self-regulatory organization 
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 self-regulatory organization 
has prepared summaries, set forth in Sections A, B, and C below, of the 
most significant aspects of such statements.

[[Page 21518]]

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    Gross revenue is defined for member assessment purposes under 
Section 5 of Schedule A to the NASD By-Laws (``Section 5'') as total 
income reported on FOCUS form Part II or IIA. Members, however, are 
allowed certain exclusions. Income derived from interest and dividends 
is currently an allowable exclusion under Section 5.
    The NASD surveyed members' FOCUS filings for 1994 and conducted 
discussions with a number of member firm representatives, from which 
the NASD determined that, along with the normal interest income from 
customer margin accounts and interest and dividends from trading and 
investment positions, a significant portion of interest revenue for 
certain members is associated with the member's trading strategies 
involving, for example, repurchase, reverse repurchase, and stock loan/
borrow transactions, which are considered over-the-counter revenues 
from the securities business.
    The NASD is proposing to amend Section 5 of Schedule A by deleting 
a provision which currently allows a member to exclude its interest and 
dividends from gross revenue for assessment purposes. The proposed rule 
change, however, would add a new provision to allow a member to deduct 
from gross revenue for assessment purposes either: (i) its interest and 
dividend expenses but not in excess of related interest and dividend 
revenue; or, alternatively, (ii) 40% of interest earned by the member 
on customer securities accounts. The first deduction is intended to 
allow the member to subtract directly-related expenses from interest 
and dividend revenue to be included in the definition of gross revenue. 
The alternative deduction is intended to eliminate the potential for 
inequitable allocation of assessments on those members whose interest 
and dividend revenue is obtained without significant expenses related 
to trading strategies, (e.g., if a member derives interest revenue 
primarily from margin accounts and finances this lending through its 
own capital). It would also be consistent with the assessment of 
interest and dividend revenue by the Securities Investor Protection 
Corporation (``SIPC''), which permits an alternative offset to gross 
interest and dividend revenue consisting of 40% of interest earned on 
customer securities accounts. The proposed rule change, in addition, 
would allow a member to deduct from its gross revenue the first $50,000 
of net interest and dividend revenue in order to continue to encourage 
the accumulation of net capital, particularly by smaller members.
    Based on NASD data, the NASD estimates that the proposed rule 
change, if adopted for 1995, would have generated assessment revenue of 
$3 million based on the budgeted level of assessment revenue of $39 
million for that year.
    The proposed rule change would also amend Section 5 to provide 
alphabetical references to its two primary subsections and by replacing 
all bullets referencing its secondary subsections with numerical 
references.
    The NASD is proposing that the proposed rule change take effect for 
the 1996 assessment based on revenues generated in calendar year 1995.
2. Statutory Basis
    The NASD believes that the proposed rule change is consistent with 
the provisions of Section 15A(b)(5) of the Act \2\ which requires that 
the rules of the association provide for the equitable allocation of 
reasonable dues, fees and other charges among members in that the 
proposed rule change would recognize interest and dividend revenue as a 
part of a member's gross revenue for assessment purposes, while 
recognizing that expenses incurred in connection with such interest and 
dividend revenue should be allowed to be deducted from such revenue 
(e.g. as part of ``matched transactions''). It would also allow members 
whose business incurs less direct expense in connection with interest 
and dividend revenue to alternatively deduct 40% of interest earned by 
the member on customer securities accounts. It would, in addition, 
allow members to deduct from their gross revenue the first $50,000 of 
net interest and dividend revenue for assessment purposes in order to 
continue to encourage the accumulation of net capital. The proposed 
rule change also would be consistent with the SIPC's assessment of such 
revenue.
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    \2\ 15 U.S.C. 78o-3.
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The NASD published for comment in Notice to Members 95-94 (October 
27, 1995) (``NTM 95-94'') a proposal to include net interest and 
dividends in the definition of gross revenue for assessment purposes 
under Section 5.\3\ One commentor argued that the proposed rule change 
contained in NTM 95-94 discriminates against fixed income firms which 
finance mostly liquid collateral (i.e., governments and mortgages) and 
will make the small, match-book spreads of these firms even smaller, 
thereby forcing certain firms to move their match-book business and 
proprietary trading accounts to a non-regulated entity. The commentor 
also argued that the proposed rule change would be unfair to small 
members whose ratio of ``other qualified revenue'' to ``revenue from 
sales of shares'' may be higher than large companies. The NASD modified 
the proposed rule change published for comment to address such concerns 
by allowing a member to choose from one of two alternative deductions 
relating to its interest and dividend revenue and, in addition, to 
deduct from its gross revenue the first $50,000 of net interest and 
dividend revenue.
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    \3\ A copy of NTM 95-54 was submitted as Exhibit 2 to the NASD's 
proposal and is available for inspection and copying in the 
Commission's Public Reference Room.
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    Based on the foregoing, 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

    Twenty comment letters were received in response to NTM 95-94.\4\ 
Of the twenty commentors, four commentors supported but expressed 
certain concerns, and sixteen opposed the proposed rule change. The 
commentors are referenced by the number attached to their comment 
letter in the list of comment letters attached at Exhibit 3.
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    \4\ Copies of the comment letters were submitted as Exhibit 3 to 
the NASD's proposal and are available for inspection and copying in 
the Commission's Public Reference Room.
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1. Definition of Non-Securities Business Revenue
    Commentors (Nos. 1, 4, 11, 13, and 14) argue that dividends from a 
member's pure investment account are not revenue generated from the 
securities business but the fruit of hard work from previous years. The 
NASD believes that a member's proprietary investment account is 
retained business capital maintained to generate gross revenue for the 
member's securities business. Such proprietary accounts play an 
integral part in the member's securities business and are subject to 
NASD regulatory oversight. Revenue from such proprietary accounts are 
part of the member's securities business and,

[[Page 21519]]

therefore, are appropriate for inclusion in the definition of gross 
revenue for assessment purposes.
    One insurance commentor (No. 12) argues that it should only be 
assessed for interest and dividend revenue relating to the interest and 
dividends attributable to the capital necessary to operate its 
securities business. The NASD's position is that an insurance company's 
interest and dividend revenue from its insurance business will not be 
included in the definition of gross revenue for assessment purposes.
2. Effect on Net Capital
    Commentors (Nos. 1, 3, 4, 11 and 20) argue that the NTM 95-94 
proposal would discourage members from accumulating passive investments 
that increase the firm's net capital and protect public investors. The 
NASD amended the proposed rule change contained in NTM 95-94 to address 
such concerns by allowing a member to deduct from its gross revenue the 
first $50,000 of net interest and dividend revenue in addition to 
allowing the member to deduct one of two other alternative deductions 
provided by the proposed rule change.
3. Equitable Allocation of Dues, Fees and Assessments
    NTM 95-94 stated that the proposed rule change was partially 
intended to fund the increased costs associated with implementing the 
recommendations of the Rudman Committee. Commentors (Nos. 1, 10, 12 and 
19) argue that the proposed rule change inequitably allocates the 
regulatory costs resulting from the Rudman Committee recommendations to 
firms with significant passive investments which are not used by such 
firms in their securities business. One commentor recommends that, in 
order to equitably allocate such Rudman Committee related-costs, the 
NASD should determine the interest assessment on a firm-by-firm basis 
by considering such factors as the firm's standing with the NASD, the 
historical audit performance, the risks and liquidity associated with a 
firm's trading and collateral positions, whether or not a firm has 
significant customer or institutional business, and the firm's credit 
and risk management policies.
    The NASD notes that the proposed rule change is only partially 
intended to fund certain Rudman recommendations and its overall intent 
is to fund the NASD's broader regulatory budget requirements. The NASD 
believes that using gross revenue for assessment purposes has 
historically provided for the equitable allocation of reasonable 
assessments among members. The proposed rule change's inclusion of 
interest and dividends from retained capital and certain trading 
situations in the definition of gross revenue is appropriate because 
the NASD is required to oversee the related-securities activity. The 
proposed rule change, therefore, is part of the same assessment 
approach that has historically been followed by the NASD and the 
securities industry. The proposed rule change, as already noted, would 
also be consistent with current SIPC assessment provisions. The NASD, 
therefore, believes that the members' arguments for changing the basis 
of such assessments are not justified.
4. Discrimination Against Certain Members
    As previously noted, one commentor (No. 10) argues that the 
proposed rule change contained in NTM 95-94 discriminates against fixed 
income firms which finance mostly liquid collateral (i.e., governments 
and mortgages) and will make the small, match-book spreads of these 
firms even smaller, thereby forcing certain firms to move their match-
book business and proprietary trading accounts to a non-regulated 
entity. The commentor also argues that it would be unfair to small 
members whose ratio of ``other qualified revenue'' to ``revenue from 
sales of shares'' is higher than large companies. The NASD has modified 
the proposed rule change published for comment to address such concerns 
by allowing a member to deduct from its gross revenue the first $50,000 
of net interest and dividend revenue in addition to allowing the member 
to deduct one of two other alternative deductions provided by the 
proposed rule change.
    The NASD further believes that a member could not use a non-
regulated entity to handle its U.S. match-book business because this 
would subject such an entity to registration as a broker/dealer under 
Section 15 of the Act. This would also be true for the handling of the 
member's proprietary trading accounts.
5. Clearing Capital
    Commentors (No. 6, 8, and 15) expressed concerns regarding 
potential assessments on their clearing capital. Two commentors (6 and 
8) argue that members that put up clearing capital to be in business 
should not be assessed on the interest on this capital, or 
alternatively assessed only on yearly income above some amount, perhaps 
$100,000. One commentor (No. 15) only supports the proposed rule change 
because it believes its security deposits with clearing brokers would 
be exempt. It is the position of the NASD that a member's clearing 
capital serves the function of capital in any business, i.e., to run 
the business and increase gross revenue for the business. Further, the 
requirements for clearing capital are subject to NASD regulatory 
oversight and, therefore, justified for inclusion in gross revenue for 
assessment purposes. The NASD, however, has amended the proposed rule 
change contained in NTM 95-94 to allow a member to deduct from its 
gross revenue the first $50,000 of net interest and dividend revenue in 
order to address the concerns of smaller members regarding this matter.
6. NASD Assessment Discounts
    One Commentor (No. 19) argues that the NASD currently ``discounts'' 
member assessments, presumably because the current system, without 
change, already provides more funds than is necessary for operations. 
The commentor, therefore, argues that the NASD does not need a new 
funding category. The NASD believes that its practice of discounting 
member assessments provides the NASD with the flexibility to equitably 
return to its members a portion of assessments during business cycles 
wherein the aggregate gross revenue of the securities industry is 
normal or better, while ensuring the NASD with sufficient funds to meet 
the regulatory mandates of the Act during business cycles in which 
gross revenue of the securities industry has significantly decreased. 
This practice of discounting member assessments has proven to be an 
effective funding method for oversight of the securities industry and, 
therefore, has proven itself to be an important part of the investor 
protections provided by the NASD to the securities markets. In 
addition, the NASD's definition of gross revenue for assessment 
purposes should equitably include all categories of revenue from a 
member's securities business. The NASD believes that the inclusion of 
net interest and dividend revenue from the member's retained capital 
and trading strategies, in the definition of gross revenue for 
assessment purposes, is appropriate in assessing all gross revenue from 
the securities business regulated by the NASD.
7. NASD SIPC Rationale
    One commentor (No. 19) argues that the administrative and 
compliance activity of the NASD is separated too far in its nature from 
the insurance activity of the SIPC to provide a compelling argument 
that NASD's fund raising be consistent with SIPC. The NASD notes

[[Page 21520]]

that in further conforming its assessment policy to SIPC's, the 
Association is not intending to imply that its business is equivalent 
to SIPC's, but rather that the proposed rule change is based on 
assessment policy that has already been found to be an equitable 
allocation of reasonable assessments among members of the securities 
industry.
8. Net Interest Revenue Derived From Exchange-Listed Securities
    One commentor (No. 7) states that a substantial amount of its net 
interest revenue is derived from margin loans secured by exchange-
listed securities and securities lending activities involving exchange-
listed securities. The commentor notes that Schedule A, Section 5 of 
the NASD By-Laws excludes income from the sale of exchange-listed 
securities, and therefore, argues that net interest revenue from such 
exchange listed securities should also be excluded. The commentor also 
notes that it would be extremely difficult, if not impossible, to break 
out net interest revenue as to its source of origin, i.e., exchange 
versus non-exchange securities. The NASD believes that interest derived 
from margin loans and securities lending activities, involving 
exchange-listed securities or customer accounts including such 
securities, does not itself represent an exchange transaction but 
rather a regulated over-the-counter transaction. Such non-exchange 
activity is significantly different than the current Section 5 
exclusion from gross revenue regarding member commissions, trading or 
investment gains derived from transactions executed on a registered 
national securities exchange or a foreign securities exchange. The NASD 
also acknowledges and agrees with the impracticality of segregating 
such income between exchange and non-exchange business.
9. Request for NASD Audited Annual Financial Income Statement and 
Balance Sheet/Simplified Revenues Assessment
    Two commentors (Nos. 2 and 5) argue that the NASD should provide a 
detailed accounting to demonstrate the need for additional revenues. 
One commentor (No. 2) argues for an audited annual financial income 
statement and balance sheet of the NASD corporate body to erase 
misperceptions that a surplus may already exist. The NASD, in response 
to the first comment, notes that an audited financial accounting of the 
association's activities is provided annually to the membership and the 
interested public in the organization's annual report. With respect to 
the second comment, the NASD maintains a level of working capital and 
equity which is prudent in its business judgment in order to ensure 
that the NASD is able to fulfill its regulatory mandates.
    One commentor (No. 2) argues that if the need for additional 
assessment revenues exists, then the additional revenues can be 
obtained ``by simply increasing the current assessment by 7.7%.'' The 
NASD believes it is more appropriate and equitable to include interest 
and dividends revenue in gross revenue as provided by the proposed rule 
change before increasing the assessment percentage on gross revenue for 
all members. The NASD believes that the proposed rule change enhances 
the equitable allocation of assessments by adding certain interest and 
dividend revenue derived from retained capital and certain trading 
practices to the definition of gross revenue for assessment purposes.
    A commentor (No. 5) argues that if the need for additional revenue 
is shown to be temporary, then the assessment should be temporary. The 
NASD does not intend the proposed rule change to be temporary and notes 
that the purpose of the proposed rule change is to meet ongoing 
budgetary requirements.
10. Member Vote
    One commenter (No. 1) argues that the inclusion of any new revenue 
category should be subject to membership vote. The NASD notes that 
Article VI, Section1 of the By-Laws permits the Board of Governors to 
make changes in member assessments without recourse to the membership 
for approval. This provision of the By-Laws was adopted by the Board of 
Governors and approved by the Commission as an appropriate regulatory 
function of the NASD under the Act. The proposed rule change is, 
however, subject to publication for comment by the SEC and the SEC will 
exercise its independent review function in determining whether to 
approve or disapprove the proposed rule change.
11. Other Comments
    Four commentors (Nos. 9, 16, 17, and 18) supported the proposed 
rule change contained in NTW 95-94 as providing more consistent 
treatment of net interest and dividend revenue. The commentors argue, 
however, that since additional revenue will be received by the NASD 
under the proposed rule change, an offset should take place through a 
reduction in other member charges. They argue that the proposed rule 
change comes at a time when firms are looking to eliminate costs, 
increase efficiency and protect capital. Another commentor (No. 3) 
argues that the NASD should attempt to meet its budgetary challenges as 
its membership is doing, i.e., investigating more efficient ways of 
accomplishing objectives and cutting costs. The NASD concurs with the 
latter commentor and continues to address budgetary challenges by 
increasing the efficiency of oversight of the broker/dealer industry. 
However, increased efficiencies of NASD operations alone, as suggested 
by the former commentors, do not meet the budgetary challenges required 
to fund the commitment of greater resources to the NASD's broker/dealer 
regulation activities in compliance with the regulatory mandate of the 
Act, as amended.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of 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 to 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 the file number in the caption 
above and should be submitted by May 31, 1996.


[[Page 21521]]


    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority, 17 CFR 200.30-(a)(12).
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-11747 Filed 5-9-96; 8:45 am]
BILLING CODE 8010-01-M