[Federal Register Volume 63, Number 243 (Friday, December 18, 1998)]
[Notices]
[Pages 70173-70177]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-33558]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40784; File No. SR-NASD-98-44]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc., 
Relating to Enhanced Supervision of Unregistered Persons Performing 
Limited Marketing Activities

December 11, 1998.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on July 6, 1998, the National Association of Securities Dealers, Inc. 
(``NASD'' or ``Association'') through its wholly-owned subsidiary, the 
NASD Regulation, Inc. (``NASDR'') filed with the Securities and 
Exchange Commission (``SEC'' or ``Commission'') the proposed rule 
change as described in Items I, II, and III below, which Items have 
been prepared by the NASDR. On December 2, 1998, the NASDR submitted 
Amendment No. 1 to the proposed rule change.\3\ 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).
    \2\ 17 CFR 240.19b-4.
    \3\ See Letter from Gary L. Goldsholle, Assistant General 
Counsel, NASDR, to Katherine A. England, Assistant Director, 
Division of Market Regulation, Commission, dated November 30, 1998 
(``Amendment No. 1''). In Amendment No. 1, the NASDR proposes to 
amend its filing by deleting its reference to the use by member 
firms of third-party telemarketing firms for limited marketing 
activities.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The NASDR is proposing to amend Rule 1060 and create a new 
Interpretative Material, IM-3010, to codify existing practice by 
exempting from registration persons whose securities business is 
limited to certain limited marketing activities and specify supervisory 
requirements for members concerning such unregistered persons. Below is 
the text of the proposed rule change. Proposed new language is in 
italics.

1060. Persons Exempt From Registration

    (a) The following persons associated with a member are not required 
to be registered with the Association:
    (1) persons associated with a member whose functions are solely and 
exclusively clerical or ministerial;
    (2) persons associated with a member who are not actively engaged 
in the investment banking or securities business;
    (3) persons associated with a member whose functions are related 
solely and exclusively to the member's needs for nominal corporate 
officers or for capital participation; and
    (4) persons associated with a member whose functions are related 
solely and exclusively to:
    (A) effecting transactions on the floor of a national securities 
exchange and who are registered as floor members with such exchange;
    (B) transactions in municipal securities, except as provided in 
Rule 1110 hereof, or
    (C) transactions in commodities; and
    (5) persons associated with a member whose investment banking or 
securities business is limited to marketing activities through the 
telephone or other electronic communications media for the following:
    (A) extending invitations to firm-sponsored events at which any 
substantive presentations and account or order solicitation will be 
conducted by appropriately registered personnel;
    (B) inquiring whether the prospective or existing customer wishes 
to discuss investments with a registered person; and
    (C) inquiring whether the prospective or existing customer wishes 
to receive investment literature from the firm.

In connection with subparagraphs (A), (B) and (C), unregistered persons 
shall be permitted to mention the products and services generally 
available from

[[Page 70174]]

the member, provided, however, that such unregistered persons shall not 
discuss the attributes or merits of any particular investment products 
or services or class of products or services, pre-qualify prospective 
customers as to financial status and investment history and objectives, 
or solicit new accounts or orders. Nothing in this subparagraph shall 
affect the ability of administrative personnel to contact customers 
regarding clerical or ministerial matters affecting a customer's 
account(s).

IM-3010. Supervision of Solicitation and Marketing Activities by 
Unregistered Persons

    Each member employing or using unregistered associated persons in 
accordance with Rule 1060(a)(5) (hereinafter referred to as 
``unregistered marketers'') shall ensure that the member's supervisory 
system includes the following:
    (a) Background Investigation. Prior to employing or using an 
unregistered marketer, the member shall conduct a reasonable 
investigation into the background of such person to determine that he 
or she is not subject to a disqualification as defined in the 
Association's By-Laws.
    (b) Instruction and Training. The member, or a person designated by 
the member, shall instruct all unregistered marketers acting on behalf 
of the member concerning the scope of their permissible activities, 
including: the matters that they may discuss pursuant to Rule 
1060(a)(5), the telemarketing time-of-day and disclosure obligations 
required under Rule 2211, and the requirement to make and maintain a 
centralized do-not-call list pursuant to IM-3110 and to refrain from 
soliciting customers whose names are included on the list.
    (c) Designated Principals. The member shall designate one or more 
principals who shall be responsible for implementing and overseeing the 
member's supervisory system concerning the employment or use of 
unregistered marketers;
    (d) Signed Acknowledgment. The member shall not permit unregistered 
marketers to contact customers on behalf of the member until the 
unregistered marketer acknowledges, in writing or by electronic means, 
that he or she:
    (i) is an associated person of the member;
    (ii) as an associated person:
    a. is not subject to a disqualification as defined in the 
Association's By-Laws; and
    b. submits to the authority of the jurisdiction of the Association 
and
    (iii) has been instructed by the member, or a person designated by 
the member, concerning the permissible activities of unregistered 
marketers, as specified in subparagraph (b).
    (e) Compensation. Unregistered marketers shall be compensated on an 
hourly or salary basis only, and shall not receive any bonus or 
additional compensation or other incentives tied to transactions.
    (f) Monitoring. Registered persons shall periodically monitor calls 
made by unregistered marketers to ensure that they comply with the 
limitations described in Rule 1060(a)(5).
    (g) Recordkeeping. The member shall prepare written records 
demonstrating compliance with the provisions of this interpretation, 
which shall include reports documenting the frequency of periodic 
monitoring and the results of such monitoring. The member also shall 
keep copies of all scripts used by unregistered marketers calling on 
their behalf. The member shall preserve each record for a period of not 
less than three years from the date the record was created, the first 
two years in a readily accessible place. In addition, the member shall 
retain the acknowledgment required in subparagraph (d) for a period of 
not less than three years from the date an individual ceased marketing 
on behalf of the member, the first two years in a readily accessible 
place.

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

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

1. Purpose

Background

    The Association's current policy, contained in Notice to Members 
(``NTM'') 88-50, permits unregistered individuals to extend invitations 
to firm-sponsored events and to inquire whether a prospective customer 
wishes to discuss investments with a registered person or receive 
investment literature. The proposed rule change adds certain specific 
supervisory requirements concerning the activities of these 
unregistered persons, while codifying in the NASD's rules the extent to 
which such persons may act on behalf of a member without registration.
    Specifically, under the proposed rule change, members using 
unregistered persons for the permitted activities will be required to 
supervise and periodically monitor such persons to ensure that their 
marketing activities do not exceed the narrowly prescribed limits. In 
addition, members will be required to conduct a background 
investigation on unregistered persons, provide instruction and training 
on the scope of their limited permissible activities, designate one or 
more principals to be responsible for the marketing activities of 
unregistered persons, and compensate such unregistered persons on an 
hourly or salary basis only. Any unregistered person who proposes 
marketing to customers on behalf of a member also must acknowledge in 
writing certain matters, including that he or she submits to the 
authority of the Association.

The Proposal in Notice to Members 97-58

    In August 1997, in NTM 97-58, the NASDR proposed a requirement to 
register all persons associated with or used by a member who 
communicate with the public for the purpose of soliciting the purchase 
of securities or related services or identifying prospective customers. 
The proposal contained an exemption permitting unregistered persons to 
communicate with existing customers of a member firm for three limited 
activities: (1) extending invitations to firm-sponsored events; (2) 
inquiring whether a customer wishes to speak with a registered person; 
and (3) inquiring whether a customer wishes to receive investment 
literature from the firm.
    The proposed rule change herein, like its predecessor in NTM 97-58, 
is designed to address the use of high pressure and aggressive cold 
calls by unregistered persons, often using specially designed scripts. 
It also addresses the NASDR's concern that members may not be 
consistently applying the current cold calling requirements and that 
members may be employing unregistered persons under the guise of 
performing the limited functions described above, when in fact such 
persons are engaged in much broader solicitation activities. Finally, 
it addresses the NASDR's concern that unregistered persons soliciting

[[Page 70175]]

customers may provide inaccurate or misleading information to 
customers.
    Based upon the comments received in response to NTM 97-58, and 
input provided by the various NASD standing-committees, the NASDR is 
recommending an alternative approach. The proposed rule change is no 
longer as much a general rule on ``cold calling'' per se as it is a 
rule addressing the circumstances under which unregistered persons may 
conduct limited marketing activities, such as extending invitations to 
firm-sponsored events, inquiring whether a prospective or existing 
customer wishes to speak with a registered person or receive investment 
literature.
    The proposed rule change represents a significant shift from the 
position articulated in NTM 97-58. This shift stems from the NASDR's 
conclusion after considering all of the input received in the 
rulemaking process, that registration may not be the most appropriate 
regulatory mechanism to address the NASDR's concerns. This point was 
raised by many of the commenters and committees that considered the 
initial proposal. In general, the commenters and committees believe 
that registration would not address the substance of cold calls, which, 
they believe, is what really should be of concern to the NASDR. The 
commenters and committees also believe that registration should not be 
required of persons who perform the limited functions permitted in NTM 
88-50. Registration, they argue, would be a costly and impractical 
solution to a problem that is more effectively addressed through 
increased supervision and enforcement.

The New Proposal

    The NASDR's proposed rule change codifies generally the current 
restrictions governing the use of unregistered persons that engage in 
marketing activities as set forth in NTM 88-50, and establishes more 
comprehensive supervisory responsibilities of members towards such 
unregistered persons. The NASDR believes that the proposed rule change 
would achieve several important regulatory objectives. First, it would 
educate members about their responsibilities regarding the use of 
unregistered persons that engage in marketing activities. Second, it 
would signal to the membership the NASDR's renewed attention to the 
problem of marketing. Third, and perhaps most importantly, since the 
new rule would require SEC approval, it would provide a clear, and in 
some cases, an additional and more easily provable basis on which to 
bring enforcement actions against firms and individuals that exceed the 
narrow boundaries established for the use of unregistered persons to 
engage in marketing activities.
    The proposed rule change also seeks a more careful balance between 
the burdens and benefits of registration. While avoid the expense of 
registration, the NASDR believes the proposed rule change retains many 
of the protections that registration would provide. Under the proposed 
rule change, line NTM 88-50, members would be required to conduct a 
reasonable background investigation to determine that no prospective 
unregistered person who intends marketing to customers on behalf of the 
member is subject to a disqualification as defined by the By-Laws. In 
addition, under the proposed rule change, such unregistered persons 
would continue to be deemed associated persons, and thus, subject to 
the jurisdiction of the Association. The proposed rule change makes the 
status of unregistered persons who perform limited marketing activity 
more clear than NTM 88-50 by requiring all such persons to execute an 
acknowledgment stating that they are associated persons and subject to 
the Association's jurisdiction. Persons performing these functions, 
however, would not be required to complete the series 7 examination--an 
examination that the staff believes is unnecessary for the limited 
activities permitted by unregistered persons. NASDR staff considered 
implementing a specific ``cold calling'' exam but concluded that there 
would not be sufficient material to make such an examination 
meaningful.
    While the proposed rule change was originally conceived to address 
problems resulting from cold calling activity, the current proposal 
covers activity occurring in electronic communications media generally. 
In light of the rapid growth of the Internet and other electronic 
communications media, the proposed rule change ensures that the 
requirements imposed by these new rules cannot be circumvented by 
moving marketing activity from the telephone to non-traditional media. 
If, for example, a member uses an unregistered person to post a message 
inviting the public to a seminar on an Internet bulletin board or 
during a conversation in a chat room, such conduct should be subject to 
the same requirements and supervision as communication over the 
telephone.
    The proposed rule change is based upon the premise, as articulated 
in NTM 88-50, and set forth in NASD Rule 1031(b), that persons 
associated with a member who are engaged in the investment banking or 
securities business for the member, including the functions of 
solicitation'' are required to register as a ``representative.'' Rule 
1060 lists a series of exemptions from registration for certain 
categories of persons associated with a member. Proposed new rule 
1060(a)(5) would add a new category and exempt persons whose investment 
banking or securities business is limited to marketing to customers 
through the telephone or other electronic communications media for the 
following: (1) extending invitations to firm-sponsored events at which 
any substantive presentations and account or order solicitation will be 
conducted by appropriately registered personnel; (2) inquiring whether 
the prospective or existing customer wishes to discuss investments with 
a registered person; and (3) inquiring whether the prospective or 
existing customer wishes to receive investment literature from the 
firm. By including marketing towards existing as well as prospective 
customers, the new rule makes clear that contacts with existing 
customers should be governed by the same restrictions as contacts with 
prospective customers.
    New rule 1060(a)(5) clarifies what unregistered persons may say in 
connection with their marketing activities. Specifically, the rule 
states that ``unregistered persons shall be permitted to mention the 
products and services generally available from the member, provided 
that they do not discuss the attributes or merits of any particular 
investment products or services, pre-qualify prospective customers as 
to financial status and investment history and objectives, or solicit 
new accounts or orders.'' In addition, new rule 1060(a)(5) states that 
it shall not affect the ability of administrative personnel to contact 
customers regarding clerical or ministerial matters affecting a 
customer's account.

Supervisory Responsibilities

    The comprehensive supervisory responsibilities set forth in the 
proposed rule change contain many of the supervisory responsibilities 
set forth in NTM 88-50, with several significant additions. The 
supervisory responsibilities contained in NTM 88-50 and codified in the 
proposed IM-3010 are: (1) Instructing unregistered persons who are 
marketing on behalf of a member concerning the scope of their 
permissible activities; (2) conducting a reasonable investigation into 
the background of any potential unregistered person to determine that

[[Page 70176]]

such person is not statutorily disqualified from becoming associated 
with the member; and (3) compensating unregistered persons on an hourly 
or salary basis only, without any bonuses or other incentives tied to 
transactions.
    The additional supervisory obligations that would be imposed by the 
proposed rule change include a requirement for members to obtain an 
acknowledgement from any unregistered person who intends marketing to 
customers on behalf of the member stating that he or she: (1) Is an 
associated person of the member; (2) as an associated person (a) is not 
subject to a disqualification as defined in the By-Laws and (b) submits 
to the jurisdiction of the Association; and (3) has been instructed by 
the member, or a person designated by the member, concerning the scope 
of permissible marketing activities in which such unregistered persons 
may engage.
    The proposed rule change also would require members to periodically 
monitor the activities of unregistered persons marketing on their 
behalf to confirm that such persons are complying with the limitations 
placed upon them. The NASDR proposes allowing members to determine what 
level and form of monitoring is appropriate, although we would expect 
members to increase the frequency of monitoring in response to 
complaints or other indicia that marketing abuses may be taking place. 
Members may satisfy the monitoring requirements in a variety of 
methods, including periodically ``listening in'' on marketing calls, or 
contacting previously marketed persons to determine the scope of any 
communication by the unregistered person. Whatever method members 
choose, they would be required to maintain a written record of the 
verification procedures used and the results of the periodic 
monitoring.
    The recordkeeping requirements of the proposed rule change are an 
integral part of the supervisory system. The signed acknowledgements 
and records of periodic monitoring will help provide assurance that the 
restrictions placed upon unregistered marketers are being followed. 
NASDR staff has also included a specific requirement for members to 
maintain copies of all scripts used by unregistered persons calling on 
their behalf. Scripts used by marketers frequently contain the issues 
to be discussed and suggested responses to questions that may arise 
during a conversation. From a regulatory perspective, scripts are often 
very probative of the substance of a cold call or marketing effort, and 
thus would be particularly useful in determining whether a member's use 
of unregistered marketers is in compliance with the limitations imposed 
by the proposed rule.
    The proposed rule change also would require members to designate 
one or more registered principals to be responsible for overseeing the 
member's supervisory obligations relating to the employment and use of 
unregistered persons engaged in marketing on behalf of the member. The 
NASDR believes that firms are likely to be more diligent in supervising 
unregistered persons if members designate specific individuals with 
responsibility for overseeing such activity.

Additional Issues

    Some banks and bank affiliated firms have argued that the proposed 
rule change could unduly limit marketing activities by bank employees. 
Although the NASDR preliminarily believes that the potential customer 
protections that will be derived from the increased supervision of the 
activities of unregistered persons outweigh these concerns, we would be 
interested in receiving further comments on the advisability of 
applying these rules to bank employees, as well as any possible bases 
for excluding such employees. In particular, for example, would it be 
appropriate to exclude entities that are otherwise regulated under 
federal or state law, such as banks and insurance companies?
    We also wish to obtain further public comment on whether the 
proposed rule change should be modified to reach the activities of 
unregistered third-party telemarketing firms that independently 
generate leads and then sell such leads to member firms. Since the 
Association's jurisdiction would not extend to communications by third-
party telemarketing firms that are not made on behalf of a particular 
member, we are concerned about a potential loophole in our proposed 
rule change in that members may be able to avoid application of the 
proposed rule change simply by purchasing leads from third-party 
telemarketing firms that independently generate leads and/or prequalify 
customers but do not do so on behalf of any particular member. On the 
other hand, if a member repeatedly purchases leads from a third-party 
telemarketing firm, the NASDR would take the position that the third-
party telemarketing firm is impliedly acting on behalf of the member 
and would be subject to the provisions of the proposed rule change.
2. Statutory Basis
    The NASDR believes that the proposed rule change is consistent with 
the provisions of Section 15A(b)(6) of the Act,\4\ which require that 
the Association adopt and amend its rules to promote just and equitable 
principles of trade, and generally provide for the protection of 
investors and the public interest. The NASDR believes that the proposed 
rule change codifying the Association's marketing and cold calling 
restrictions, with the addition of specified supervisory requirements, 
will sharply and effectively limit the marketing activities of 
unregistered persons while ensuring the member firms closely supervise 
and monitor the activities of unregistered persons marketing on their 
behalf.
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    \4\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The NASDR does not believe 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.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants or Others

    NASD's Notice to Members 97-58 was published for comment in August 
1997. Forty-three comments were received in response to the Notice. Of 
the forty-three comment letters received, 14 were in favor of the 
proposal and 25 were opposed, and 4 expressed no opinion.

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

    Within 35 days of the publication of this notice in the Federal 
Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    A. By order approve such proposed rule change, or
    B. Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. In addition to any other issues that 
the public may wish to address, the

[[Page 70177]]

Commission specifically requests comments on the following questions:
    Should NASD member firms be permitted to use third-party 
telemarketing firms for the limited marketing activities set forth in 
the proposal (i.e., as unregistered marketers)?
    To what extent are third-party telemarketing firms currently used 
by member firms for cold calling or marketing purposes?
    What types of member firms typically rely on third-party 
telemarketing firms to conduct cold calling on their behalf (i.e., 
large firms, medium-sized, or small firms)?
    The proposal requires member firms to ``periodically monitor'' the 
calls made by unregistered persons on their behalf to ensure that the 
discussions are limited to permissible topics. There is, however, no 
requirement that such calls be tape recorded. How would member firms 
monitor calls by unregistered persons working off-site at third-party 
telemarketing firms or working for member firms off-site?
    If a member firm can use third-party telemarketers, how can a 
member firm be certain that unregistered persons working for third-
party telemarketing firms will limit their conversations with existing 
and prospective members to the permissible topics?
    Will the required ``reasonable background investigation'' be 
sufficient to ensure that individuals who have been suspended from the 
industry are not permitted to engage in limited marketing activities?
    Would member firms be able to adequately supervise the limited 
marketing activities of employees of third-party telemarketing firms?
    What steps should firms take if a third-party telemarketer fails to 
comply with these requirements?
    What should the NASD do to ensure that such limited marketing 
activities conducted off-site at third-party telemarketing firms are 
appropriately supervised by member firms?
    If the use of third-party telemarketing firms is permitted, the 
proposal would require employees of third party telemarketing firms to 
acknowledge in writing or electronically that they are associated 
persons. The Commission notes that there is no requirement for an 
electronic signature or any other heightened restrictions in place. 
Will an electronic acknowledgment provide the member firm and the NASD 
with sufficient information as to the true identity of the individual?
    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 submissions, 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 at the Commission's Public 
Reference Room. Copies of such filing will also be available for 
inspection and copying at the principal office of the NASD. All 
submissions should refer to File No. SR-NASD-98-44 and should be 
submitted by January 8, 1999.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\5\
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    \5\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 98-33558 Filed 12-17-98; 8:45 am]
BILLING CODE 8010-01-M