[Federal Register Volume 64, Number 78 (Friday, April 23, 1999)]
[Notices]
[Pages 20036-20043]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-10200]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41302; File No. SR-NASD-99-07]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc. Creating 
a Discovery Guide for Use in NASD Arbitrations

April 16, 1999.
    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 January 29, 1999, the National Association of Securities Dealers, 
Inc. (``NASD'' or ``Association''), through its wholly owned subsidiary 
NASD Regulation, Inc. (``NASD Regulation''), filed with the Securities 
and Exchange Commission (``Commission'') the proposed rule change as 
described in Items I, II, and III below, which Items have been prepared 
by NASD Regulation. On March 23, 1999, NASD Regulation submitted 
Amendment No 1 to the proposed rule change.\3\ NASD Regulation 
submitted Amendment No. 2 to the proposed rule change on April 9, 
1999.\4\ The Commission is publishing this notice of the rule change, 
as amended, 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 Alden S. Adkins, Senior vice President and 
General Counsel, NASD Regulation, to Katherine A. England, Assistant 
Director, Division of Market Regulation, Commission, dated March 23, 
1999. In Amendment No. 1, NASD Regulation made minor changes to the 
Discovery Guide in response to some of the Commission's concerns 
about the Guide (``Amendment No. 1'').
    \4\ See letter from S. Alden, Senior Vice President and General 
Counsel, NASD Regulation, to Katherine A. England, Assistant 
Director, Division of Market Regulation, Commission, dated April 9, 
1999. In Amendment No. 2, NASD Regulation made minor changes to 
clarify some of the language within the Discovery Guide (``Amendment 
No. 2'').
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    NASD Regulation has filed with the Commission a proposed Discovery 
Guide for use in NASD arbitration proceedings to improve the discovery 
process in NASD-sponsored securities arbitrations. Below is the text of 
the proposed rule change which would create the Discovery Guide and 
Document Production Lists.
* * * * *

Discovery Guide

    For NASD arbitrations, the Discovery Guide supplements the 
section in The Securities Industry Conference on Arbitration 
(``SICA'') publication entitled ``The Arbitrator's Manual,'' and 
captioned ``Prehearing Conference,'' found on pages 11 through 16, 
regarding public customer cases.

I. The Need for New Discovery Procedures

    Discovery disputes have become more numerous and time consuming. 
The same discovery issues repeatedly arise. To minimize discovery 
disruptions, the NASD Regulation Office of Dispute Resolution has 
developed too initiatives to standardize the discovery process: 
early appointment of arbitrators to conduct an initial prehearing 
conference and document production lists (``Document Production 
Lists'').
    No requirement under the Discovery Guide supersedes any record 
retention requirement of any federal or state law or regulation or 
any rule of a self-regulatory organization.
    The Discovery Guide and Document Production Lists are designed 
for customer disputes with firms and Associated Person(s) \5\ The 
Discovery Guide also discusses additional discovery requests, 
information requests, depositions, admissibility of evidence, and 
sanctions.
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    \5\ NASD Regulation may develop separate Document Production 
Lists for intra-industry disputes.
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    The Discovery Guide, including the Document Production Lists, 
will function as a guide for the parties and the arbitrators; it is 
not intended to remove flexibility from arbitrators or parties in a 
given case. For instance, arbitrators can order the production of 
documents not provided for by the Document Production Lists or alter 
the production schedule described in the Discovery Guide. Further, 
nothing in the Discovery Guide precludes the parties from 
voluntarily agreeing to an exchange of documents in a manner 
different from that set forth in the Discovery Guide. In fact, the 
Office of Dispute Resolution encourages the parties to agree to the 
voluntary exchange of documents and information and to stipulate to 
various matters. The fact that an item appears on a Document 
Production List does not shift the burden of establishing or 
defending any aspect of a claim.

II. Document Production Lists.

    The Office of Dispute Resolution will provide the parties with 
Document Production Lists (attached to the Discovery Guide) at the 
time it serves the statement of claim in customer cases. The 
arbitrators and the parties should consider the documents described 
in Document Production Lists 1 and 2 presumptively discoverable. 
Absent a written objection, documents on Document Production Lists 1 
and 2 shall be exchanged by the parties within the time frames set 
forth below.
    The arbitrators and parties also should consider the additional 
documents identified in Document Production Lists 3 through 14, 
respectively, discoverable, as indicated, for cases alleging the 
following causes of action: churning, failure to supervise 
misrepresentation/omission, negligence/breach of fiduciary duty, 
unauthorized trading, and unsuitability. For the general document 
production and for each of these causes of action, there are 
separate Document Production Lists for firms/Associated Person(s) 
and for customers.
    NASD Rule 10321 provides that the parties shall cooperate to the 
fullest extent practicable in the voluntary exchange of documents 
and information to expedite the arbitration process. As noted, 
nothing in the Discovery Guide precludes parties from voluntarily 
agreeing to an exchange of documents in a manner different from that 
set forth in the Discovery Guide.
A. Time Frames for Document Production and Objections
    The parties should produce all required documents listed in the 
applicable Document Production Lists not later than thirty days \6\ 
from the date the answer is due or filed, whichever is earlier. If a 
party redacts any portion of a document prior to production, the 
redacted pages (or ranges of pages) shall be labeled ``redacted.'' A 
party may object to the production of any document, which would include 
an objection based upon an established privilege such as the attorney-
client privilege. If any party objects to the production of any 
document listed in the relevant Document Production Lists, the party 
must file written objections with the Office of Dispute Resolution and 
serve all parties not later than thirty days following the date the 
answer is due or filed, whichever is earlier. Objections should set 
forth the reasons the party objects to producing the documents. An 
objection to the production of a document or a category of documents is 
not an acceptable reason to delay the production of any document not 
covered by the objection. A response to an objection should be served 
on all parties within 10 days from service of the written objections. 
Objections and responses should be filed with the Office of Dispute 
Resolution at the time they are served on the parties. The 
arbitrator(s) shall then determine whether the objecting party has 
overcome the presumption based upon sufficient reason(s).
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    \6\ All time periods referenced herein are calendar days.

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[[Page 20037]]

B. Confidentiality \7\
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    \7\ Section II. B. is also applicable to additional discovery 
requests and information requests (see sections IV. and V.).
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    If a party objects to document production on grounds of privacy or 
confidentiality, the arbitrator(s) or one of the parties may suggest a 
stipulation between the parties that the document(s) in question will 
not be disclosed or used in any manner outside of the arbitration of 
the particular case, or the arbitrator(s) may issue a confidentiality 
order. The arbitrator(s) shall not issue an order or use a 
confidentiality agreement to require parties to produce documents 
otherwise subject to an established privilege. Objections to the 
production of documents, based on an established privilege, should be 
raised in accordance with the time frame for objections set forth 
above.
C. Affirmation in The Event That There Are No Responsive Documents or 
Information
    If a party responds that no responsive information or documents 
exist, the customer or the appropriate person in the brokerage firm who 
has personal knowledge (i.e., the person who has conducted a physical 
search), upon the request of the requesting party, must: (1) State in 
writing that he/she conducted a good faith search for the requested 
information or documents; (2) describe the extent of the search; and 
(3) state that based on the search, no such information or documents 
exist.

III. The Initial Prehearing Conference

    To maximize the efficient administration of a case by the 
arbitration panel,\8\ the Office of Dispute Resolution staff will 
schedule an initial prehearing conference in which the arbitrator(s) 
usually participates.\9\ The initial prehearing conference gives the 
arbitrator(s) and the parties an opportunity to organize the management 
of the case, set a discovery cut-off date,\10\ identify dispositive or 
other potential motions, schedule hearing dates, determine whether 
mediation is desirable, and resolve any other preliminary issues.\11\ 
During the initial prehearing conference, the arbitrator(s) and the 
parties should schedule hearing dates for the earliest available time, 
consistent with the parties' need to prepare adequately for the 
hearing.
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    \8\ The panel consists of three arbitrators in most cases. 
Claims between $25,000 and $50,000 may proceed with a single 
arbitrator. Claims under $25,000 are decided by a single arbitrator, 
generally on the pleadings.
    \9\ In some instances, the parties may opt out of the initial 
prehearing conference. To opt out, parties must supply the following 
information to the Office of Dispute Resolution by the specified 
deadline:
    (1) A minimum of four sets of mutually agreeable hearing dates;
    (2) A discovery cut-off date;
    (3) A list of all anticipated motions with the motion due dates, 
opposition due dates, and reply due dates provided;
    (4) A minimum of four dates and times for any proposed 
prehearing conferences to hear motions; and
    (5) A determination whether briefs will be submitted and, if so, 
the due date for submission.
    \10\ The Office of Dispute Resolution recommends that the panel 
set a cut-off date during the initial prehearing conference for 
service of discovery requests, giving due consideration to time 
frames that permit timely resolution of objections and disputes 
prior to the scheduled exchange of hearing exhibits pursuant to the 
NASD Code of Arbitration Procedure.
    \11\ The arbitrators should direct one of the parties to prepare 
and forward to the Office of Dispute Resolution, within 48 hours, a 
written order memorializing the results of the prehearing 
conference, approved as to form and content by the other parties. 
When motions are heard at the initial prehearing conference, the 
panel may order the parties to submit the order with a stipulation 
as to form and content from all parties.
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    Prior to the initial prehearing conference, each arbitrator should 
become familiar with the claims and defenses asserted in the pleadings 
filled by the parties. At the initial prehearing conference, the 
arbitrator(s) should order time limits for discovery that will allow 
the scheduling of hearing dates within a reasonable time and address 
all outstanding discovery disputes. If the exchange of properly 
requested documents has not occurred, the arbitrator(s) should order 
the production of all required documents, including those outlined in 
the Document Production List (see section II. above), within 30 days 
following the conference.

IV. Additional Discovery Requests

    The parties may request documents in addition to those identified 
in the Document Production Lists pursuant to Rule 10321(b). Unless a 
longer period is allowed by the requesting party, requests should be 
satisfied or objected to within 30 days from the date of service of the 
document request. A response to an objection should be served on all 
parties within 10 days from service of the written objections. 
Requests, objections, and responses should be filed with the Office of 
Dispute Resolution at the time they are served on the parties.
    A party may move to compel production of documents when the adverse 
party (a) refuses to produce such documents or (b) offers only to 
produce alternative documents that are unacceptable to the requesting 
party. The Office of Dispute Resolution will provide the chairperson of 
the panel with the motion, opposition, and reply, along with the 
underlying discovery documents the parties have attached to their 
pleadings. The chairperson should determine whether to decide the 
matter on the papers or to convene a prehearing conference (usually via 
telephone). In considering motions to compel, particularly where non-
production is based upon an argument asserting an established 
privilege, such as the attorney-client privilege, the arbitrator(s) 
should always give consideration to the arguments set forth by both 
sides, particularly as to the relevancy of the documents or 
information. The arbitrator(s) should carefully consider such motions, 
regardless of whether item requested is on any of the Document 
Production Lists. If in doubt, the arbitrator(s) should ask the 
requesting party what specific documents it is trying to obtain and 
what it seeks to prove with the documents.

V. Information Requests

    Like requests for documents, parties may serve requests for 
information pursuant to Rule 10321(b). Requests for information are 
generally limited to identification of individuals, entities, and time 
periods related to the dispute; such requests should be reasonable in 
number and not require exhaustive answers or fact finding. Standard 
interrogatories, as utilized in state and federal courts, are generally 
not permitted in arbitration.
    Unless a longer period is allowed by the requesting party, 
information requests should be satisfied or objected to within 30 days 
from the date of service of the requests. A response to an objection 
should be served on all parties within 10 days from service of the 
written objections. Requests, objections, and responses should be filed 
with the Office of Dispute Resolution at the time they are served on 
the parties.
    A party may move to compel responses to requests for information 
that the adverse party refuses to provide. The Office of Dispute 
Resolution will provide the chairperson of the panel with the motion, 
opposition, and reply, along with the underlying discovery documents 
the parties have attached to their pleadings. The chairperson should 
determine whether to decide the matter on the papers or to convene a 
prehearing conference (usually via telephone).

VI. Depositions

    Depositions are strongly discouraged in arbitration. Upon request 
of a party, the arbitrator(s) may permit depositions, but only under 
very limited circumstances, such as: (1) To preserve

[[Page 20038]]

the testimony of ill or dying witnesses; (2) to accommodate essential 
witnesses who are unable or unwilling to travel long distances for a 
hearing and may not otherwise be required to participate in the 
hearing; (3) to expedite large or complex cases; and (4) to address 
unusual situations where the arbitrator(s) determines that 
circumstances warrant departure from the general rule. Balanced against 
the authority of the arbitrator(s) to permit depositions, however, is 
the traditional reservation about the overuse of depositions in 
arbitration.

VII. Admissibility

    Production of documents in discovery does NOT create a presumption 
that the documents are admissible at the hearing. A party may state 
objections to the introduction of any document as evidence at the 
hearing to the same extent that any other objection may be raised in 
arbitration.

VIII. Sanctions

    The arbitration panel should issue sanctions if any party fails to 
produce documents or information required by a written order, unless 
the panel \12\ finds that there is ``substantial justification'' for 
the failure to produce the documents or information. The panel has wide 
discretion to address noncompliance with discovery orders. For example, 
the panel may make an adverse inference against a party or assess 
adjournment fees, forum fees, costs and expenses, and/or attorneys' 
fees caused by noncompliance. In extraordinary cases, the panel may 
initiate a disciplinary referral against a registered entity or person 
who is a party or witness in the proceeding or may, pursuant to Rule 
10305(b), dismiss a claim, defense, or proceeding with prejudice as a 
sanction for intentional failure to comply with an order of the 
arbitrator(s) if lesser sanctions have proven ineffective.
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    \12\ As with other rulings, an arbitration panel's ruling need 
only be by majority vote; it need not be unanimous.
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* * * * *

Document Production Lists

* * * * *

List 1

Documents to be Produced in all Customer Cases \13\

Firm/Associated Persons(s)

    (1) All agreements with the customer, including, but not limited 
to, account opening documents, cash, margin, and option agreements, 
trading authorizations, powers of attorney, or discretionary 
authorization agreements, and new account forms.
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    \13\ Only named parties must produce documents pursuant to the 
guidelines set forth herein. However, non-parties may be required to 
produce documents pursuant to a subpoena or an arbitration panel 
order to direct the production of documents (see Rule 10322). In 
addition, the arbitration chairperson may use the Document 
Production Lists as guidance for discovery issues involving non-
parties.
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    (2) All account statements for the customer's account(s) during 
the time period and/or relating to the transaction(s) at issue.
    (3) All confirmations for the customer's transaction(s) at 
issue. As an alternative, the firm/Associated Person(s) should 
ascertain from the claimant and produce those confirmations that are 
at issue and are not within claimant's possession, custody, or 
control
    (4) All ``holding (posting) pages'' for the customer's 
account(s) at issue or, if not available, any electronic equivalent.
    (5) All correspondence between the customer and the firm/
Associated Person(s) relating to transaction(s) at issue
    (6) All notes by the firm/Associated Person(s) or on his/her 
behalf, including entries in any diary or calendar, relating to the 
customer's account(s) at issue.
    (7) all recordings and notes of telephone calls or conversations 
about the customer's account(s) at issue that occurred between the 
Associated Persons(s) and the customer (and any person purporting to 
act on behalf of the customer), and/or between the firm and the 
Associated Person(s).
    (8) All Forms RE-3, U-4, and U-5, including all amendments, all 
customer complaints identified in such forms and all customer 
complaints of a similar nature against the Associated Person(s) 
handling the account(s) at issue.
    (9) All sections of the firm's Compliance Manual(s) related to 
the claims alleged in the statement of claim, including any separate 
or supplemental manuals governing the duties and responsibilities of 
the Associated Person(s) and supervisors, any bulletins (or similar 
notices) issued by the compliance department, and the entire table 
of contents index to each such Manual.
    (10) All analyses and reconciliations of the customer's 
account(s) during the time period and/or relating to the 
transaction(s) at issue.
    (11) All records of the firm/Associated Person(s) relating to 
the customer's account(s) at issue, such as, but not limited to, 
internal reviews and exception and activity reports which reference 
the customer's account(s) at issue.
    (12) Records of disciplinary action taken against the Associated 
Person(s) by any regulator or employer for all sales practices or 
conduct similar to the conduct alleged to be at issue.
* * * * *

LIST 2

Documents to be Produced in All Customer Cases

CUSTOMER

    (1) All customer and customer-owned business (including 
partnership or corporate federal income tax returns, limited to 
pages 1 and 2 of Form 1040, Schedules B, D, and E, or the equivalent 
for any other type of return, for the three years prior to the first 
transaction at issue in the statement of claim through the date of 
the statement of claim was filed.
    (2) Financial statements or similar statements of the customer's 
assets, liabilities and/or net worth for the period(s) covering the 
three years prior to the first transaction at issue in the statement 
of claim through the date the statement of claim was filed.
    (3) Copies of all documents the customer received from the firm/
Associated Person(s) and from any entities in which the customer 
invested through the firm/Associated Person(s), including monthly 
statements, opening account forms, confirmations, prospectuses, 
annual and periodic reports, and correspondence.
    (4) Account statements and confirmations for accounts maintained 
at securities firms other than the respondent firm for the three 
years prior to the first transaction at issue in the statement of 
claim through the date the statement or claim filed.
    (5) All agreements, forms, information, or documents relating to 
the account(s) at issue signed by or provided by the customer to the 
firm/Associated Person(s).
    (6) All account analyses and reconciliations prepared by or for 
the customer relating to the account(s) at issue.
    (7) All notes, including entries in diaries or calendars, 
relating to the account(s) at issue.
    (8) All recordings and notes of telephone calls or conversations 
about the customer's account(s) at issue that occurred between the 
Associated Person(s) and the customer (any person purporting to act 
on behalf of the customer).
    (9) All correspondence between the customer (and any person 
acting on behalf of the customer) and the firm/Associated Person(s) 
relating to the account(s) at issue.
    (10) Previously prepared written statements by persons with 
knowledge of the facts and circumstances related to the account(s) 
at issue, including those by accountants, tax advisors, financial 
planners, other Associated Person(s), and any other third party.
    (11) All prior complaints by or on behalf of the customer 
involving securities matters and the firm's/Associated Person(s') 
response(s).
    (12) Complaints/Statements of Claim and Answers filed in all 
civil actions involving securities matters and securities 
arbitration proceedings in which the customer has been a party, and 
all final decisions and awards entered in these matters.
    (13) All documents showing action taken by the customer to limit 
losses in the transaction(s) at issue.
* * * * *

List 3

Churning

Firm/Associated Person(s)

    (1) All commission runs relating to the customer's account(s) at 
issue or, in the alternative, a consolidated commission report 
relating to the customer's account(s) at issue.
    (2) All documents reflecting compensation of any kind, including 
commissions, from all sources generated by the Associated

[[Page 20039]]

Person(s) assigned to the customer's account(s) for the two months 
preceding through the two months following the transaction(s) at 
issue, or up to 12 months, whichever is longer. The firm may redact 
all information identifying customers who are not parties to the 
action, except that the firm/Associated Person(s) shall provide at 
least the least four digits of the non-party customer account number 
for each transaction.
    (3) Documents sufficient to describe or set forth the basis upon 
which the Associated Person(s) was compensated during the years in 
which the transaction(s) or occurrence(s) in question occurred, 
including: (a) any bonus or incentive programs; and (b) all 
compensation and commission schedules showing compensation received 
or to be received based upon volume, type of product sold, nature of 
trade (e.g., agency v. principal), etc.
* * * * *

List 4

Churning

Customer

    No additional documents identified.
* * * * *

List 5

Failure to Supervise

Firm/Associated Person(s)

    (1) All commission runs and other reports showing compensation 
of any kind relating to the customer's account(s) at issue or, in 
the alternative, a consolidated commission report relating to the 
customer's account(s) at issue.
    (2) All exception reports and supervisory activity reviews 
relating to the Associated person(s) and/or the customer's 
account(s) that were generated not earlier than one year before or 
not later than one year after the transaction(s) at issue, and all 
other documents reflecting supervision of the Associated Person(s) 
and the customer's account(s) at issue.
    (3) Those portions of internal audit reports at the branch in 
which the customer maintained his/her account(s) that: (a) focused 
on the Associated Person(s) or the transaction(s) at issue; and (b) 
were generated not earlier than one year before or not later than 
one year after the transaction(s) at issue and discussed alleged 
improper behavior in the branch against other individuals similar to 
the improper conduct alleged in the statement of claim.
    (4) Those portions of examination reports or similar reports 
following an examination or an inspection conducted by a state or 
federal agency or a self-regulatory organization that focused on the 
Associated Person(s) or the transaction(s) at issue or that 
discussed alleged improper behavior in the branch against other 
individuals similar to the improper conduct alleged in the statement 
of claim.
* * * * *

List 6

Failure to Supervise

Customer

    No additional documented identified.
* * * * *

List 7

Misrepresentation/Omissions

Firm/Associated Person(s)

    Copies of all materials prepared or used by the firm/Associated 
Person(s) relating to the transactions or products at issue, 
including research reports, prospectuses, and other offering 
documents, including documents intended or identified as being ``for 
internal use only,'' and worksheets or notes indicating the 
Associated Person(s) reviewed or read such documents. As an 
alternative, the firm/Associated Person(s) may produce a list of 
such documents that contains sufficient detail for the claimant to 
identify each document listed. Upon further request by a party, the 
firm/Associated Person(s) must provide any documents identified on 
the list.
* * * * *

List 8

Misrepresentation/Omissions

Customer

    (1) Documents sufficient to show the customer's ownership in or 
control over any business entity, including general and limited 
partnerships and closely held corporations.
    (2) Copy of the customer's resume.
    (3) Documents sufficient to show the customer's complete 
educational and employment background or, in the alternative, a 
description of the customer's educational and employment background 
if not set forth in a resume produced under item 2.
* * * * *

List 9

Negligence/Breach of Fiduciary Duty

Firm/Associated Person(s)

    Copies of all materials prepared or used by the firm/Associated 
Person(s) relating to the transactions or products at issue, 
including research reports, prospectuses, and other offering 
documents, including documents intended or identified as being ``for 
internal use only,'' and worksheets or notes indicating the 
Associated Person(s) reviewed or read such documents. As an 
alternative, the firm/Associated Person(s) may produce a list of 
such documents that contains sufficient detail for the claimant to 
identify each document listed. Upon further request by a party, the 
firm/Associated Person(s) must provide any documents identified on 
the list.
* * * * *

List 10

Negligence/Breach of Fiduciary Duty

Customer

    (1) Documents sufficient to show the customer's ownership in or 
control over any business entity, including general and limited 
partnerships and closely held corporations.
    (2) Copy of the customer's resume.
    (3) Documents sufficient to show the customer's complete 
educational and employment background or, in the alternative, a 
description of the customers educational and employment background 
if not set forth in a resume produced under item 2.
* * * * *

List 11

Unauthorized Trading

Firm/Associated Person(s)

    (1) Order tickets for the customer's transaction(s) at issue.
    (2) Copies of all telephone records, including telephone logs, 
evidencing telephone contact between the customer and the firm/
Associated Person(s).
    (3) All documents relied upon by the firm/Associated Person(s) 
to establish that the customer authorized the transaction(s) at 
issue.
* * * * *

List 12

Unauthorized Trading

Customer

    1. Copies of all telephone records, including telephone logs, 
evidencing telephone contact between the customer and the firm/
Associated Person(s).
    2. All documents relied upon by the customer to show that the 
transaction(s) at issue was made without his/her knowledge or 
consent.
* * * * *

List 13

Unsuitability

Firm/Associated Person(s)

    (1) Copies of all materials prepared, used, or reviewed by the 
firm/Associated Person(s) related to the transactions or products at 
issue, including but not limited to research reports, prospectuses, 
other offering documents, including documents intended or identified 
as being ``for internal use only,'' and worksheets or notes 
indicating the Associated Person(s) reviewed or read such documents. 
As an alternative, the firm/Associated Person(s) may produce a list 
of such documents. Upon further request by a party, the firm/
Associated Person(s) must provide any documents identified on the 
list.
    (2) Documents sufficient to describe or set forth the basis upon 
which the Associated Person(s) was compensated in any manner during 
the years in which the transaction(s) or occurrence(s) in question 
occurred, including, but not limited to: (a) any bonus or incentive 
program: and (b) all compensation and commission schedules showing 
compensation received or to be received based upon volume, type of 
product sold, nature of trade (e.g., agency v. principal), etc.
* * * * *

[[Page 20040]]

List 14

Unsuitability

Customer

    (1) Documents sufficient to show the customer's ownership in or 
control over any business entity, including general and limited 
partnerships and closely held corporations.
    (2) Written documents relied upon by the customer in making the 
investment decision(s) at issue.
    (3) Copy of the customer's resume.
    (4) Documents sufficient to show the customer's complete 
educational and employment background or, in the alternative, a 
description of the customer's educational and employment background 
if not set forth in a resume produced under item 3.
* * * * *

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

    In its filing with the Commission, NASD Regulation 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. NASD Regulation 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
    The Discovery Guide, which includes Document Production Lists, 
provides guidance to parties on which documents they should exchange 
without arbitrator or staff intervention, and to arbitrators in 
determining which documents customers and member firms or associated 
persons are presumptively required to produce in customer arbitrations. 
The NASD developed the Discovery Guide because parties and their 
attorneys often do not comply or do not comply fully with discovery 
requests in NASD arbitrations. The proposal will streamline discovery 
in arbitrations in several ways, including reducing the number and 
scope of document productions and other discovery disputes, thereby 
reducing staff, arbitrator and party resources required to resolve such 
disputes. The Discovery Guide is a consensus document. It was developed 
over more than a two-year period, and reflects the view of many 
arbitration experts, experienced practitioners, and self-regulatory 
organization (``SRO'') arbitration staff.
    The Discovery Guide and Document Production Lists will function as 
a guide for the parties and the arbitrators; they are not intended to 
bind arbitrators in a given case or to bind parties. For instance, 
arbitrators can order the production of documents not provided for by 
the Document Production Lists or alter the production schedule 
described in the Discovery Guide. Further, nothing in the Discovery 
Guide precludes the parties from voluntarily agreeing to an exchange of 
documents in a manner different from that set forth in the Discovery 
Guide or in the Document Production Lists. In fact, the Office of 
Dispute Resolution (``ODR'') of NASD Regulation encourages the parties 
to agree to the voluntary exchange of documents and information and to 
stipulate to various matters. However, the Discovery Guide is binding 
on parties to the extent it is used by arbitrators to order the 
exchange of documents.

Background

    In January 1996, the Arbitration Policy Task Force (``Task 
Force''), in Securities Arbitration Reform: Report of the Arbitration 
Policy Task Force to the Board of Governors of NASD (``Task Force 
Report''), made a number of broad recommendations to the NASD Board of 
Governors to improve the securities arbitration process administered by 
the NASD Board of Governors to improve the securities arbitration 
process administered by the NASD. One of these recommendations states 
that: ``Automatic production of essential documents should be required 
for all parties, and arbitrators should play a much greater role in 
directing discovery and resolving discovery disputes.''\14\ The Task 
Force reported that parties and their attorneys routinely failed to 
comply with discovery requests or only complied partially. In addition, 
the Task Force noted that existing NASD rules did not provide guidance 
to an arbitrator as to the proper scope of discovery and, thus, 
discovery disputes were resolved largely according to the standards of 
individual arbitrators.\15\ According to the Task Force, some 
arbitrators had experience in civil litigation, but others had little 
knowledge or training that would enable them to resolve a dispute 
according to any uniform standard or rules. \16\
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    \14\ Task Force Report at 2.
    \15\ Id. at 79.
    \16\ Id.
---------------------------------------------------------------------------

    After the work of the Task Force was completed, several groups were 
formed to work on the discovery issue. Each group was composed of 
persons offering diverse perspectives, and all made a substantial 
contribution to the process. The proposed Discovery Guide is the 
product resulting from these groups' efforts which were composed of 
arbitration experts, experienced practitioners, and SRO arbitration 
staff. Among those contributing to the Discovery Guide were persons who 
are members of the Securities Industries Conference on Arbitration 
(``SICA'') \17\, members of the Securities Industry Association 
(``SIA''), directors of the Public Investors Arbitration Bar 
Association (``PIABA''), industry representatives from major broker-
dealers, counsel for claimants, and counsel for the industry. The 
Discovery Guide represents a compromise reached over more than two 
years among a variety of securities industry and investor 
representatives and their counsel. Most of the contributors believe the 
proposal represents an opportunity to improve discovery in arbitration.
---------------------------------------------------------------------------

    \17\ SICA was formed to develop and maintain a Uniform Code of 
Arbitration and to provide a forum for the discussion of new 
developments in securities arbitration among arbitration SRO forums 
and participants in those forums. The membership includes 
representatives from the SRO's with securities arbitration forums, 
three of four ``public'' members, and a representative from the SIA.
---------------------------------------------------------------------------

    The approval of the Discovery Guide would result in the 
implementation of key recommendations of the Task Force by establishing 
the practice in customer arbitrations that essential documents will be 
produced, and requiring that arbitrators play a greater role in 
directing the discovery process and resolving discovery disputes. The 
Discovery Guide follows the Task Force's recommendation in all but one 
respect. Although the Task Force recommended that any proposed 
arbitration rule or guideline require that documents be produced 
automatically, the Discovery Guide is drafted so that the documents are 
presumptively discoverable instead to give the arbitrators more 
discretion in managing the discovery process and to provide more 
flexibility to the process.

Features of the Discovery Guide

    The Discovery Guide will be used as a supplement or an addendum to 
the guidance regarding discovery set forth in The Arbitrator's Manual, 
published by SICA, and particularly the provisions in the section 
entitled, ``Prehearing Conference,'' at pages 11-16. The Arbitrator's 
Manual is compiled by members of SICA as a guide for arbitrators, and 
is designed to

[[Page 20041]]

supplement and explain the Uniform Code of Arbitration as developed by 
SICA. By the terms of The Arbitrator's Manual, the procedures and 
policies contained therein are discretionary and may be changed by the 
arbitrators. Further, nothing in the Discovery Guide, including The 
Document Production Lists, precludes the parties from voluntarily 
agreeing to an exchange of documents in a manner different from that 
set forth in the Discovery Guide.
    The Discovery Guide consists of introductory and instructional 
text, and fourteen Document Production Lists. It is intended for use by 
arbitrators in customer arbitrations only. These lists include the 
following (parenthetical references refer to the party from whom 
documents are sought):

List 1: Documents To Be Produced In All Customer Cases (Firm/
Associated Person(s))
List 2: Documents To Be Produced In All Customer Cases (Customer)
List 3: Churning (Firm/Associated Person(s))
List 4: Churning (Customer)
List 5: Failure To Supervise (Firm/Associated Person(s))
List 6: Failure To Supervise (Customer)
List 7: Misrepresentation/Omission (Firm/Associated Person(s))
List 8: Misrepresentation/Omission (Customer)
List 9: Negligence/Breach Of Fiduciary Duty (Firm/Associated 
Person(s))
List 10: Negligence/Breach Of Fiduciary Duty (Customer)
List 11: Unauthorized Trading (Firm/Associated Person(s))
List 12: Unauthorized Trading (Customer)
List 13: Unsuitability (Firm/Associated Person(s))
List 14: Unsuitability (Customer).

    The ODR will provide the parties with the Discovery Guide including 
the Document Production Lists at the time ODR serves the statement of 
claim. The document production requirements in the first two Document 
Production Lists, ``List 1, Documents To Be Produced In All Customer 
Cases: (Firm/Associated Person(s)),'' and ``List 2, Documents To Be 
Produced In All Customer Cases: Customer,'' would apply in virtually 
all cases involving member-customer or associated person-customer 
disputes, unless the arbitrator(s), in the exercise of discretion, 
determines that some or all of the documents in the relevant Document 
Production Lists should not be produced. For cases in which allegations 
of churning, failure to supervise, misrepresentation/omission, 
negligence/breach of fiduciary duty, unauthorized trading, or 
unsuitability are stated, additional Document Production Lists (e.g., 
Document Production Lists 3 and 4--Churning) provide additional 
guidance. If a Document Production List is applicable, the Discovery 
Guide is drafted to guide the arbitrator(s) to order production, unless 
in the exercise of discretion, the arbitrator(s) believes that there is 
good cause not to order production.
    In addition to specific document production requirements, the 
Discovery Guide also discusses other topics such as confidential 
treatment of documents, additional discovery requests, depositions, 
admissibility of evidence, arbitrator participation, and sanctions. 
These general instructions are discussed below.
    Confidential Treatment. Under the Discovery Guide, parties may 
stipulate that private or confidential document(s) will not be 
disclosed or used in any manner outside of the arbitration of the 
particular case. Alternatively, the arbitrator(s) may issue 
confidentiality orders. The Discovery Guide further provides that 
arbitration panels shall not issue orders or use confidentiality 
agreements to require parties to produce documents otherwise protected 
by established privileges.
    Additional Discovery Requests. The Discovery Guide states that 
parties may request documents in addition to those identified in the 
Document Production Lists, and it provides guidance regarding the 
timing of such requests. Unless a longer period is allowed by the 
requesting party, requests should be satisfied or objected to within 30 
days from the date of service of the document request. Any response to 
objections to a request should be served on all parties within 10 days 
of service of the objection.
    The Discovery Guide provides a mechanism for a party to seek to 
compel production of documents when the adverse party (a) refuses to 
produce such documents or (b) offers only to produce alternative 
documents that are unacceptable to the requesting party. The Discovery 
Guide directs the arbitrator(s) to carefully consider such motions, 
regardless of whether the item requested is on any of the Document 
Production Lists.
    Depositions. The Discovery Guide enables the arbitrator(s) to allow 
depositions, but only under very limited circumstances, such as: (a) to 
preserve the testimony of ill or dying witnesses; (b) to accommodate 
essential witnesses who are unable or unwilling to travel long 
distances for a hearing and may not otherwise be required to 
participate in the hearing; (c) expedite large or complex cases; and 
(d) to address unusual situations where the arbitrator(s) determines 
that circumstances warrant departure from the general guidance.
    Admissibility. Production of documents pursuant to the Discovery 
Guide does not create a presumption that the documents are admissible 
at the arbitration hearing. Nothing in the Discovery Guide prevents a 
party from objecting to the introduction of any document as evidence at 
the hearing to the same extent that any other objection may be raised 
in arbitration.
    Arbitrator Participation. Under the Discovery Guide, the NASD 
arbitrator(s) will participate in the initial and subsequent prehearing 
conferences to organize the management of the case, set a discovery 
cut-off date, identify dispositive or other potential motions, schedule 
hearing dates, determine whether mediation is desirable, and resolve 
any other preliminary issues. If the exchange of properly requested 
discovery has not occurred, the Discovery Guide provides that the 
arbitrator(s) may order the production of all required documents 
subject to production.
    Sanctions. The Discovery Guide instructs arbitration panels to 
issue sanctions if any party fails to produce documents or information 
required by a written order, unless the panel \18\ finds that there is 
``substantial justification'' for the failure to produce the documents 
or information. The Discovery Guide gives wide discretion to address 
noncompliance with discovery orders. For example,the panel may make an 
adverse inference against a party or assess adjournment fees, forum 
fees, cost and expenses, and/or attorney's fees caused by 
noncompliance. In extraordinary cases, the Discovery Guide permits the 
panel to initiate a disciplinary referral against a registered entity 
or person who is a party or witness in the proceeding or may, pursuant 
to Rule 10305(b), dismiss a claim, defense, or proceeding with 
prejudice as a sanction for intentional failure to comply with an order 
of the arbitrator(s) if lesser sanctions have proven ineffective.
---------------------------------------------------------------------------

    \18\ An arbitration panel's ruling need only be by majority 
vote; if need not be unanimous.
---------------------------------------------------------------------------

The Discovery Guide Is a Guideline

    As noted, the Discovery Guide will function as a guide for the 
parties and the arbitrator(s), and is intended to supplement The 
Arbitrator's Manual, which does not create any binding regulatory 
obligations. Further, the policies set forth in the Discovery Guide are 
discretionary and may be changed by the arbitrator(s). Moreover, the 
parties may agree to a voluntary exchange of documents in a manner that

[[Page 20042]]

is different from that set forth in the Discovery Guide.
2. Statutory Basis
    NASD Regulation believes that the proposed Discovery Guide is 
consistent with the provisions of Section 15A(b)(6) of the Act, which 
requires, among other things, that the Association's rules must be 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, and, in general, to 
protect investors and the public interest. The NASD believes that the 
Discovery Guide will reduce the number and limit the scope of disputes 
involving document productions and other matters, thereby improving the 
arbitration process for the benefit of public investors, broker/dealer 
members, and associated persons who are the users of the process.

B. Self-Regulatory Organization's Statement on Burden on Competition

    NASD Regulation does not believe that the proposed Discovery Guide 
will result in any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act, as amended.

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

    Written comments were neither solicited nor received.

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

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

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether utilizing the 
Discovery Guide, as amended, is consistent with the Act. In addition to 
any other issues that the public may wish to address, the Commission 
specifically requests comments on the following aspects of the 
Discovery Guide:

A. The Discovery Guide as a Compromise Document

    The Discovery Guide provides guidance to parties on which documents 
they should exchange without arbitrator or staff intervention in NASD-
sponsored arbitrations, and to arbitrators in determining which 
documents customers and member firms or associated persons are 
presumptively required to produce in customer arbitrations. In January 
1996, the Arbitration Policy Task Force chaired by former Commission 
Chairman David Ruder recommended that ``[a]utomatic production of 
essential documents should be required for all parties, and arbitrators 
should play a much greater role in directing discovery and resolving 
discovery disputes.'' Task Force Report (January 1996), at 2.
    The NASD's National Arbitration and Mediation Committee, together 
with advisors from various diverse backgrounds, helped to draft the 
Discovery Guide over a period of two years in an effort to implement 
this recommendation. Among those contributing to the Discovery Guide 
were persons who are members of SICA, members of SIA, directors of 
PIABA, industry representatives, representatives from major broker-
dealers, counsel for claimants, and counsel for the industry. The 
Discovery Guide reflects a compromise between the various interests of 
the drafters.
    The Commission seeks comment on whether the Discovery Guide's 
document discovery lists, when considered as a whole, reflect a 
balanced compromise between the various interests of the drafters.
    The Commission seeks comment on whether the Discovery Guides 
document discovery lists, when considered as a whole, reflect a 
balanced compromise between the production needs of, and burdens on, 
both claimants and industry defendants in customer arbitrations. For 
example, while some may believe production of a particular class of 
documents on one of the industry production lists is burdensome, there 
may be an equally burdensome production requirement on the 
corresponding customer production list. Comments should provide 
specific examples to support their views of whether the Discovery Guide 
is a balanced effort to make both sides in an arbitration produce more 
relevant documents more quickly. Comments should take into account 
that, as noted in the Discovery Guide, parties are not precluded from 
seeking additional classes of documents either by agreement or by order 
of the arbitrators in any particular case.

B. Customer Personal Financial Information

    Under List 2 of the Discovery Guide, claimants in all cases are 
asked to produce a significant amount of personal financial 
information. For example, claimants are asked to produce portions of 
all customer and customer-owned business federal income tax returns 
(List 2, Item 1), financial statements or similar statements of the 
customer's assets, liabilities and or net worth (List 2, Item 2), and 
account statements and confirmations for accounts maintained at a 
securities firm other than the respondent firm (List 2, Item 4) for a 
period of at least three years and as many as six years.\19\
---------------------------------------------------------------------------

    \19\ These requests seek documents covering the period from 3 
years prior to the transaction(s) in issue through the time the 
claim is filed. Since most arbitration claims must be brought within 
3 years from the date of the transaction under applicable statutes 
of limitations, depending on when a claim is filed, a claimant may 
have to produce 6 years' worth of personal financial information.
---------------------------------------------------------------------------

    The Commission seeks comment on whether the scope of these requests 
on List 2 is reasonable in all customer cases. For example, should 
these requests be limited to a lesser amount of personal financial and 
tax information (e.g., either tax returns or financial statements), or 
to a shorter period of coverage (e.g., financial information covering a 
year before the transactions at issue until the date the claim is 
made)? Should federal income tax returns be made presumptively 
discoverable in only certain types of cases where the information 
contained in those documents may be more relevant (such as 
unsuitability cases (List 14)), than in other types of cases (such as 
churning claims)?
    The Commission also seeks comment on whether the relative 
production burden is reasonably equivalent for both claimants and 
respondents in an arbitration proceeding. The drafters of the Discovery 
Guide sought to effect a compromise between competing interests, with 
each party being required to give up certain types of information in 
order to receive other types of information on a regular and timely 
basis. For example, does requiring customers to produce personal 
financial information (List 2, Items 1, 2, and 4) balance the 
respondent's obligation to produce records of customer complaints and 
disciplinary action, without time limitation (List 1, Items 8 and 12). 
\20\

[[Page 20043]]

Commenters should provide specific examples to support their opinions 
where possible.
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    \20\ List 1, Item 8 requires firms/associated persons to produce 
``[a]ll Forms RE-3, U-4, and U-5s, including all amendments, all 
customer complaints identified in such forms, and all customer 
complaints of a similar nature against the Associated Person(s) 
handling the account(s) at issue.'' List 1, Item 12 calls for 
production of ``[r]ecords of disciplinary action taken against the 
Associated Person(s) by any regulator or employer for all sales 
practices or conduct similar to the conduct alleged to be at 
issue,'' in all cases.
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C. Privilege Issues

    The Discovery Guide states in Part II.B. that ``[t]he arbitrator(s) 
shall not issue an order or use a confidentiality agreement to require 
parties to produce documents otherwise subject to an established 
privilege.'' Those privileges that would be deemed ``established,'' 
however, are not listed in the Guide. While the attorney-client 
privilege would clearly be an example of an established privilege, 
would it be helpful to parties and arbitrators to identify if other 
privileges also could be claimed? Do securities firms intend to assert 
any other types of privileges? Is the absence of specificity an 
invitation to argument about whether a privilege has been 
``established''?
    As the NASD has stressed, the Lists of presumptively discoverable 
documents were the result of significant compromise between 
representatives of the industry, the plaintiffs' bar, and other 
interested persons. Each group agreed to include certain types of 
documents in the Lists that it could otherwise object to producing 
because it would receive other types of documents in return. Is the 
term ``established privilege'' sufficiently limited to assure that the 
balance between competing interests that the NASD sought to achieve 
through the Discovery Guide will not be upset?
    The Commission therefore seeks comment on the privileges that 
should be considered ``established'' for purposes of the Discovery 
Guide. Should the only privilege recognized as ``established'' be the 
attorney/client privilege (and the related work product doctrine)? In 
light of the compromises reached in fashioning the Discovery Guide, 
should a party be precluded from asserting a blanket privilege to keep 
from producing an entire category of documents contained on one of the 
discovery Lists?

D. Internal Audit Reports

    List 5, Item 3(a) calls for the production of those portions of 
internal audit reports that ``focused on'' the associated person(s) or 
transaction(s) at issue. There may be instances where an internal audit 
report does not ``focus on'' a particular person or transaction, but 
may nonetheless relate to a claim made in arbitration. For example, an 
internal report that addresses a particular practice of the firm or 
branch office may be relevant to the customer's claim even if it does 
not ``focus on'' the associated person named in the customer's 
complaint.
    Therefore, the Commission would like comment on whether the 
internal audit reports subject to production under List 5, Item 3(a) 
should be limited to those that ``focus on'' the associated person(s) 
or transaction(s) at issue in the claim, or whether the class of 
internal audit reports should be expanded to include those that 
``concern'' or ``relate to'' the claims made in the arbitration. Is the 
limitation in List 5, Item 3(a) to reports that ``focus on'' the 
associated person(s) and transaction(s) at issue necessary to prevent 
production of audit reports that are unrelated to the claims in a 
particular arbitration, or does the limitation exclude particular types 
of reports that will almost always be relevant?
    List 5, Item 3(b) requires production of those portions of internal 
audit reports that ``were generated not earlier than one year before or 
not later than one year after the transaction(s) at issue and discussed 
alleged improper behavior in the branch against other individuals 
similar to the improper conduct alleged in the statement of claim.'' 
Does this provision help ensure that all portions of internal audit 
reports that may be relevant to the claims asserted in an arbitration 
will be produced by firms? Would an expansion of the documents called 
for in List 5, Item 3(a) upset the balance strived for by the members 
of the NASD's drafting committee?

E. Particular Types of Claims

    Lists 1 and 2 set forth documents to be produced in all customer 
cases by firms/associated persons and customers, respectively. Lists 3 
through 14 call for the production of additional classes of documents 
in particular types of cases, including churning (Lists 3 and 4), 
failure to supervise (Lists 5 and 6), misrepresentation/omission (Lists 
7 and 8), negligence/breach of fiduciary duty (Lists 9 and 10), 
unauthorized trading (Lists 11 and 12) and unsuitability (Lists 13 and 
14). Are there other types of specific claims that should be included 
in particular lists in the Discovery Guide? For instance, claims 
alleging failure to obtain best execution on particular trades do not 
have individualized production lists. Because of the nature of best 
execution claims, the documents called for in List 11 may be relevant 
in those cases. Should List 11 also apply to best execution claims as 
well as unauthorized trading claims? When commenting, commenters should 
take into account that recently best execution has become a topic of 
significant interest.\21\
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    \21\ See, e.g., Newton v. Merrill Lynch, Pierce, Fenner & Smith 
Incorporated, et al., 135 F.3d 266 (3d Cir. 1998); Order Execution 
Obligations, Exchange Act Release No. 37619A, 61 FR 48290 (Sept. 12, 
1996) (duty of best execution requires broker-dealer to seek the 
most favorable terms reasonably available under the circumstances of 
the customer's transaction).
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    Person making written submissions should file six copies thereof 
with the Secretary, Securities and Exchange Commission, 450 Fifth 
Street, N.W., Washington, D.C. 20549-0690. 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. 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-99-07 and should be 
submitted by May 14, 1999.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\22\
---------------------------------------------------------------------------

    \22\ 17 CFR 200.30-3(a)(12)
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-10200 Filed 4-22-99; 8:45 am]
BILLING CODE 8010-01-M