[Federal Register Volume 64, Number 111 (Thursday, June 10, 1999)]
[Notices]
[Pages 31338-31341]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-14683]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41469; File No. SR-NYSE-97-25]


Self-Regulatory Organizations; New York Stock Exchange, Inc.; 
Order Granting Approval to Proposed Rule Change and Notice of Filing 
and Order Granting Accelerated Approval to Amendment No. 1 to Proposed 
Rule Change to Amend its Rule 382 Relating to Carrying Agreements

June 2, 1999

I. Introduction

    On September 16, 1997, the New York Stock Exchange, Inc. (``NYSE'' 
or ``Exchange'') submitted to the Securities and Exchange Commission 
(``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 NYSE Rule 382 to monitor the activities 
of introducing firms that are parties to carrying agreements.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4
---------------------------------------------------------------------------

    The proposed rule change was published for comment in the Federal 
Register on October 14, 1997.\3\ Seven comment letters were received on 
the proposal.\4\ On November 12, 1998, the NYSE submitted to the 
Commission a letter responding to the issues raised in the comment 
letters received by the Commission.\5\ On November 25, 1998, the NYSE 
submitted Amendment No. 1 to the proposed rule change.\6\ This order 
approves the proposed rule change and approves Amendment No. 1 on an 
accelerated basis.
---------------------------------------------------------------------------

    \3\ See Securities Exchange Act Release No. 39200 (October 3, 
1997), 62 FR 53369.
    \4\ See Letters to Jonathan Katz, Secretary, Commission, from 
Mark R. Grewe, Schroder & Co. Inc., dated October 14, 1997 
(``Schroder''); Jonathan Kord Lagemann, Esq., dated October 30, 
1997; Olga Monetti, dated October 29, 1997; Stephen Tenison, Senior 
Vice President-Compliance, Global Financial Services, L.L.C., dated 
October 29, 1997 (``Global''); J. David Coker, Coker & Palmer, Inc., 
dated October 29, 1997 (``Coker & Palmer''); Erich Sokolower, 
Managing Director, Repex & Co., Inc., dated October 31, 1997 
(``Repex''); and Thomas J. Berthel, Chairman, Local Firms Committee, 
Edward Schlitzer, Chairman, Clearing Firms Committee, and Thomas A. 
Franko, Ad Hoc Clearing Subcommittee, Securities Industry 
Association, dated November 3, 1997 (``SIA'').
    \5\ See Letter from James E. Buck, Senior Vice President and 
Secretary, NYSE, to Richard Strasser, Assistant Director, Division 
of Market Regulation (``Division''), Commission, dated November 11, 
1998 (``NYSE Response Letter'').
    \6\ See Letter from James E. Buck, Senior Vice President and 
Secretary, NYSE, to Richard C. Strasser, Assistant Director, 
Division, Commission, dated November 24, 1998 (``Amendment No. 1''). 
In Amendment No. 1, NYSE proposes to amend its filing to: (1) delete 
the proposed requirement that, in response to customer complaints, 
the carrying firm must notify the customers of their right to 
transfer their accounts; and (2) add a good cause exclusion from 
certain provisions of the proposed rule when the introducing firm is 
an affiliated entity of the carrying firm.
---------------------------------------------------------------------------

II. Description of the Proposal

    The NYSE proposes to revise NYSE Rule 382 to enhance the ability of 
the Exchange and other securities self-regulatory organizations 
(``SROs'') to monitor the activities of introducing firms that are 
parties to carrying agreements. NYSE Rule 382 governs the contractual 
agreements, known as ``carrying agreements. NYSE Rule 382 governs the 
contractual agreements, known as ``carrying agreements,'' between a 
carrying firm and an introducing firm, that allocate certain functions 
and responsibilities associated with the carrying of, and transactions 
in, customer accounts. Generally, the proposed amendments to NYSE Rule 
382 would provide for increased monitoring of customer complaints 
regarding introducing firms, require specific procedures for 
introducing firms requesting reports offered by carrying firms, and 
address procedures and responsibilities of introducing firms that are 
permitted to issue negotiable instruments of the carrying firms.
    Specifically, the proposal, as amended, would require a carrying 
firm to provide promptly any written customer complaint it receives 
regarding the introducing firm to the introducing firm and the 
introducing firm's Designated Examining Authority (``DEA''). In 
addition, the proposal would require that the carrying firm notify the 
customer who submitted the written complaint in writing that the 
complaint was received and that it was provided to the introducing firm 
and the DEA. As initially proposed, the carrying firm would also have 
been required, in response to customer complaints, to inform customers 
of their right to transfer their accounts to another broker-dealer. As 
discussed further below, this provision was subsequently deleted from 
the proposal in response to comment letters received by the 
Commission.\7\
---------------------------------------------------------------------------

    \7\ See Amendment No. 1, supra note 6.
---------------------------------------------------------------------------

    The proposal also would require a carrying firm to provide to each 
of its introducing firms, at the beginning of the agreement and 
annually thereafter, a list of all exception and other reports that it 
offers to assist its introducing firms in supervising and monitoring 
their customer accounts. The proposal would require each introducing 
firm to notify the carrying firm of those specific reports offered that 
should be provided to the firm.\8\
---------------------------------------------------------------------------

    \8\ In addition, the carrying firm will be required to retain 
and preserve copies of the specific reports requested by, or 
supplied to, the introducing firm or have the capability to: (1) 
recreate copies of reports provided, or (2) make available the 
report format and data elements provided in the original reports 
necessary to recreate the original reports.
---------------------------------------------------------------------------

    In addition, the proposal would require the carrying firm to 
provide written notice, on an annual basis within 30 days of July 1 of 
each year (i.e., between June 1 and July 31), to the introducing firm's 
Chief Executive Officer, Compliance Officer, and DEA, of the list of 
reports offered to the introducing firm and to specify those reports 
actually requested or supplied as of the report date.
    The Exchange also proposes to amend its original filing to conform 
its rule language to the amended proposal submitted by the National 
Association of Securities Dealers, Inc. (``NASD'').\9\ The proposal, as 
amended, would grant the NYSE the discretion, upon a showing of good 
cause, to grant exemptions from the requirements relating to the 
handling of customer complaints and the provision of exception reports 
in instances where the introducing firm is an affiliated entity of the 
carrying firm.\10\
---------------------------------------------------------------------------

    \9\ See Amendment No. 1, supra note 6.
    \10\ Id.
---------------------------------------------------------------------------

    Finally, the proposal addresses those agreements that allow 
introducing firms to issue negotiable instruments (e.g., checks) to 
their customers, for which the carrying firm is the maker or drawer. 
The proposed rule provides that the introducing firm must represent to 
the carrying firm that it has supervisory procedures in place, which it 
enforces and which are satisfactory to the carrying firm, with respect 
to the issuance of such instruments.

III. Summary of Comments

    The Commission received seven comment letters on the proposed rule 
change.\11\ As discussed further below, all of the commenters, except 
one,\12\ generally opposed the proposal: four expressed concerns that 
the proposal was unnecessarily broad,\13\ while two stated that the 
proposal was inadequate

[[Page 31339]]

as it failed to hold carrying firms responsible for the actions of 
their introducing firms.\14\ Two of the commenters specifically opposed 
any attempts by the NYSE to hold carrying firms liable for the actions 
of their introducing brokers.\15\ In response, the NYSE stated that the 
proposed rule change would not hold the carrying firms responsible for 
the actions of their introducing firms, noting, ``the proposals are not 
intended to alter the fundamental carrying/clearing contractual 
relationship.'' \16\
---------------------------------------------------------------------------

    \11\ See note 4, supra.
    \12\ See SIA Letter, supra note 4.
    \13\ See Letters from Schroder, Global, Coker & Palmer, and 
Repex, supra note 4.
    \14\ See Letters from Lagemann and Monetti, supra note 4.
    \15\ See Letters from Schroder and SIA, supra note 4.
    \16\ See NYSE Response Letter, supra note 5.
---------------------------------------------------------------------------

A. Customer Complaints

    Two of the comment letters stated that requiring carrying firms to 
send copies of written customer complaints to the introducing firm's 
DEA is unnecessary because the introducing firm is already required to 
submit information about its customer complaints to its DEA.\17\ In 
response, the NYSE distinguished the proposed customer complaint 
requirements from existing reporting rules, such as NYSE Rule 351, 
which require statistical information about customer complaints to be 
provided to the DEA on a quarterly basis. The NYSE noted that the 
proposal would supplement, rather than duplicate, the existing 
reporting requirements by requiring that copies of actual written 
complaints be provided immediately to the DEA.\18\
---------------------------------------------------------------------------

    \17\ See Letters from Schroder and Global, supra note 4.
    \18\ See NYSE Response Letter, supra note 5.
---------------------------------------------------------------------------

    Three comment letters expressed concerns that the proposed 
notification provisions advising complaining customers of their rights 
to transfer their accounts would be misleading as it could create the 
perception that the subject of the complaint necessarily warranted a 
transfer.\19\ For example, one commenter pointed out that the proposed 
statement ``might well cause the customer to infer wrongdoing and take 
his or her business elsewhere, regardless of the merit of the complaint 
or the underlying circumstances * * *.'' \20\ Another commenter 
suggested that the proposed response ``should be reserved for only 
serious allegations where a transfer of account is an appropriate 
response.''\21\ In response, the NYSE proposes to delete this provision 
from its proposal, noting that investor education initiatives may more 
effectively accomplish the objectives of the proposed requirements.\22\
---------------------------------------------------------------------------

    \19\ See Letters from Schroder, Global, and SIA, supra note 4.
    \20\ See SIA Letters, supra note 4.
    \21\ See Global Letter, supra note 4.
    \22\ See Amendment No. 1, supra note 6; see also NYSE Response 
Letter, supra note 5.
---------------------------------------------------------------------------

B. Exception Reports

    One commenter believed that the proposed requirement that carrying 
firms provide a notice, on an annual basis, of reports offered to their 
introducing firms was unnecessary and served no ongoing useful 
purpose.\23\ This commenter recommended that the DEA and introducing 
broker should be permitted to choose whether or not to receive such 
annual notices.\24\ In response, the Exchange reaffirmed its belief 
that the annual notice would serve as an important regulatory tool for 
the introducing firm's DEA by enhancing the DEA's ability to conduct 
on-site examinations and by providing useful information regarding the 
specific data available to the introducing firm to monitor its customer 
accounts.\25\ The NYSE further noted that the proposal would require 
carrying firms to provide information about updated, and possibly 
reformatted, reports that might be useful to the introducing firm, as 
well.\26\
---------------------------------------------------------------------------

    \23\ See Global Letter, supra note 4.
    \24\ Id.
    \25\ See NYSE Response Letter, supra note 4.
    \26\ Id.
---------------------------------------------------------------------------

C. Negotiable Instruments

    One commenter noted that the representations required of the 
introducing firm that it have supervisory procedures in place with 
respect to check writing that are ``satisfactory'' to the carrying firm 
places responsibility on the carrying firm that may be inconsistent 
with other requirements, noting that NYSE rule 382(b)(4) permits the 
responsibility for the receipt and delivery of funds to be allocated 
pursuant to the carrying agreement.\27\ The NYSE stated that although 
the carrying firm, as the maker or drawer of the negotiable instrument, 
should be satisfied as to the adequacy of the introducing firm's 
procedures relating to the issuance of such negotiable instruments, the 
proposal was not intended ``to impose supervisory obligations on the 
carrying organization that are not part of its contractual allocated 
responsibilities or part of its supervisory responsibilities pursuant 
to Rule 382.'' \28\
---------------------------------------------------------------------------

    \27\ See SIA Letter, supra note 4.
    \28\ See NYSE Response Letter, supra Note 5.
---------------------------------------------------------------------------

IV. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of Section 6 of the Act \29\ and the rules and 
regulations thereunder applicable to a national securities 
exchange.\30\ The Commission believes that the proposed rule change is 
consistent with and furthers the objectives of Section (b)(5) of the 
Act \31\ in that it is designed to prevent fraudulent and manipulative 
acts and practices, to promote just and equitable principles of trade, 
to remove impediments to and perfect the mechanism of a free and open 
market and, in general, to protect investors and the public interest.
---------------------------------------------------------------------------

    \29\ 15 U.S.C. 78f.
    \30\ In approving this rule, the Commission considered the 
proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \31\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    The Commission believes that the proposed rule change, by assisting 
the NYSE to better monitor the activities of introducing firms, should 
help to prevent fraudulent and manipulative acts and practices. The 
proposal and the companion proposal submitted by the NASD \32\ 
represent an important step toward addressing recent concerns about 
questionable sales practices and potentially fraudulent activity 
engaged in by some introducing firms.\33\ The Commission expects that 
the proposed rules, by establishing procedures for the handling of 
customer complaints, the offer and receipt of exception reports, and 
the introducing firm's issuance of negotiable instruments of the 
carrying firm, should assist the SROs in their regulatory efforts. In 
addition, by requiring carrying firms to provide to their introducing 
firms copies of customer complaints and lists of available exception 
reports, the proposal should help introducing firms to better monitor 
their customer accounts.
---------------------------------------------------------------------------

    \32\ The Commission is simultaneously approving the NASD's 
amended proposal, File No. SR-NASD-97-76.
    \33\ The Commission encourages the NYSE, the NASD, and others to 
continue to consider additional measures focusing on introducing and 
clearing firm processes that would assist in detecting and deterring 
fraudulent and manipulative activities.
---------------------------------------------------------------------------

A. Customer Complaints

    The proposed customer complaint provisions of the proposal would 
require carrying firms to provide any written customer complaint they 
receive regarding the introducing firm to the introducing firm and the 
introducing firm's DEA. In addition, the proposal would require that 
the customer who submitted the written complaint be

[[Page 31340]]

notified in writing by the carrying firm that the complaint was 
received and that it was provided to the introducing firm and the DEA.
    The Commission believes the proposed requirements relating to the 
handling of customer complaints received by carrying firms are 
reasonable. These procedures should enhance the ability of introducing 
firms and their DEAs to monitor complaints. In particular, DEAs and 
firms should be better able to identify patterns of complaints and to 
determine, for example, whether there is a problem with the firms' 
supervisory procedures, operations, or an individual registered 
representative. The Commission notes the commenters' concerns that the 
proposal is duplicative because existing NYSE Rule 351 requires member 
firms to report to the Exchange statistical and summary information 
regarding customer complaints.\34\ The Commission, however, believes 
that because this proposal would require the submission of a copy of 
the actual complaint to the DEA, the proposed reporting requirements 
supplement, rather than duplicate, the existing reporting requirements.
---------------------------------------------------------------------------

    \34\ See Letters from Schroder and Global, supra note 4.
---------------------------------------------------------------------------

    Moreover, the Commission agrees with the commenters that the 
notification provisions, initially proposed, which required carrying 
firms to advise complaining customers of their right to transfer their 
accounts, could have created the perception that the subject of the 
customer's complaint warranted a transfer. Many customer complaints 
relate to operational issues, such as delayed dividend checks, and are 
easily resolved by the firm. The Commission believes that broader 
investor education initiatives designed to inform investors of their 
rights would more effectively achieve the same objectives without 
creating the possibility of unnecessary confusion. The Commission is 
working with the SROs on educational initiatives in this area. 
Accordingly, the Commission believes that the NYSE's proposal to delete 
the proposed notification provision is appropriate.

B. Exception Reports

    The proposal also would require carrying firms to provide a list of 
all reports that are offered to their introducing firms and would 
require each introducing firm to provide its carrying firm with a list 
of specific reports requested. The proposal further would require 
carrying firms to provide to their introducing firms and the 
introducing firms' DEA written annual notice, within 30 days of July 1, 
of the list of reports offered to each introducing firm and to specify 
those reports actually requested or supplied as of the report date.
    Exception and other reports are important tools in the monitoring 
and supervision of customer accounts, from both a risk management and 
customer services perspective. For example, reports that flag unusual 
account activity or possible unauthorized trades may allow for early 
detection and correction of potential problems with a firm's 
supervisory procedures, operations, or an individual registered 
representative. In addition, the Commission believes that information 
regarding reports available and those reports requested as of a 
specific date should assist both the introducing firm in assessing its 
prospective needs and the introducing firm's DEA in its regulatory 
efforts.
    Finally, the Commission notes that the proposed requirements 
relating to exception reports apply to all carrying firm/introducing 
firm relationships, regardless of the manner in which the date is 
transmitted from the carrying firm to the introducing firm. Therefore, 
the proposed rules are equally applicable to carrying agreements that 
provide for the transmission from the clearing firm to the introducing 
firm of raw data, rather than information organized in a formatted 
report. Under either scenario, the Commission expects the introducing 
firm to determine what information is needed for the proper supervision 
of its customer accounts, and to have the ability to use the data 
provided by its carrying firm in its supervisory efforts.

C. Exemption for Good Cause Shown

    The NYSE is proposing to include an exemption from the customer 
complaint and exception report provisions of the proposal for those 
situations in which carrying firms are already performing these 
compliance functions for their introducing firm affiliates. The 
Commission believes that it is reasonable for the Exchange to have the 
authority to grant such an exemption in the limited circumstances in 
which the introducing firm is an affiliated entity of the carrying firm 
to avoid duplication of efforts.
    In addition, the Commission notes that this proposed revision to 
the NYSE's original filing seeks to conform the Exchange's rule 
language to the amended proposal submitted by the NASD. The Commission 
believes that uniformity between the NYSE's and the NASD's rules in 
this area should ease the compliance burden on introducing firms and 
their carrying brokers alike, as well as enhance the usefulness of the 
rules for the firms' respective DEAs.

D. Negotiable Instruments

    The Commission believes that the proposed procedures to be followed 
by introducing firms that issue negotiable instruments for which the 
carrying firm is the maker or drawer are reasonable. Specifically, the 
Commission believes that it is appropriate for the introducing firm to 
be required to represent to the carrying firm that it has supervisory 
procedures in place, which it enforces, and which are satisfactory to 
the carrying firm. A carrying firm that finds that its introducing firm 
does not have minimal safeguards and procedures for the issuance of 
checks drawn on the carrying firm's account should, at a minimum, 
reexamine its relationship with the introducing firm. The Commission 
views the proposed requirement as a supplement to, rather than a 
replacement for, any other obligation or legal liability of the 
carrying firm as maker or drawer of the instrument.\35\
---------------------------------------------------------------------------

    \35\ See, e.g., NYSE Information Memo No. 96-4 (November 22, 
1996); NYSE Interpretation Handbook, p. 561-62, (k)(2)(ii)/017.
---------------------------------------------------------------------------

    The Commission finds good cause for approving proposed Amendment 
No. 1 prior to the thirtieth day after the date of publication of 
notice of filing thereof in the Federal Register. In Amendment No. 1, 
the NYSE addresses the concerns raised in the seven comment letters 
received by the Commission on this proposal. Moreover, Amendment No. 1 
modifies the original filing only slightly, in response to specific 
comments raised by interested parties. Specifically, Amendment No. 1 
deletes the proposed rule language requiring carrying firms to include 
in their responses to customer complaints a statement regarding the 
customer's right to transfer the account to another broker-dealer. As 
discussed above, the Commission believes that alternative investor 
education initiatives to inform public customers of their rights as 
investors would be equally effective, without raising the possibility 
of customer confusion regarding whether the carrying firm believes such 
action is warranted. Amendment No. 1 also adds a good cause exclusion 
from certain provisions of the proposed rule in circumstances in which 
the introducing firm is an affiliated entity of the carrying firm and 
the carrying firm has assumed the responsibility for performing certain 
compliance functions for the introducing firm. As the modifications 
proposed in

[[Page 31341]]

Amendment No. 1 are reasonable and do not significantly alter the 
original proposal, the Commission believes that Amendment No. 1 raises 
no new issues of regulatory concern. Accordingly, the Commission 
believes that it is consistent with section 6 of the Act \36\ to 
approve Amendment No. 1 to the proposed rule change on an accelerated 
basis.
---------------------------------------------------------------------------

    \36\ 15 U.S.C. 78f.
---------------------------------------------------------------------------

V. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 1, including whether Amendment No. 1 
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 20549-0609. 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 all such filings will also be 
available for inspection and copying at the principal office of the 
NYSE. All submissions should refer to File No. SR-NYSE-97-25 and should 
be submitted by July 1, 1999.

VI. Conclusion

    The Commission believes that the proposal, as amended, should 
significantly assist the efforts of introducing firms and their DEAs to 
fulfill their supervisory responsibilities. Specifically, the 
Commission believes that, by ensuring that carrying firms provide 
introducing firms with important information about their customers' 
accounts and by requiring that the introducing firms have in place 
supervisory procedures with respect to their issuance of negotiable 
instruments, the proposed rules should enhance good business practices 
by introducing firms. Further, by requiring that introducing firms 
receive copies of customer complaints and exception and other reports 
about their customers' account, the proposal should assist introducing 
firms in more quickly identifying and addressing potential problems 
with their supervisory procedures, operations, or an individual 
registered representative. This should reduce the risks to both the 
firm and its customers from questionable sales practice and potentially 
fraudulent activity.
    In addition, the Commission believes that the proposal should also 
assist the regulatory efforts of the introducing firms' DEAs. 
Specifically, the Commission believes that the proposal may allow 
earlier detection by an introducing firm's DEA of potentially 
fraudulent activity, which will benefit investors and the public. 
Therefore, the Commission finds the approval of the proposed rule 
change, as amended, is consistent with the requirements of the Act 
applicable to a national securities exchange, and in particular, with 
the requirements of section 6(b)(5) of the Act \37\ and the rules and 
regulations thereunder.
---------------------------------------------------------------------------

    \37\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

    It Is Therefore Ordered, pursuant to section 19(b)(2) of the 
Act,\38\ that the proposed rule change (SR-NYSE-97-25) is approved, as 
amended.

    \38\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\39\
---------------------------------------------------------------------------

    \39\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-14683 Filed 6-9-99; 8:45 am]
BILLING CODE 8010-01-M