[Federal Register Volume 63, Number 78 (Thursday, April 23, 1998)]
[Notices]
[Pages 20232-20236]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-10796]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39883; File No. SR-NASD-97-69]
Self-Regulatory Organizations; Order Granting Approval of
Proposed Rule Change, as Amended, and Notice of Filing and Order
Granting Accelerated Approval of Amendment No. 2 to the Proposed Rule
Change by the National Association of Securities Dealers, Inc. Relating
to the Tape Recording of Conversations
April 17, 1998.
I. Introduction
On September 12, 1997, the National Association of Securities
Dealers, Inc. (``NASD''), through its regulatory subsidiary NASD
Regulation, Inc. (``NASD Regulation'') 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\ In this filing, NASD
Regulation proposed amendments to Rule 3010 to require the tape
recording of conversations where members hire more than a specified
percentage of registered persons from certain firms that have been
expelled or that have had their broker/dealer registration revoked for
violations of sales practices rules. The proposed rule change also
includes a conforming rule change to Rule 9610. Notice of this proposed
rule change was published in the Federal Register on December 5, 1997
(as amended, the ``Notice'').\3\ The Commission received one comment
letter, which expressed concerns about using tape recording as a method
of supervision, in response to the Notice.\4\ On March 9, 1998, NASD
Regulation filed Amendment No. 2 with the Commission.\5\ This order
approves the rule change, as amended, and grants accelerated approval
of Amendment No. 2 to the rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 39361 (November 26,
1997), 62 FR 64422 (File No. SR-NASD-97-69). Amendment No. 1 to the
proposed rule filing was filed on November 12, 1997. The changes
contained in this amendment were included in the Notice. See Letter
from Mary N. Revell, Associate General Counsel, NASD Regulation, to
Katherine A. England, Assistant Director, Division of Market
Regulation, Commission (November 17, 1997).
\4\ See Letter from R. Gerald Baker, Securities Industry
Association (``SIA''), to Jonathan G. Katz, Secretary, Commission,
dated February 11, 1998.
\5\ See letter from Mary N. Revell, Associate General Counsel,
NASD Regulation, to Katherine A. England, Assistant Director, Office
of Market Supervision, Division of Market Regulation (March 9,
1998). In Amendment No. 2, NASD Regulation: (1) Applies the proposal
to firms that have a work force comprised of a specified number of
registered persons who were employed by a ``disciplined firm''
within the last three years instead of two years; (2) requires firms
to establish special procedures to supervise the telemarketing
activities of registered persons instead of registered
representatives; (3) amends the definition of registered persons to
include those persons who register as municipal securities
principals or representatives pursuant to Municipal Securities
Rulemaking Board Rule G-3; and (4) provides guidance on what would
constitute ``reasonable procedures for reviewing the tape recordings
made pursuant to the requirements of'' the taping rule in a Notice
to Members announcing approval of the rule.
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II. Background
At its meeting in July 1996, the NASD Regulation Board of Directors
authorized the staff to issue a Notice to Members soliciting comment on
proposed changes to NASD supervisory Rule 3010 to require the tape
recording of telephone conversations of registered representatives in
certain circumstances. The Rule was developed both to respond to
concerns expressed in the Joint Regulatory Sales Practice Sweep
(``Sweep'') Report \6\ regarding the
[[Page 20233]]
need for heightened supervision of certain registered representatives
with troubled regulatory and compliance records and also to address the
particular problems that occur when a firm hires a larger number of
individuals who formerly worked at a firm that has been expelled or has
had its registration revoked (a ``Disciplined Firm'') where they were
inadequately supervised and trained.
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\6\ Staffs of the NASD, New York Stock Exchange (``NYSE''),
North American Securities Administrators Association (``NASAA''),
and the Office of Compliance Inspections and Examinations, SEC,
Joint Regulatory Sales Practice Sweep: A Review of the Sales
Practice Activities of Selected Registered Representatives and the
Hiring, Retention, and Supervisory Practices of the Brokerage Firms
Employing Them (March 1996). The Sweep was an initiative involving
the staffs of the NASD, the SEC, the NYSE, and representatives of
the NASAA (collectively, the ``Working Group'') to review the sales
practice activities of selected registered representatives and the
hiring, retention, and supervisory practices of the brokerage firms
employing them in order to identify possible problem registered
representatives, review their sales practices, and assess whether
adequate hiring, retention, and supervisory mechanisms are in place.
The Sweep Report was released on March 18, 1996.
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NASD Regulation stated in its filing that one of the key findings
of the Sweep Report concerned the willingness of some firms to employ
registered representatives with a history of disciplinary actions or
customer complaints.\7\ Based on this finding, the Working Group
collectively recommended that firms that hire registered
representatives with a recent disciplinary history involving sales
practice abuse or other customer harm should implement special
supervisory procedures tailored to the individual registered
representative, which include a heightened level of scrutiny of the
registered representative's activities by his or her supervisor, for a
period of time.\8\ The Sweep Report recommended that, if firms fail to
establish such special supervisory procedures, the self-regulatory
organizations (``SROs'') should consider revising their rules to
specifically require that registered representatives with a recent
history of disciplinary actions involving sales practice abuse or other
customer harm be placed under special supervision by the firm for a
period of time.
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\7\ The current proposal focuses on the disciplinary history of
the firm that formerly employed the registered representative.
\8\ Id. at ii, iv.
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NASD Regulation and the NYSE have issued a memorandum discussing
the Sweep Report and providing guidance on actions firms could take to
provide heightened supervision of problem registered
representatives.\9\ While the special procedures designed to provide a
heightened level of supervision recommended by the Sweep Report and
described in the NASD/NYSE memorandum may provide adequate supervision
of associated persons in most circumstances, NASD Regulation proposes
to adopt specific procedures in certain situations in order to provide
the level of supervision required by Rule 3010.
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\9\ NASD Notice of Members 97-19 (April 1997); NYSE Information
Memo 97-20 (April 15, 1997).
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NASD Regulation proposes to amend NASD Rule 3010 to require firms
that hire a specified number of individuals from Disciplined Firms to
tape-record telephone conversations between their registered persons
and existing and potential customers. The proposed Rule would apply
when a firm hires a substantial number of registered persons from a
firm or firms that have been expelled or had their registrations
revoked for sales practice abuse. The measures are designed to prevent
a reoccurrence of sales practice abuse or other customer harm that
caused the Disciplined Firm to be expelled or have its registration
revoked. The proposal is similar to an interpretation adopted by the
National Futures Association (``NFA'') in 1993 to combat abusive cold
calling.\10\ The NFA's interpretation is discussed below.
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\10\ See Letter from Lynn K. Gilbert, Deputy Director, Commodity
Futures Trading Commission, to Daniel J. Roth, General Counsel, NFA
(January 19, 1993).
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A. Notice to Members 96-59 and Original Proposal
In its filing with the Commission, NASD Regulation described Notice
to Members 96-59 (``NTM 96-59''), which contained the original proposed
Rule (``original proposal'' or ``original Rule'').\11\ NASD
Regulation's original proposal captured a broader swath of firms. It
would have been triggered whenever a significant portion of a member's
work force was comprised of associated persons who formerly were
employed by a Disciplined Firm or firms or when the firm itself was a
Disciplined Firm. The original proposal defined a Disciplined Firm, for
purposes of the Rule, as one that had been disciplined (e.g., expelled,
suspended, or enjoined) by a regulatory entity, an SRO, or a court
within the previous five years for telemarketing or sales-practice
abuses in connection with the solicitation, offer, or sale of
securities.
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\11\ See Notice to Members 96-59 (September 1996).
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NASD Regulation's original proposal also stated that if more than
20 percent of a member's sales force of associated persons previously
were employed by a Disciplined Firm, the member would have been
required to adopt special written procedures to supervise the
telemarketing activities of its associated persons. Firms that were
themselves Disciplined Firms also would have been required to adopt
these procedures. The procedures would have required, at a minimum,
that the employer member tape record all telephone conversations
between all of its associated persons and both existing and potential
customers, and maintain these procedures for two years. For each firm
that was itself a Disciplined Firm, at the end of the two-year period,
NASD Regulation would have conducted an evaluation to determine
whether, and for how long, the firm would continue to be subject to the
requirements of the Rule. The Rule also would have required firms
subject to the taping requirement to review the tapes periodically to
ensure compliance with securities laws and NASD rules, to submit
reports to NASD Regulation on their supervision of telemarketing
activities, and to retain and index the tapes.
B. Comments and Response on the Original Proposal
NASD Regulation received 42 comment letters in response to its
initial Notice to Members.\12\ Of the 42
[[Page 20234]]
comment letters, 39 were opposed to the proposal, including those filed
by the Securities Industry Association, Lehman Brothers, Merrill Lynch,
Morgan Stanley, and Smith Barney. NASD Regulation stated that most of
the commenters supported the NASD's objective in proposing the taping
Rule and agreed that firms should be discouraged from recruiting groups
of registered persons from a Disciplined Firm, however, they did not
believe that tape recording of conversations was an appropriate
regulatory requirement and feared that regulators will require even
more comprehensive tape recording in the future.
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\12\ NASD Regulation received the following comment letters: (1)
Letter from Brian C. Underwood, A.G. Edwards & Sons, Inc.
(``Edwards''), dated October 31, 1996; (2) Letter from Kevin P.
Howe, American Express Financial Advisors (``AEFA''), dated October
31, 1996; (3) Letter from G. Thomas Mitchell, Aurora Insurance and
Securities, Inc. (``Aurora''), dated October 10, 1996; (4) Letter
from Jerome Snyder, Barington Capital Group, L.P. (``Barington''),
dated October 23, 1996; (5) Letter from Leslie D. Smith, Berthel
Fisher Company (``Berthel''), dated October 25, 1996; (6) Letter
from Walter I. Miller, Capital Growth Planning, Inc. (``Capital''),
dated September 24, 1996; (7) Letter from Sanford D. Greenberg,
Chatfield Dean & Co. (``Chatfield Dean''), dated October 31, 1996;
(8) Letter from Neil Lawrence Lane, Citicorp Investment Services
(``CIS''), dated October 31, 1996; (9) Letter from David J. Master,
Coastal Securities (``Coastal''), dated October 31, 1996; (10)
Letter from John Polanin, Jr., Cowen & Company (``Cowen''), dated
November 7, 1996; (11) Letter from Richard L. Sandow, Cullum &
Sandow Securities, Inc. (``Cullum''), dated October 17, 1996; (12)
Letter from Gregg Thaler, Duke & Company, Inc. (``Duke I''), dated
October 10, 1996; (13) Letter from William Rotholz, Duke & Company,
Inc. (``Duke II''), dated October 29, 1996; (14) Letter from Shannon
Braymen, Duncan-Smith Securities, Inc. (``Duncan-Smith''), dated
October 22, 1996; (15) Letter from James H. Pyle et al., E.E. Powell
& Company, Inc., dated October 21, 1996; (16) Letter from Nancy K.
Port, Equity Services, Inc. (``ESI''), dated October 30, 1996; (17)
Letter from Rick Fetterman, Fetterman Investments, Inc., dated
October 1, 1996; (18) Letter from Herbert O. Sontz, GKN Securities
(``GKN''), dated October 31, 1996; (19) Letter from Lawrence E.
Wesneski, Hoak Breedlove Wesneski & Co. (``Hoak''), dated October
21, 1996; (20) Letter from Cabell B. Birdsong, Investors Security
Company, Inc. (``ISC''), dated October 22, 1996; (21) Letter from
David A. Rich, Jefferies & Company, Inc., dated November 8, 1996;
(22) Letter from Thomas P. Koutris, John Hancock Distributors, Inc.,
dated September 23, 1996; (23) Letter from A.E. Monahan, Keystone
Capital Corporation (``Keystone''), dated October 7, 1996; (24)
Letter from Paul B. Uhlenhop, Lawrence, Kamin, Saunders & Uhlenhop
(``Lawrence, Kamin''), dated October 29, 1996; (25) Letter from
Kathryn S. Reinmann, Lehman Brothers Inc. (``Lehman''), dated
October 31, 1996; (26) Letter from Kenneth S. Spirer, Merrill Lynch,
Pierce, Fenner & Smith (``Merrill Lynch''), dated November 14, 1996;
(27) Letter from Jack G. Levin, Montgomery Securities
(``Montgomery''), dated January 16, 1997; (28) Letter from Frederick
W. Bogdan, Morgan Stanley & Co., Incorporated (``Morgan Stanley''),
dated October 30, 1996; (29) Letter from Dennis S. Kaminski, Mutual
Service Corporation (``MSC''), dated October 29, 1996; (30) Letter
from Richard Berenger, Nathan & Lewis Securities, Inc. (``Nathan &
Lewis''), dated October 18, 1996; (31) Letter from Douglas L.
Dunahay, Neidiger/Tucker/Bruner Inc. (``Neidiger''), dated October
29, 1996; (32) Letter from Edward T. Borer, Philadelphia Corporation
(``PC''), dated October 17, 1996; (33) Letter from Michael
Flannigan, Protective Group Securities Corporation (``PGSC''), dated
September 24, 1996; (34) Letter from Robert A. Fitzner, Jr., RAF
Financial Corporation (``RAF''), dated October 29, 1996; (35) Letter
from Glen F. Hackmann, Robert W. Baird & Co., Incorporated
(``Baird''), dated October 31, 1996; (36) Letter from Douglas F.
Schofield, Schofield Investments, Inc., dated September 18, 1996;
(37) Letter from Richard O. Scribner, Allen B. Holeman, and C. Evan
Steward, SIA, dated November 4, 1996; (38) Letter from Dov S.
Schecter, Smith Barney Inc. (``Smith Barney''), dated October 31,
1996; (39) Letter from Patrick G. Haayes, Stratton Oakmont, Inc.
(``Stratton''), dated October 30, 1996; (40) Letter from Walter H.
Schlobohm, dated February 10, 1997; (41) Letter from John Maceranka,
The Windmill Group, Inc., dated September 28, 1996; and (42) Letter
from Stanley J. Allen Jr., Yee, Desmond, Schroeder & Allen, Inc.
(``Yee''), dated October 28, 1996.
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The definition of a Disciplined Firm is too broad: NASD Regulation
stated that many of the commenters believe the definition of a
Disciplined Firm in the original Rule was too broad. For example, the
original definition would have included a firm that was the subject of
an injunction for a technical or inadvertent violation of state law or
as the result of a consensual injunction involving only a fraction of
the firm's business and employees. NASD Regulation responded by
narrowing the definition of a Disciplined Firm to include firms that
have been expelled from membership in a securities industry SRO or that
have had their registration revoked by the SEC due to telemarketing or
sales practice abuses.
The Rule is too broad with respect to the individuals included in
the percentage calculation and the time frame: NASD Regulation stated
that commenters complained the Rule was too broad in several respects.
First, commenters said the Rule would target firms and individuals for
the actions of other firms and individuals of which they had no
knowledge or control \13\ Second, the commenters criticized the Rule's
application to all individuals that had ever been employed by a
Disciplined Firm in the calculation of the percentage that would
trigger the special supervisor procedures.\14\ Finally, NASD Regulation
stated that commenters believed the Rule should be limited to personnel
who have contact with customers, such as registered representatives,
and should exclude clerical and ministerial employees from both the 20%
calculation and the taping requirement.\15\
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\13\ See, e.g., letters from Lehman and Morgan Stanley.
\14\ See, e.g., letters from Edwards, Morgan Stanley, Nathan &
Lewis, PC, SIA, and Stratton.
\15\ See, e.g., letters from Edwards, Barington, Chatfield Dean,
Cullum, Duke II, ESI, ISC, Morgan Stanley, Baird, and Stratton.
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In response, NASD Regulation narrowed the scope of the original
Rule to apply only to firms that hire a specified percentage of
individuals who were employed at a Disciplined Firm within the last
three years. NASD Regulation also limited the individuals calculated in
the percentage to register persons, leaving out clerical and
ministerial personnel. Also, NASD Regulation limited the persons
subject to the taping requirement to registered representative in
conversations with both existing and potential customers.
The Rule does not achieve the stated purpose: NASD Regulation noted
that several commenters questioned whether the original Rule goes
beyond the scope of the Sweep Report and would be effective in
achieving the Sweep Report recommendations because taping is not an
effective means of supervising sales efforts.\16\
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\16\ See, e.g., letters from CIS, Duke II, ESI, Lehman, Merrill
Lynch, MSC, Nathan & Lewis, and SIA.
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NASD Regulation responded by emphasing that the taping requirement
is being restricted to particularly egregious situations. They stated
their concern that when a firm hires high percentages of employees from
firms that have been expelled by an SRO or that have had their
registration revoked by the Commission, these groups of employees are
unlikely to have been trained or supervised adequately. In addition,
NASD Regulation stated its belief in the in terrorem effect of
recording telephone conversations to deter sales practice abuses.
Finally, the NASD believes the Rule directly addresses the issues
raised when a firm hires a high percentage of individuals who were
employed by a Disciplined Firm where they were inadequately trained and
supervised.
The costs of the Rule are too great: The NASD noted that some
commenters expressed concerns that the costs of the original Rule would
be too high, considering the limited benefits of the Rule. The
commenters also stated that the Rule would have a disproportionate
effect on small firms.\17\
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\17\ The commenters stated that small firms would be
disproportionately effected both in the cost of taping and in the
numbers of firms likely to become subject to the threshold
percentage of 20%. See letters from Capital, Cowen, Duncan-Smith,
Hoak, SIA, and Yee.
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The NASD stated that its narrowing of many aspects of the Rule
would result in lower compliance costs. Specifically, in the revised
proposal, the NASD exempted firms with five or fewer registered persons
from the Rule and tiered the structure for determining the percentage
of employees that trigger the taping requirement so that smaller firms
would have to hire 30% or more of their registered persons from
Disciplined Firms before they would trigger the requirement. In
addition, the NASD stated that by narrowing the definition of a
Disciplined Firm, fewer firms will be subject to the taping
requirement.\18\ Finally, with respect to certain practical compliance
difficulties, the NASD agreed to provide firms with all the relevant
information they need to determine whether they are in compliance with
the Rule.
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\18\ The NASD revised the definition of Disciplined Firm to
include only expelled and revoked firms in order to focus, at least
initially, on the most egregious cases with the greatest supervisory
and disciplinary problems. For the two-year period 1995-1996, 14
firms met the definition of Disciplined Firm: 4 firms were expelled
from SRO membership and 10 had their registrations revoked. This
approach is similar to the one taken by the NFA, and will allow the
NASD to gain experience with the implementation of the Rule before
it considers expanding the definition of Disciplined Firm to include
firms that have been suspended from SRO membership or from SEC
registration.
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Privacy concerns: The NASD stated that many commenters felt the
original Rule would invade the privacy of both a firm's customers as
well as the firm's registered representatives, which would be unfair to
both firms and registered representatives that did not have
disciplinary histories. Commenters also believe that the Rule would
conflict with federal and state wiretapping laws. Finally, they are
concerned that the
[[Page 20235]]
Rule does not restrict the accessibility and manner in which the tapes
may be used.\19\
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\19\ See, e.g., letters from AEFA, Duke II, Lawrence, Kamin,
Lehman, Morgan Stanley, MSC, Neidiger, Montgomery, SIA, and Smith
Barney.
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As stated above, because the Rule has been revised to address only
the most egregious situations, the impact on privacy will be minimized.
Also, upon approval, NASD Regulation will inform NASD members that, in
complying with this Rule, they must also comply with federal and state
civil and criminal statutes governing the tape recording of
conversations. This is the same approach the NFA has taken with respect
to this issue.\20\
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\20\ See Interpretive Notice to NFA Compliance Rule 2-9,
Supervision of Telemarketing Activity, 9021 (February 18, 1997).
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Each state has a statute governing wiretapping; there also is a
federal statute governing wiretapping and electronic surveillance.\21\
The federal statute and the majority of the state statutes permit
taping of telephone conversations with the consent of one party (``one-
party statutes''),\22\ a minority of state statutes require the consent
of all parties to the conversation (``two-party statutes'').\23\ Three
issues arise from the proposed Rule: what is necessary to comply with
one-party statutes; what is necessary to comply with two-party
statutes; and how to comply where a conversation occurs between a
person in a one-party state and a person in a two-party state. The NASD
has left compliance with the state statutes on wiretapping and privacy
for each broker-dealer.
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\21\ 18 U.S.C. Secs. 2519 et seq.
\22\ In one-party statute states, the only issue is whether the
registered representative knows of and consents to the tape
recording. Since the recording requirement would run to the firm,
and the equipment would be the firm's, it might be argued that the
firm, and not the representative, is doing the recording. Therefore,
it would be necessary for the firm to insure that the representative
has notice and consents to the tape recording of his or her
telephone conversations. This could be accomplished through a clause
in an employment agreement or employee handbook or other written
notice to the representative.
\23\ In two-party statute states, it would be necessary to
insert on the firm's telephone line a recording stating that all
telephone conversations are being taped, similar to customer service
lines in other industries. Some states require a system of beeps or
buzzers that sound throughout the conversation. Another possibility
is to insert a clause into the customer agreement notifying
customers that their calls will be tape recorded. Some states also
have a ``business use exception'' to the two-party statute consent
requirement, but it is worded and applied differently in each state.
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C. Proposed Rule
As revised and filed with the Commission, the proposed Rule would
apply whenever a specified percentage of a member firm's sales force is
comprised of registered persons who were employed within the last three
years by a firm that has been expelled from membership in a securities
industry SRO or has had its registration as a broker/dealer revoked by
the SEC. The requisite percentage varies depending on the size of the
firm, from 40 percent for a small firm to 20 percent for a larger firm.
The firm must establish the required supervisory procedures within 30
days of receiving notice from NASD Regulation or obtaining actual
knowledge that it is subject to the provisions of the Rule.
Under the proposed Rule, if the requisite percentage of a member's
sales force previously was employed by a Disciplined Firm, the member
would be required to adopt special written procedures to supervise the
telemarketing activities of all of its registered persons. The
procedures would require, at a minimum, that the member tape record all
telephone conversations between all of its registered persons and both
existing and potential customers for a period of three years, and
maintain these supervisory procedures for two years. The Rule would
require firms to ensure that they tape record all regularly used means
of telecommunications, including cellular phones. The Rule also would
require firms subject to the taping requirement to establish reasonable
procedures for reviewing the tape recordings to ensure compliance with
securities laws and NASD rules, to submit reports to the NASD on their
supervision of telemarketing, and to retain and catalog the tapes.
While each firm is responsible for complying with the Rule, NASD
Regulation will provide firms with all of the information that they
need to determine if they are subject to the requirements of the Rule.
NASD Regulation believes that firms should be able to rely on the
accuracy of the information provided to them by the NASD. Therefore,
the NASD anticipates that a firm will be disciplined for failure to
comply with the Rule only if it has actual knowledge of information
that would make the firm subject to the Rule that is inconsistent with
the information provided by NASD Regulation to the firm that indicated
that the firm was not subject to the Rule.
NASD Regulation will compile and maintain several lists that firms
will be able to review on a quarterly basis to assist them to determine
if they are in compliance with the Rule. The primary list that will be
prepared will be a list of firms that meet the definition of
Disciplined Firm. Two additional lists will be prepared that should be
helpful. One list will contain an alphabetical listing of all
registered persons who had worked for Disciplined Firms within the last
three years. Another list will be compiled containing the same list of
people grouped according to the firm for which they currently work. In
order to alert firms that they are approaching the percentage that
would make them subject to the requirements of the Rule, the second
list will contain a computation of the percentage of all registered
persons at the firm represented by registered persons who had been
employed at a Disciplined Firm within the last three years.
The Rule is thus very similar to an NFA interpretation concerning
supervision of telemarketing activity.\24\ NFA member firms subject to
the requirements of the interpretation must tape record all sales
solicitations. The NFA interpretation applies to firms that meet
criteria relating to the percentage of the firm's associated persons
who formerly were employed at a firm that was closed down and barred
from the industry through enforcement actions for deceptive
telemarketing practices.\25\ These firms are required by the NFA
interpretation to tape record sales solicitations. An NFA member
subject to these procedures may seek a waiver of the taping requirement
upon a satisfactory showing that its current supervisory procedures
provide effective supervision over its employees, including enabling
the member to identify potential problem areas before customer abuse
occurs. The NFA has rarely granted such waivers. In one instance, a
waiver was granted to a firm that did not engage in telemarketing and
had only institutional customers. In two other instances, partial
waivers were granted to firms that hired outside consultants. NFA
informed NASD Regulation that they were not satisfied with the work
performed by the outside consultants and would not grant such waivers
in the future.\26\ In response to commenter requests, NASD Regulation
has included a waiver provision in the proposed Rule, and also has
proposed a
[[Page 20236]]
conforming change to the Rule 9600 Series.\27\
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\24\ See Interpretive Notice to NFA Compliance Rule 2-9,
Supervision of Telemarketing Activity, para. 9021 (February 18,
1997).
\25\ In early 1997, 44 firms met the NFA definition of
Disciplined Firm. See Interpretive Notice to NFA Compliance Rule 2-
9, Supervision of Telemarketing Activity, para. 9021 (February 18,
1997).
\26\ Telephone conversation between Mary N. Revell, Associate
General Counsel, NASD, and Daniel Driscoll, Vice President,
Compliance, NFA (February 26, 1997).
\27\ See, e.g., letters from Edwards, Barington, Cullum, Duke I,
Duke II, Duncan-Smith, GKN, Hoak, Morgan Stanley, Baird, and
Montgomery.
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III. Discussion
For the reasons discussed below, the Commission finds that the
proposed rule change is consistent with the requirements of the Act and
the rules and the regulations thereunder applicable to registered
securities associations, in particular the requirements of Section
15A(b)(6) of the Act.\28\ Among other things, Section 15A(b)(6) of the
Act requires that the rules of a national securities association be
designed to foster cooperation and coordination with persons engaged in
regulating, clearing, settling, processing information with respect to,
and facilitating transactions in securities, to remove impediments to
and perfect the mechanism of a free and open market and a national
market system, and in general, to protect investors and the public
interest.
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\28\ 15 U.S.C. Sec. 78o-3(b)(6).
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In particular, the Commission believes that the proposed rule
change will discourage the revival of disciplined firms that have been
barred by the industry or that have had their registrations revoked by
the Commission. In essence, firms that decide to hire significant
numbers of employees from disciplined firms will be required to ensure
a proper supervisory environment that protects investors and prevents
fraudulent and manipulative telemarketing acts and practices. The
monitoring of registered persons' telephone conversations will help to
provide additional supervision of individuals who formerly worked at a
disciplined firm where they were inadequately trained and supervised.
In the Notice, the Commission requested comments on all aspects of
the proposal, as well as the need to inform investors that their calls
are being taped. The Commission received one comment letter concerning
the proposal. The SIA expressed general concerns about tape recording
conversations as a method of supervision. While the Commission
recognizes the limitations of this form of supervision, the Commission
believes that if registered persons know their phone calls are being
taped then they are more likely to avoid making false or exaggerated
representations. In addition, compliance officals will have another
tool to monitor persons who worked previously at firms with significant
sales practice problems. Moreover, the fact that tapes of the telephone
conversations will be available to persons who have disputes with
broker-dealer firms will spur firms with a substantial percentage of
representatives from an expelled firm to take extra measures to
supervise these persons.
No comments were received concerning the issue of notice to
investors that their calls are being taped. NASD Regulation has
indicated its belief that the issue of notification is addressed by
state privacy laws and that firms will be required to independently
determine that state laws are satisfied. The Commission believes that
the best practice would be for member firms to notify their registered
persons and customers that their telephone calls are being tape
recorded.
The Commission expects the NASD to monitor the Rule and assess its
effectiveness. For example, the NASD should monitor the number of firms
that become subject to the Rule as well as firms that hire
representatives from disciplined firms but do not trigger the taping
requirement to see if there is a need to adjust the percentages. Also,
the NASD should monitor the number of firms exempt from the Rule
because they have five or fewer employees to determine if this is an
effective exclusion. Furthermore, the NASD should make sure firms
comply with state laws on notification.
The Commission finds good cause for approving Amendment No. 2 prior
to the thirtieth day after the date of publication of notice thereof in
the Federal Register. Amendment No. 2 applies the proposal to member
firms with a work force comprised of a specified number of registered
persons who were employed by a ``disciplined firm'' within the last
three years instead of two years.\29\ In the Notice, the Commission
requested comment on whether the original two-year time frame was
appropriate. Although no comments were received on this issue, NASD
Regulation and the Commission believe that a three-year time frame will
better capture registered persons who worked at disciplined firms
during a period of inadequate training, supervision, and sales practice
abuses. Therefore, the Commission believes that granting accelerated
approval to Amendment No. 2 is appropriate and consistent with Section
15A of the Act.\30\
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\29\ Amendment No. 2 also makes several technical amendments
which clarify the application of the previously noticed changes to
Rules 3010 and 9610.
\30\ 15 U.S.C. Sec. 78o-3.
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IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment No. 2 to the proposed rule change,
including whether the proposed rule change is consistent with the Act.
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 Amendment No. 2
that are filed with the Commission, and all written communications
relating to Amendment No. 2 between the Commission and any persons,
other than those that may be withheld from the public in accordance
with the provisions of 5 U.S.C. Sec. 552, will be available for
inspection and copying in the Commission's Public Reference Room.
Copies of the filing will also be available for inspection and copying
at the principal office of the NASD. All submissions should refer to
File No. SR-NASD-97-69 and should be submitted by May 15, 1998.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\31\ that the proposed rule change (SR-NASD-97-69), including
Amendment No. 2 thereto, is approved on an accelerated basis.
\31\ 15 U.S.C. Sec. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\32\
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\32\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-10796 Filed 4-22-98; 8:45 am]
BILLING CODE 8010-01-M