[Federal Register Volume 63, Number 3 (Tuesday, January 6, 1998)]
[Notices]
[Page 584]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-158]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39498; File No. SR-CHX-97-21]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the Chicago Stock Exchange, Incorporated, Regarding 
Suitability of Customer Recommendations

December 29, 1997.
    On September 18, 1997, the Chicago Stock Exchange, Incorporated 
(``CHX'' or ``Exchange'') filed with the Securities and Exchange 
Commission (``SEC'' or ``Commission'') pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act''),\1\ a proposed rule 
change regarding the suitability of customer recommendations. The 
proposed rule change was published for comment in the Federal 
Register.\2\ The Commission received no comment letters on the proposed 
rule change, and for the reasons discussed below, is approving the 
proposal.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 3907 (November 6, 1997), 
62 FR 61157 (November 21, 1997).
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I. Description of Proposal

    The Exchange proposes to add Article VIII, Rule 25 to the 
Exchange's Rules. The Exchange currently does not have rule that 
expressly addresses suitability, churning and related matters for 
Exchange members. While the Exchange believes that such conduct may 
currently fall within existing Exchange rules, such as the Exchange's 
rule relating to ``just and equitable'' activity, the Exchange believes 
that it is desirable at this time to specifically address this type of 
conduct. As a result, the purpose of the proposed rule change is to add 
Rule 25 to Article VIII of the Exchange's rules, requiring that, in 
recommending to a customer the purchase, sale or exchange of any 
security, a member must have reasonable grounds for believing that the 
recommendation is suitable for such customer upon the basis of the 
facts, if any, disclosed by such customer as to his other security 
holdings and as to his financial situation and needs.
    Specifically, prior to the execution of a transaction recommended 
to a customer, other than transactions with customers where investments 
are limited to money market mutual funds, a member would be required to 
make reasonable efforts to obtain information concerning the customer's 
financial status, the customer's tax status, the customer's investment 
objectives, and such other information used or considered to be 
reasonable by such member or registered representative in making 
recommendations to the customer.
    The rule change would contain a non-exclusive list of practices 
that the Exchange deems to violate a member's duty to recommend to a 
customer only securities suitable for that customer. These would be: 
(1) Recommending speculative low-priced securities to customers without 
knowledge of or an attempt to obtain information concerning the 
customer's other securities holdings, their financial situation and 
other necessary data; (2) excessive activity in a customer's account, 
often referred to a ``churning'' or ``overtrading''; (3) trading in 
mutual fund shares, particularly on a short-term basis; (4) fraudulent 
activity (including establishing fictitious accounts in order to 
execute transactions which otherwise would be prohibited, executing 
transactions in discretionary accounts in excess of or without actual 
authority from customers, causing the execution of transactions which 
are unauthorized by customers or the sending of confirmations in order 
to cause customers to accept transactions not actually agreed upon, and 
unauthorized use or borrowing of customers' funds and securities); and 
(5) recommending the purchase of securities or the continuing purchase 
of securities in amounts that are inconsistent with the reasonable 
expectation that the customer has the financial ability to meet such a 
commitment.
    In addition, with regard to derivative financial products, the rule 
change would require that members make every effort to familiarize 
themselves with each customer's financial situation, trading 
experience, and ability to meet the risks involved with such products 
and to make every effort to make customers aware of the pertinent 
information regarding new financial products.

II. Discussion

    The Commission finds that the proposed rule change is consistent 
with Section 6(b)(5) of the Act and the rules and regulations 
thereunder applicable to a national securities exchange, and 
specifically, with the requirements of Section 6(b).\3\ In particular, 
the Commission believes that the proposal is consistent with the 
Section 6(b)(5) requirements that the rules of an exchange be designed 
to promote just and equitable principles of trade, to prevent 
fraudulent and manipulative acts, and in general to protect investors 
and the public interest.
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    \3\ 15 U.S.C. 78f(b).
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    The Commission believes that the Exchange's proposal to add Article 
VIII, Rule 25 to the Exchange's Rules benefits investors by requiring 
exchange members, in recommending to a customer the purchase, sale or 
exchange of any security, to have reasonable grounds for believing that 
the recommendation is suitable for such customer upon the basis of the 
facts, if any, disclosed by such customer as to his other security 
holdings and as to his financial situation and needs. The Commission 
also believes that including a non-exclusive list of practice that the 
Exchange deems violates a member's duty of suitability with the rule is 
a beneficial guide for investors. Additionally, the proposal will 
benefit exchange members by providing them a rule specifically 
addressing suitability, churning and related conduct.

III. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\4\ that the proposed rule change (SR-97-21) be, and hereby is, 
approved.

    \4\ 15 U.S.C. 78s(b)(12).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\5\
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    \5\ 17 CFR 300.30(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-158 Filed 1-5-98; 8:45 am]
BILLING CODE 8010-01-M