[Federal Register Volume 63, Number 234 (Monday, December 7, 1998)]
[Notices]
[Pages 67496-67499]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-32400]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40723; File No. SR-NASD-98-52]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Approving Proposed Rule Change and Amendment No. 1 
Thereto and Notice of Filing and Order Granting Accelerated Approval to 
Amendment No. 2 to the Proposed Rule Change Relating to Supervision of 
Correspondence

November 30, 1998.

I. Introduction

    On July 24, 1998, the National Association of Securities Dealers, 
Inc. (``NASD'') or ``Association''), through its wholly-owned 
subsidiary, the NASD Regulation, Inc. (``NASDR''), submitted to the 
Securities and Exchange Commission (``SEC'' or ``Commission''), 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to 
amend NASD Rule 3010 to state that firms must review incoming, written 
correspondence to identify customer complaints and funds. On August 26, 
1998, the NASDR submitted Amendment No. 1 to the proposed rule 
change.\3\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Letter from Mary N. Revell, Associate General Counsel, 
NASDR, to Katherine A. England, Assistant Director, Division of 
Market Regulation (``Division''), Commission, dated August 24, 1998 
(``Amendment No. 1''). In Amendment No. 1, NASDR proposes to replace 
the word ``should'' in the text of the proposed rule with the word 
``must.''
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    The proposed rule change, as amended, was published for comment in 
the Federal Register on September 3, 1998.\4\ Four comment letters were 
received on the proposal.\5\ On November 12, 1998, the NASDR filed 
Amendment No. 2 to the proposed rule change.\6\ The Commission solicits 
comments on Amendment No. 2 from interested persons. This order 
approves the proposed rule change and Amendment No. 1 thereto and 
approves Amendment No. 2 to the proposed rule change on an accelerated 
basis.
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    \4\ See Securities Exchange Act Release No. 40372 (August 27, 
1998), 63 FR 47059..
    \5\ See Letters to Jonathan G. Katz, Secretary, Commission, from 
Michael L. Kerley, Vice President and Chief Legal Officer, MML 
Investors Services, Inc., dated September 18, 1998 (``MML Letter''); 
Theodore A. Mathas, President NYLIFE Securities, dated September 23, 
1998 (``NYLSEC Letter''); Janet G. McCallen, Executive Director, 
International Association for Financial Planing, dated September 23, 
1998 (``IAFP Letter''); and Joseph P. Savage, Assistant Counsel, 
Investment Company Institute, dated September 24, 1998 (``ICI 
Letter'').
    \6\ See Letter from Mary N. Revell, Associate General Counsel, 
NASDR, to Katherine A. England, Assistant Director, Division, 
Commission, dated November 12, 1998 (Amendment No. 2''). In 
Amendment No. 2, in addition to making several technical amendments, 
the NASDR addresses the issues raised in the comment letters. The 
NASDR proposes to revise its draft Notice to Members to clarify 
that: (1) registered representatives can forward opened mail; (2) 
maintenance of a log should be only for ``securities'' products; and 
(3) customers should be informed that they can contact a central 
office of the member firm for any reason, including to file a 
complaint. The NASDR also proposes to specifically state that member 
firms have a legal right to review incoming, written correspondence. 
Finally, the NASDR proposes to change the effective date of the new 
amendments to 60 days following publication of its Notice to 
Members.
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II. Background and Description of the Proposal

    In December 1997, the SEC approved rule amendments and a Notice to 
Members that were designed to allow firms to develop flexible 
supervisory procedures for the review of correspondence with the 
public.\7\ The amendments were intended to recognize the growing use of 
electronic communications such as ``e-mail'' while still providing for 
effective supervision. Notice to Members 98-11, issued by the

[[Page 67497]]

NASD in January 1998, announced approval of the rule amendments, the 
effective date of the new rules, and provided guidance to firms on how 
to implement these rules. Subsequent to Commission approval of the 
amendments, but before the amended rules went into effect, the 
Commission received 14 comment letters, primarily from members in the 
insurance industry, objecting to certain provisions in the new 
rules.\8\ The commenters primarily objected to a provision in Notice to 
Member 98-11 which states that firms will be required to review all 
incoming, written correspondence directed to registered representatives 
and related to a member's investment banking or securities business. 
The NASDR added this provision to Notice to Members 98-11 to address 
two regulatory concerns raised by the Commission: (1) ensuring that 
firms capture all customer complaints; and (2) preventing registered 
representatives from taking cash or checks out of customer letters.
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    \7\ See Securities Exchange Act Release No. 39510 (December 31, 
1997) 63 FR 1131 (January 8, 1998).
    \8\ See Letters to Jonathan G. Katz, Secretary, Commission, from 
Carl B. Wilkerson, American Council of Life Insurance, dated January 
9, 1998 and January 29, 1998; Beverly A. Byrne, BenefitsCorp 
Equities, Inc., dated January 26, 1998; Michael S. Martin, The 
Equitable Life Assurance Society of the United States, dated January 
29, 1998; Janet G. McCallen, International Association for Financial 
Planning, dated February 13, 1998; W. Thomas Boulter, Jefferson 
Pilot Financial, dated January 28, 1998; Leonard M. Bakal, 
Metropolitan Life Insurance Company and MetLife Securities, Inc., 
dated January 28, 1998; Michael L. Kerley, MML Investors Services, 
Inc. dated January 26, 1998; Mark D. Johnson, The National 
Association of Life Underwriters, dated February 5, 1998; Theodore 
Mathas, NYLIFE Securities, dated January 16, 1998 and January 29, 
1998; Beverly A. Byrne, One Orchard Equities, Inc., dated January 
26, 1998; Dodie Kent, Pruco Securities Corporation, dated January 
29, 1998; and James T. Bruce, Wiley, Rein & Fielding, on behalf of 
the Electronic Messaging Association, dated January 30, 1998.
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    The commenters stated that it would be very difficult or impossible 
for a registered principal to conduct a pre-distribution review of all 
incoming, written correspondence, particularly correspondence received 
by registered representatives in small, one- or two-person offices. In 
response to these concerns, the effective date of the requirement to 
review all incoming, written correspondence was delayed to allow the 
NASDR and member firms time to develop and implement alternative, 
workable procedures for the review of incoming, written correspondence 
that addresses the regulatory concerns about preventing 
misappropriation of customer funds and diversion of customer 
complaints.\9\ The rule amendments and all other provisions in the 
Notice became effective on April 7, 1998.\10\
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    \2\ See Securities Exchange Act Release Nos. 39665 (February 13, 
1998) 63 FR 9032 (February 23, 1998); 39866 (April 14, 1998) 63 FR 
19778 (April 21, 1998); and 40178 (July 7, 1998) 63 FR 37911 (July 
14, 1998).
    \10\ See Securities Exchange Act Release No. 39866, supra note 
9.
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    NASDR Rule 3010(d)(2) currently requires each member to develop 
written policies and procedures for review of correspondence with the 
public relating to its investment banking or securities business 
tailored to its structure and the nature and size of its business and 
customers. The NASDR proposes to amend the rule to state that these 
procedures must include review of incoming, written correspondence 
directed to registered representatives and related to the member's 
investment banking or securities business to properly identify and 
handle customer complaints, funds, and securities. This proposed 
amendment will clarify that firms must develop supervisory procedures 
that specifically address the regulatory concerns identified by the 
Commission.
    The accompanying Notice to Members will provide guidance on how to 
implement the proposed rule change.\11\ In particular, the Notice 
states that, in conducting reviews of incoming, written correspondence 
to identify customer complaints and funds, where the office structure 
permits review of all correspondence, members should designate a 
registered or associated person to open and review correspondence prior 
to use or distribution to identify customer complaints and funds. The 
designated person must not be supervised or under the control of the 
registered person whose correspondence is opened and reviewed. 
Unregistered persons who have received sufficient training to enable 
them to identify complaints and checks would be permitted to review 
correspondence.
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    \11\ The Notice that will be issued when this proposed rule is 
approved will state that the requirement set forth in Notice to 
Members 98-11 is no longer applicable and has been superseded by the 
amendment to Rule 3010(d)(2) and the guidance provided in the 
Notice.
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    Where the office structure does not permit the review of 
correspondence prior to use or distribution, the Notice states that the 
firm would have to employ alternative procedures reasonably designed to 
assure adequate handling of complaints and checks. Procedures that 
could be adopted include the following:
     After opening his or her own mail, the registered 
representative can forward incoming, written correspondence related to 
the firm's investment banking or securities business to an Office of 
Supervisory Jurisdiction (OSJ) or a branch manager for review on a 
weekly basis;
     Maintenance of a separate log for all checks received and 
securities products sold, which is forwarded to the supervising branch 
on a weekly basis;
     Communication to clients that they can contact the broker/
dealer directly for any matter, including the filing of a complaint and 
provides them with an address and phone number of a central office of 
the broker/dealer for this purpose; and
     Branch examination verification that the procedures are 
being followed.
    The Notice also states that, regardless of the method used for 
initial review of incoming, written correspondence, as with other types 
of correspondence, Rule 3010(d)(1) would still require review by a 
registered principal of some of each registered representative's 
correspondence with the public relating to the member's investment 
banking or securities business.

III. Summary of Comments

    The Commission received four comment letters on the proposed rule 
change.\12\ Two of the commenters generally opposed the proposal; \13\ 
two of the commenters generally supported the proposal.\14\ The 
commenters opposing the proposal believe that any possible benefits of 
the proposal are outweighed by the associated burdens.\15\ 
Specifically, the proposal's opponents believe that even if a member 
firm's business structure permits the review of incoming, written 
correspondence prior to use or distribution, NASD Rule 3010 should not 
require such review.\16\ Instead, member firms should be permitted the 
flexibility to design their own procedures to identify customer 
complaints and funds.\17\ The NASDR has not modified its proposal in 
response to these comments.
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    \12\ See note 5, supra.
    \13\ See NYLSEC Letter and ICI Letter, supra note 5.
    \14\ See MML Letter and IAFP Letter, supra note 5.
    \15\ See NYLSEC Letter and ICI Letter, supra note 5.
    \16\ Id.
    \17\ Id.
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    One commenter also recommends that NASDR should eliminate the 
``requirements'' to forward correspondence and logs to a reviewer on a 
weekly basis and instead, to permit review on a regular basis.\18\ In 
response, the NASDR notes that its proposed Notice to Members does not 
establish ``requirements'' for those member firms with office 
structures that do not permit

[[Page 67498]]

review of all incoming correspondence.\19\ Instead, the proposed Notice 
to Members provides several examples of alternative procedures that 
member firms might employ to assure adequate handling of customer 
complaints and funds.
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    \18\ See NYLSEC Letter, supra note 5.
    \19\ See Amendment No. 2, supra note 6.
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    One commenter requests that if the proposal is adopted, the 
effective date of the amendments should be postponed for six months to 
provide member firms with sufficient time to implement the additional 
requirements.\20\ The NASDR declines to postpone the effective date of 
the amendments for six months, noting that member firms have been on 
notice since the issuance of NASD's Notice to Members 98-11 in January 
1998 that some type of review of incoming, written correspondence would 
be required. To provide member firms with some time to implement the 
required changes, the NASDR proposes to change the effective date of 
the new amendments to 60 days following publication of the Notice to 
Members announcing Commission approval of the proposal.\21\
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    \20\ See NYLSEC Letter, supra note 5.
    \21\ See Amendment No. 2, supra note 6.
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    In addition, one commenter suggests that the rule specify that if a 
member firm doesn't normally receive written correspondence directed to 
register representatives, the member should not have to develop 
procedures to address such correspondence.\22\ The NASDR has not 
modified its proposal in response to this comment.
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    \22\ See ICI Letter, supra note 5.
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    One commenter requests that the NASDR specifically state that 
member firms have a legal right to review incoming mail, to parallel a 
similar statement made by the New York Stock Exchange.\23\ In response, 
the NASDR proposes to revise its draft Notice to Members to include 
such a statement.\24\
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    \23\ See MML Letter, supra note 5.
    \24\ See Amendment No. 2, supra note 6.
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    Another commenter recommends that the NASDR clarify in the examples 
provided in its Notice to Members that: (1) Registered representatives 
can forward opened mail; (2) maintenance of a log should be only for 
``securities'' products; and (3) customers should be informed that they 
can contact a central office of the member firm for any reason, 
including to file a complaints.\25\ The NASDR proposes to revise its 
draft Notice to Members to implement the commenter's 
recommendations.\26\
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    \25\ See IAFP Letter, supra note 5.
    \26\ See Amendment No. 2, supra note 6.
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IV. Discussion

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
association.\27\ Specifically, the Commission believes the proposal is 
consistent with the requirements of Section 15A(b)(6) of the Act \28\ 
in that it is designed to prevent fraudulent and manipulative acts and 
practices and to protect investors and the public interest. The 
Commission believes that the proposal, which clarifies member firms' 
responsibilities with respect to the review of incoming, written 
correspondence, is designed to protect existing and prospective 
customers by ensuring that customer complaints and customer funds and 
securities are handled properly.
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    \27\ In approving this rule, the Commission has considered the 
proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \28\ 15 U.S.C. 78o-3(b)(6).
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    The NASDR proposes to amend NASD Rule 3010 to require that member 
firms' written procedures regarding the review of correspondence must 
include a review of incoming, written correspondence directed to 
registered representatives to properly identify and handle customer 
complaints and to ensure that customer funds and securities are handled 
in accordance with firm procedures. In its draft Notice to Members, the 
NASDR explains that the method used in conducting such reviews will 
depend on the firm's particular office structure. Where the office 
structure permits review of all correspondence, the NASDR will require 
that member firms designate an individual to open and review such 
correspondence prior to use or distribution to identify customer 
complaints and funds. The Commission agrees that wherever practicable, 
prior review of incoming, written correspondence should be mandated, to 
protect customer interests and possibly, reduce member firms' potential 
liability.
    The Commission recognizes, however, that there may be circumstances 
in which such prior review of incoming, written correspondence is not 
practical. In such cases, the Commission believes that the NASDR's 
proposal to require member firms to employ alternative procedures 
reasonable designed to assure adequate handling of customer complaints, 
funds, and securities is reasonable. The Commission believes that 
member firms that do not require prior review of all incoming, written 
correspondence should require, at a minimum, some combination of those 
alternative procedures provided by the NASDR as an example, or similar 
procedures, rather than relying on only one alternative procedure. The 
Commission believes that employing more than one alternative procedure 
should serve to provide additional assurances that incoming, written 
correspondence is handled appropriately.
    The Commission notes that the proposal requires the review by a 
registered principal of some of each registered representative's 
correspondence with the public relating to the member firm's investment 
banking or securities business, regardless of the method used for the 
initial review of incoming, written correspondence. The Commission 
believes that this requirement should ensure that appropriate persons 
within the firm will undertake to supervise the activities of the 
firm's registered representatives. The Commission expects that in the 
event that the firm learns of any suspect activities on the part of any 
of its registered representatives, the firm will commence a more 
thorough review of that representative's activities, including his/her 
correspondence with the public.
    The Commissions finds good cause for approving proposed Amendment 
No. 2 prior to the thirtieth day after the date of publication of 
notice of filing thereof in the Federal Register. In Amendment No. 2, 
the NASDR addresses the concerns raised in the four comment letters 
received by the Commission on this proposal. Amendment No. 2 modifies 
the original filing and the accompanying draft Notice to Members only 
slightly, in response to specific comments raised by interested 
parties. Specifically, Amendment No. 2 clarifies that member firms have 
the legal right to review incoming written correspondence and that the 
rules apply to the member firms' investment banking and securities 
business. As the modifications proposed in Amendment No. 2 are 
reasonable and do not significantly alter the original proposal, the 
Commission believes that Amendment No. 2 raises no issues of regulatory 
concern. Accordingly, the Commission believes that it is consistent 
with Section 15A(b)(6) of the Act \29\ to approve Amendment No. 2 to 
the proposed rule change on an accelerated basis.
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    \29\ 15 U.S.C. 78o-3(b)(6).
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V. Solicitation of Comments

    Interested persons are invited to submit written data, views and

[[Page 67499]]

arguments concerning Amendment No. 2, including whether Amendment No. 2 
is consistent with the Act. Persons making written submissions should 
file six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, NW, Washington, DC 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, 450 Fifth Street, NW, Washington, DC 20549. 
Copies of all such filings will also be available for inspection and 
copying at the principal office of the NASD. All submissions should 
refer to File No. SR-NASD-98-52 and should be submitted by December 28, 
1998.

VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\30\ that the proposed rule change (SR-NASD-98-52), as amended, is 
approved.

    \30\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\31\
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    \31\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-32400 Filed 12-4-98; 8:45 am]
BILLING CODE 8010-01-M