[Federal Register Volume 65, Number 113 (Monday, June 12, 2000)]
[Notices]
[Pages 36860-36877]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-14718]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42885; File No. SR-NASD-99-67]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change and Amendment No. 1 Thereto by NASD Regulation, Inc. Relating to 
Amendments to Membership Rules

June 1, 2000.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'' or ``Exchange Act''),\1\ and Rule 19b-4 thereunder,\2\ notice 
is hereby given that on November 2, 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 (``SEC'' or 
``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by NASD Regulation. On 
May 1, 2000, the NASD Regulation filed Amendment No. 1 to the proposed 
rule change.\3\ The Commission is publishing this notice to solicit 
comments on the proposed rule change, as amended, from interested 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ This 19b-4 filing, represents Amendment No. 1 to File No. 
SR-NASD-99-67.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    NASD Regulation is proposing to amend the Rule 1010 Series, which 
concerns member admission. Additions are italicized; deletions are 
[bracketed].
1010. Membership Proceedings
1011. Definitions
    Unless otherwise provided, terms used in the Rule 1010 Series shall 
have the meaning as defined in Rule 0120.
    (a) ``Applicant''
    The term ``Applicant'' means a person [or entity] that applies for 
membership in the Association under Rule 1013[,] or a member that files 
an application [to remove or modify a restriction under Rule 1017, or 
files a notice and application for continuance in membership under Rule 
1018] for approval of a change in ownership, control, or business 
operations under Rule 1017. 
    (b) ``Associated Person''
    The term ``Associated Person'' means: (1) a natural person 
registered under the Rules of the Association; or (2) a sole 
proprietor, partner, officer, director, branch manager, or other 
natural person occupying a similar status or performing similar 
functions who will be or is anticipated to be associated with the 
Applicant, or a natural person engaged in the investment banking or 
securities business who will be or is anticipated to be directly or 
indirectly controlling or controlled by the Applicant, whether or not 
any such person is registered or exempt from registration under the 
NASD By-Laws or the Rules of the Association.
    (c) ``Department''
    The term ``Department'' means the Department of Member Regulation 
of NASD Regulation.
    (d) ``Director''
    The term ``Director'' means a member of the NASD Regulation Board.
    (e) ``district''
    The term ``district'' means a district established by the NASD 
Regulation Board.
    (f) ``district office''

[[Page 36861]]

    The term ``district office'' means an office of NASD Regulation 
located in a district.
    (g) ``Governor''
    The term ``Governor'' means a member of the NASD Board.
    (h) ``Interested Association Staff''
    The term ``Interested Association Staff'' means an employee who 
directly participates in a decision under Rule 1014[,] or 1017, [or 
1018,] an employee who directly supervises an employee with respect to 
such decision, an employee who conducted an investigation or 
examination of a member that files an application under Rule 1017 [or a 
notice and application under Rule 1018], the District Director for the 
relevant district, and the head of the Department.
    (i) ``material change in business operations'' 
    The term ``material change in business operations'' includes, but 
is not limited to: 
    (1) removing or modifying a membership agreement restriction; 
    (2) market making, underwriting, or acting as a dealer for the 
first time; and
    (3) adding business activities that require a higher minimum net 
capital under SEC Rule 15c3-1. 
    [(i)](j) ``NASD Board''
    The term ``NASD Board'' means the Board of Governors of the NASD.
    [(j)](k) ``NASD Regulation Board''
    The term ``NASD Regulation Board'' means the Board of Directors of 
NASD Regulation.
    (l) ``principal place of business'' 
    The term ``principal place of business'' means the executive office 
from which the sole proprietor or the officers, partners, or managers 
of the Applicant direct, control, and coordinate the activities of the 
Applicant, unless the Department determines that the principal place of 
business is where: (1) the largest number of Associated Persons of the 
Applicant are located; or (2) the books and records necessary to 
provide information and data to operate the business and comply with 
applicable rules are located. 
    [(k)](m) ``sales practice [violations] event''
    The term ``sales practice [violations] event'' means any [conduct 
directed at or involving a customer that would constitute a violation 
of any Rule in the Rule 2000 or 3000; any provision of the Act, 
Securities Exchange Act of 1934; or any state statute prohibiting 
fraudulent conduct in connection with the offer, sale, or purchase of a 
security or in connection with the rendering of investment advice] 
customer complaint, arbitration, or civil litigation that has been 
reported to the Central Registration Depository, currently is required 
to be reported to the Central Registration Depository, or otherwise has 
been reported to the Association. 
    [(l)](n) ``Subcommittee''
    The term ``Subcommittee'' means a subcommittee of the National 
Adjudicatory Council that is constituted pursuant to Rule 1015 to 
conduct a review of a Department decision issued under the Rule 1010 
Series.
IM-1011-1. Safe Harbors for Business Expansions
    This interpretive material concerns the types of business 
expansions that will not require a member to submit a Rule 1017 
application to obtain NASD Regulation's approval of the expansion. This 
safe harbor applies to: (1) firms that do not have a membership 
agreement, and (2) firms that have a membership agreement that does not 
contain a restriction on the factors listed below.
    The safe harbor is not available to a member that has a membership 
agreement that contains a specific restriction as to one or more of the 
factors listed below. In that case, the agreement takes precedence 
because NASD Regulation has determined that a particular restriction 
should apply as to one or more of the factors, and NASD Regulation has 
issued a decision with a rationale for that restriction. Similarly, the 
safe harbor also does not apply if the member has a membership 
agreement that permits expansion beyond the limits set forth below 
(e.g., an Applicant requests and obtains approval for ten registered 
representatives in the first six months with an additional ten 
registered representatives in the next year); in such case, the 
Department has specifically considered the firm's expansion plans and 
approved them. 
    The safe harbor is not available to any member that has 
disciplinary history. For purposes of this Interpretation, 
``disciplinary history'' means a finding of a violation by the member 
or a principal of the member in the past five years by the Securities 
and Exchange Commission, a self-regulatory organization, or a foreign 
financial regulatory authority of one or more of the following 
provisions (or a comparable foreign provision) or rules or regulations 
thereunder: Sections 15(b)(4)(E) and 15(c) of the Securities Exchange 
Act of 1934; Section 17(a) of the Securities Act of 1933; SEC Rules 
10b-5 and 15g-1 through 15g-9; NASD Rules 2110, 2120, 2310, 2330, 2440, 
3010 (failure to supervise only), 3310, and 3330; and MSRB Rules G-19, 
G-30, and G-37(b) & (c). 
    For those firms to which the safe harbor is available, the 
following types of expansions are presumed not to be a material change 
in business operations and therefore do not require a Rule 1017 
application. For any expansion beyond these limits, a member should 
contact its district office prior to implementing the change to 
determine whether the proposed expansion requires an application under 
Rule 1017. Expansions in each area are measured on a rolling 12-month 
basis; members are required to keep records of increases in personnel, 
offices, and markets to determine whether they are within the safe 
harbor. 
    ``Associated Persons involved in sales'' includes all Associated 
Persons, whether or not registered, who are involved in sales 
activities with public customers, including sales assistants and cold 
callers, but excludes clerical, back office, and trading personnel who 
are not involved in sales activities. 

------------------------------------------------------------------------
                                        Safe Harbor-Number of Increase
                                       Permitted Within One Year Period
                                        Without Rule 1017 Application
------------------------------------------------------------------------
Number of Associated Persons
 Involved in Sales
    1-10...........................  10 persons.
    11 or more.....................  10 persons or a 30 percent
                                      increase, whichever is greater.
Number of Offices (registered or
 unregistered)
    1-5............................  3 offices.
    6 or more......................  3 offices or a 30 percent increase,
                                      whichever is greater.
Number of Markets Made
    1-10...........................  10 markets.
    11 or more.....................  10 markets or a 30 percent
                                      increase, whichever is greater.
------------------------------------------------------------------------


[[Page 36862]]

1012. General Provisions
(a) [Service of Notices and Decisions;] Filing by Applicant or Service 
by the Association
    [A notice or a decision issued by the Association under the Rule 
1010 Series with respect to an application shall be served promptly by 
first-class mail on the Applicant or its counsel, unless a Rule 
specifies a different method of service. Service by the Association or 
filing by an Applicant by mail shall be deemed complete upon mailing. 
Service by the Association or filing by an Applicant by commercial 
courier or facsimile shall be deemed complete on the date specified in 
the written confirmation of receipt.]
    (1) An Applicant may file an application or any document or 
information requested under the Rule 1010 Series by first-class mail, 
overnight courier, or hand delivery. If the Department and the 
Applicant agree, the Applicant also may file a requested document or 
information by facsimile. 
    (2) The Association shall serve a notice or decision issued under 
the Rule 1010 Series by first-class mail on the Applicant or its 
counsel, unless a Rule specifies a different method of service. 
    (3) Service by the Association or filing by an Applicant shall be 
deemed complete as follows: 
    (A) Service or filing by first-class mail shall be deemed complete 
on the date of postmark; 
    (B) Service or filing by overnight courier shall be deemed complete 
on the date of delivery to the overnight courier as specified in the 
airbill; 
    (C) Service or filing by hand delivery shall be deemed complete on 
the date of receipt as evidenced by a date stamp; and 
    (D) Service or filing by facsimile shall be deemed complete on the 
date specified in the document and on the written confirmation of 
transmission.

(b) Lapse of Application

    (1) Absent a showing of good cause, an application filed under Rule 
1013 or 1017 shall lapse if an Applicant fails to: 
    (A) respond fully within 60 days after service of an initial 
written request for information or documents under Rule 1013, within 30 
days after service of an initial written request for information or 
documents under Rule 1017, within 30 days after service of a subsequent 
written request for information or documents under Rule 1013 or 1017, 
or within such other time period agreed to by the Department and the 
Applicant; 
    (B) appear at or otherwise participate in a scheduled membership 
interview pursuant to Rule 1013(b) or 1017(f); or
    (C) file an executed membership agreement under Rule 1014(d) or 
Rule 1017(g)(4) within 25 days after service of the agreement, or 
within such other period agreed to by the Department and the Applicant.
    (2) If an Applicant wishes to continue to seek membership or 
approval of a change in ownership, control, or business operations, 
then the Applicant shall be required to submit a new application and 
fee under Rule 1013 or 1017, respectively. The Association shall not 
refund any fee for a lapsed application. 
[(b)] (c) Ex Parte Communications
    (1) The prohibitions against ex parte communications shall become 
effective when Association staff has knowledge that an Applicant 
intends to file a written request for review by the National 
Adjudicatory Council under Rule 1015. 
    [(1)] (2) Unless on notice and opportunity for an Applicant and 
Interested Association Staff to participate, or to the extent required 
for the disposition of ex parte matters as authorized by the Rules of 
the Association:
    (A) an Applicant, a counsel or representative of an Applicant, or 
an Interested Association Staff shall not make or knowingly cause to be 
made an ex parte communication relevant to the merits of a membership 
proceeding under the Rule 1010 Series to a Governor, a member of the 
National Adjudicatory Council or a Subcommittee thereof, or an 
Association employee who is participating or advising in a decision of 
such a person with respect to that proceeding; and
    (B) a Governor, a member of the National Adjudicatory Council or a 
Subcommittee thereof, or an Association employee who is participating 
or advising in the decision of such a person with respect to a 
membership proceeding shall not make or knowingly cause to be made to 
an Applicant, a counsel or representative of the Applicant, or an 
Interested Association Staff an ex parte communication relevant to the 
merits of that proceeding.
    [(2)] (3) A Governor, a member of the National Adjudicatory Council 
or a Subcommittee thereof, or an Association employee participating or 
advising in the decision of such a person, who receives, makes, or 
knowingly causes to be made a communication prohibited by this 
paragraph shall place in the record of the membership proceeding:
    (A) all such written communications;
    (B) memoranda stating the substance of all such oral 
communications; and
    (C) all written responses and memoranda stating the substance of 
all oral responses to all such communications.
    [(3) The prohibitions against ex parte communications shall become 
effective when Association staff has knowledge that an Applicant 
intends to file a written request for review by the National 
Adjudicatory Council under Rule 1015.]
[(c)] (d) Recusal or Disqualification
    A Governor or a member of the National Adjudicatory Council or a 
Subcommittee thereof shall not participate in a matter governed by the 
Rule 1010 Series as to which that person has a conflict of interest or 
bias, or if circumstances otherwise exist where his or her fairness 
might reasonably be questioned. In such a case, the person shall recuse 
himself or shall be disqualified as follows:
    (1) The Chair of the NASD Board shall have authority to direct the 
disqualification of a Governor, and a majority of the Governors of the 
NASD Board excluding the Chair shall have authority to direct the 
disqualification of the Chair of the NASD Board.
    (2) The Chair of the National Adjudicatory Council shall have 
authority to direct the disqualification of a member of the National 
Adjudicatory Council or a member of a Subcommittee appointed pursuant 
to Rule 1015, and the Vice Chair of the National Adjudicatory Council 
shall have authority to direct the disqualification of the Chair of the 
National Adjudicatory Council.
[(d)] (e) Computation of Time
    (1) Calendar Day
    In the Rule 1010 Series, ``day'' means calendar day.
    (2) Formula
    In computing a period of time under the Rule 1010 Series, the day 
of the act, event, default, or lapse from which the period of time 
designated begins to run shall not be included. The last day of the 
period so computed shall be included unless it is a Saturday, Sunday, 
or Federal holiday, in which event the period runs until the end of the 
next day that is not a Saturday, Sunday, or Federal holiday. 
Intermediate Saturdays, Sundays, and Federal holidays shall be excluded 
from the computation when the period prescribed is ten days or less.

[[Page 36863]]

1013. New Member Application [and Membership] and Interview
(a) Filing of Application
(1) Where To File
    [Each Applicant for Association membership shall file its 
application in two parts. The first part of the application shall be 
filed with the Membership Department and shall include the following 
documents:]
    An Applicant for Association membership shall file its application 
with the Department of Member Regulation at the district office in the 
district in which the Applicant intends to have its principal place of 
business as defined in Rule 1011(l). 
    (2) Contents
    The application shall include: 
    (A) an original signed and notarized paper Form BD, with applicable 
schedules;
    (B) an original signed paper Form U-4 for each Associated Person 
who is required to be registered under the Rules of the Association;
    (C) an original NASD-approved fingerprint card for each Associated 
Person who will be subject to SEC Rule 17f-2;
    (D) a new member assessment report;
    [(E) a new member firm contact questionnaire; and]
    [(F)] (E) a check for the appropriate fee[.];
    [(2) The second part of the application shall be filed with the 
Department of Member Regulation at the district office in the district 
in which the Applicant intends to have its principal place of business 
and shall include the following information and documents:]
    [(A)] (F) a detailed business plan [, in a form prescribed by the 
Association,] that adequately and comprehensively describes all 
material aspects of the business that will be, or are reasonably 
anticipated to be, performed at and after the initiation of business 
operations, including future business expansion plans, if any, and 
includes:
    (i) a trial balance, balance sheet, supporting schedules, and 
computation of net capital, each of which has been prepared as of a 
date that is within 30 days before the filing date of the application;
    (ii) a monthly projection of income and expenses, with a supporting 
rationale, for the first twelve months of operations;
    (iii) an organizational chart;
    (iv) [a list of] the intended [locations] location of [all 
offices,] the Applicant's principal place of business and all other 
offices, if any, whether or not such offices would be required to be 
registered under the Rules of the Association, and the names of the 
persons who will be in charge of each office;
    (v) a list of the types of securities to be offered and sold and 
the types of retail or institutional customers to be solicited;
    (vi) a description of the methods and media to be employed to 
develop a customer base and to offer and sell products and services to 
customers, including the use of the Internet, telephone solicitations, 
seminars, or mailings;
    (vii) a description of the business facilities and a copy of any 
proposed or final lease;
    (viii) the number of markets to be made, if any, the type and 
volatility of the products, and the anticipated maximum inventory 
positions;
    (ix) any plan to enter into contractual commitments, such as 
underwritings or other securities-related activities;
    (x) any plan to distribute or maintain securities products in 
proprietary positions, and the risks, volatility, degree of liquidity, 
and speculative nature of the products; [and]
    (xi) any other activity that the Applicant may engage in that 
reasonably could have a material impact on net capital within the first 
twelve months of business operations; and
    (xii) a description of the communications and operational systems 
the Applicant will employ to conduct business with customers or other 
members and the plans and procedures the Applicant will employ to 
ensure business continuity, including: system capacity to handle the 
anticipated level of usage; contingency plans in the event of systems 
or other technological or communications problems or failures that may 
impede customer usage or firm order entry or execution; system 
redundancies; disaster recovery plans; system security; disclosures to 
be made to potential and existing customers who may use such systems; 
and supervisory or customer protection measures that may apply to 
customer use of, or access to, such systems; 
    [(B) a copy of the Applicant's most recent Form BD;]
    [(C)](G) a copy of any decision or order by a federal or state 
authority or self-regulatory organization taking permanent or temporary 
adverse action with respect to a registration or licensing 
determination regarding the Applicant or an Associated Person;
    [(D)](H) a list of all Associated Persons[, the most recent Form U-
4 and Form U-5 for each Associated Person, any other document that 
discloses the disciplinary history of each Associated Person, and a 
list of any other persons or entities that will exercise control with 
respect to the Applicant's business];
    [(E)](I) documentation of any of the following events, unless the 
event has been reported to the Central Registration Depository: 
    (i) a regulatory action against or investigation of the Applicant 
or an Associated Person by the Commission, the Commodity Futures 
Trading Commission, a federal, state, or foreign regulatory agency, or 
a self-regulatory organization that is pending, adjudicated, or 
settled;
    (ii) an investment-related civil action for damages or an 
injunction against the Applicant or an Associated Person that is 
pending, adjudicated, or settled;
    (iii) an investment-related customer complaint or arbitration 
[involving sales practice violations, theft, misappropriation, 
conversion, or breach of fiduciary duty, against the Applicant or an 
Associated Person that is pending, settled, or has resulted in an award 
or judgment] that is required to be reported on Form U-4; [and]
    (iv) a criminal action (other than a minor traffic violation) 
against the Applicant or an Associated Person that is pending, 
adjudicated, or that has resulted in a guilty or no contest plea; and
    [(F)](v) a copy of any document evidencing a termination for cause 
or a permitted resignation after investigation of an alleged violation 
of a federal or state securities law, a rule or regulation thereunder, 
a self-regulatory organization rule, or an industry standard of 
conduct;
    [(G)](J) a description of any remedial action, such as special 
training [or], continuing education requirements, or heightened 
supervision, imposed on an Associated Person by a state or federal 
authority or self-regulatory organization;
    [(H)](K) a written acknowledgment that heightened supervisory 
procedures and special educational programs may be required pursuant to 
Notice To Members 97-19 for an Associated Person whose record[s] 
reflects[:
    (i)] disciplinary actions [involving] or sales practice 
[violations] events;
    [(ii) customer complaints; or
    (iii) arbitrations that were resolved adversely to the Associated 
Person;]
    [(I)](L) a copy of final or proposed contracts with banks, clearing 
entities, or service bureaus, and a general description of any other 
final or proposed contracts;
    [(J)](M) a description of the nature and source of Applicant's 
capital with supporting documentation, including a

[[Page 36864]]

list of all persons or entities that have contributed or plan to 
contribute financing to the Applicant's business, the terms and 
conditions of such financing arrangements, the risk to net capital 
presented by the Applicant's proposed business activities, and any 
arrangement for additional capital should a business need arise;
    [(K)](N) a description of the financial controls to be employed by 
the Applicant;
    [(L)](O) a description of the Applicant's supervisory system and a 
copy of its written supervisory procedures, internal operating 
procedures (including operational and internal controls), internal 
inspections plan, written approval process, and qualifications 
investigations required by Rule 3010;
    [(M)](P) a description of the number, experience, and 
qualifications of supervisors and principals and the number, 
experience, and qualifications of persons to be supervised by such 
personnel, the other responsibilities of the supervisors and principals 
with the Applicant, their full-time or part-time status, any business 
activities that the supervisors or principals may engage in outside of 
their association with the Applicant, the hours per week devoted to 
such activities, and an explanation of how a part-time supervisor or 
principal will be able to discharge his or her designated functions on 
a part-time basis;
    [(N)](Q) a description of Applicant's proposed recordkeeping 
system;
    [(O)](R) a copy of the Applicant's written training plan to comply 
with Firm Element continuing education requirements described in Rule 
1120(b), including the name of the Associated Person responsible for 
implementation; and
    (P) [a copy of the documents described in paragraph (a)(1)] a Web 
CRD entitlement request form and a Member Contact Questionnaire user 
access request form. 
    (3) Electronic Filings [The Applicant shall file both parts of the 
application simultaneously by commercial courier. The application shall 
be deemed received on the date specified in the written confirmation of 
receipt generated by the commercial courier for the delivery of the 
second part of the application to the district office.] Upon approval 
of the Applicant's Web CRD entitlement request form, the Applicant 
shall submit any amendments to its Forms BD or U-4, any additional 
Forms U-4, and any Form U-5 electronically via Web CRD. Upon approval 
of the Applicant's membership, the Applicant shall submit any 
amendments to its Member Contact Questionnaire electronically. 
    (4) Rejection Of Application That Is Not Substantially Complete 
    If the Department determines within 30 days after the filing of an 
application that the application is not substantially complete, the 
Department may reject the application and deem it not to have been 
filed. In such case, within the 30 day period, the Department shall 
serve a written notice on the Applicant of the Department's 
determination and the reasons therefor. The Association shall refund 
the application fee, less $350, which shall be retained by the 
Association as a processing fee. If the Applicant determines to 
continue to seek membership, the Applicant shall submit a new 
application and fee under this Rule.
    (5) Request For Additional Documents Or Information 
    Within 30 days after the [receipt] filing of an application, the 
Department shall [determine whether the application is complete and, if 
not, shall request] serve an initial request for any additional 
information or documents necessary to render a decision on the 
application. The Department may [request] serve subsequent requests for 
additional information or documents at any time during the membership 
application process.
    [(5)] Unless otherwise agreed by the Department and the Applicant, 
the Applicant shall file any additional information and documents with 
the Department within 60 days after service of the Department's initial 
request and 30 days after service of any subsequent request.
[(b) Lapse of Application]
    [(1) Absent a showing of good cause, an application for membership 
shall lapse if an Applicant fails to:
    (A) respond fully within 60 days after an initial request for 
information or documents, within 30 after any subsequent request, or 
within such other time period agreed to by the Department and the 
Applicant;
    (B) appear at or otherwise participate in a scheduled membership 
interview pursuant to paragraph (c); or
    (C) return an executed membership agreement under Rule 1014(c) 
within 25 days after service of the agreement.]
    [(2) The lapse of an application shall require an Applicant 
continuing to seek membership to submit a new application under 
paragraph (a).]
[(c)](b) Membership Interview
    (1) Requirement for Interview
    Before the Department [issues a] serves its decision on an 
application for new membership in the Association, the Department shall 
conduct a membership interview with a representative or representatives 
of the Applicant.
    (2) Service of Notice
    At least seven days before the membership interview, the Department 
shall serve on the Applicant a written notice that specifies the date 
and time of the interview and the representative or representatives of 
the Applicant who are required to participate in the interview. The 
Department shall serve the notice by facsimile or [commercial] 
overnight courier. The Applicant and the Department may agree to a 
shorter or longer period for notice or a different method of service 
under this subparagraph.
    (3) Time
    Unless the Department directs otherwise for good cause shown, a 
membership interview shall be scheduled to occur within 90 days after 
the [receipt] filing of an application or within 60 days after the 
[receipt] filing of all additional information or documents requested, 
whichever is later.
    (4) Place
    Unless the Department and the Applicant otherwise agree, the 
membership interview shall be conducted in the district office for the 
district in which the Applicant has or intends to have its principal 
place of business.
    (5) Updated Financial Documents
    On or before the date of the membership interview, the Applicant 
shall file an updated trial balance, balance sheet, supporting 
schedules, and computation of net capital. The Applicant shall prepare 
such documents as of a date that is within 45 days before the date of 
the membership interview, unless the Applicant and the Department agree 
on a longer period. The Applicant shall promptly notify the Department 
in writing of any material adverse change in its financial condition 
that occurs before a decision constituting final action of the 
Association is served on the Applicant.
    [(5)](6) Review of Standards for Admission
    During the membership interview, the Department shall review the 
application and the standards for admission to membership with the 
Applicant's representative or representatives.
    [(6)](7) Information From Other Sources
    During the membership interview, the Department shall provide to 
the Applicant's representative or representatives any information or 
document that the Department has obtained from the Central Registration

[[Page 36865]]

Depository or a source other than the Applicant and upon which the 
Department intends to base its decision under Rule 1014. If the 
Department receives such information or document after the membership 
interview or decides to base its decision on such information after the 
membership interview, the Department shall promptly serve the 
information or document and an explanation thereof on the Applicant.
1014. Department Decision
(a) Standards for Admission
    After considering the application, the membership interview, other 
information and documents provided by the Applicant, other information 
and documents obtained by the Department, and the public interest and 
the protection of investors, the Department shall determine whether the 
Applicant meets each of the following standards:
    (1) The application and all supporting documents are complete and 
accurate.
    (2) The Applicant and its Associated Persons have all licenses and 
registrations required by state and federal authorities and self-
regulatory organizations.
    (3) The Applicant and its Associated Persons are capable of 
complying with the federal securities laws, the rules and regulations 
thereunder, and the Rules of the Association, including observing high 
standards of commercial honor and just and equitable principles of 
trade. In determining whether this standard is met, the Department may 
take into consideration whether:
    (A) a state or federal authority or self-regulatory organization 
has taken permanent or temporary adverse action with respect to a 
registration or licensing determination regarding the Applicant or an 
Associated Person;
    (B) an Applicant's or Associated Person's record[s] reflects[: (i) 
disciplinary actions involving sales practice violations; (ii) customer 
complaints; or (iii) arbitrations that were resolved adversely to the 
Applicant or Associated Person] a sales practice event;
    (C) an Applicant or Associated Person is the subject of a pending, 
adjudicated, or settled regulatory action or investigation by the 
Commission, the Commodity Futures Trading Commission, a federal, state, 
or foreign regulatory agency, or a self-regulatory organization; a 
pending, adjudicated, or settled investment-related civil action for 
damages or an injunction; [an investment-related customer complaint or 
arbitration alleging sales practice violations, theft, 
misappropriation, conversion, or breach of fiduciary duty that is 
pending, settled, or has resulted in an award or judgment;] or a 
criminal action (other than a minor traffic violation) that is pending, 
adjudicated, or that has resulted in a guilty or no contest plea;
    (D) an Associated Person was terminated for cause or permitted to 
resign after an investigation of an alleged violation of a federal or 
state securities law, a rule or regulation thereunder, a self-
regulatory organization rule, or industry standard of conduct;
    (E) a state or federal authority or self-regulatory organization 
has imposed a remedial action, such as special training [or], 
continuing education requirements, or heightened supervision, on an 
Associated Person; and
    (F) a state or federal authority or self-regulatory organization 
has provided information indicating that the Applicant or an Associated 
Person otherwise poses a threat to public investors.
    (A) The Applicant has established all contractual or other 
arrangements and business relationships with banks, clearing 
corporations, service bureaus, or others necessary to:
    a. initiate the operations described in the Applicant's business 
plan, considering the nature and scope of operations and the number of 
personnel; and
    b. comply with the federal securities laws, the rules and 
regulations thereunder, and the Rules of the Association.
    (5) The Applicant has or has adequate plans to obtain facilities 
that are sufficient to:
    (B) initiate the operations described in the Applicant's business 
plan, considering the nature and scope of operations and the number of 
personnel; and
    (C) comply with the federal securities laws, the rules and 
regulations thereunder, and the Rules of the Association.
    (6) The communications and operational systems that the Applicant 
intends to employ for the purpose of conducting business with customers 
and other members are adequate and provide reasonably for business 
continuity in each area set forth in Rule 1013(a)(2)(F)(xii);
    [(6)](7) The Applicant is capable of maintaining a level of net 
capital in excess of the minimum net capital requirements set forth in 
SEC Rule 15c3-1 adequate to support the Applicant's intended business 
operations on a continuing basis, based on information [that is current 
within 30 days before the membership interview] filed under Rule 
1013(b)(5). The Department may impose a reasonably determined higher 
net capital requirement for the initiation of operations after 
considering:
    (A) the amount of net capital sufficient to avoid early warning 
level reporting requirements, such as SEC Rule 17a-11;
    (B) the amount of capital necessary to meet expenses net of 
revenues for at least twelve months, based on reliable projections 
agreed to by the Applicant and the Department;
    (C) any planned market making activities, the number of markets to 
be made, the type and volatility of products, and the anticipated 
maximum inventory positions;
    (D) any plan to enter into other contractual commitments, such as 
underwritings or other securities-related activities;
    (E) any plan to distribute or maintain securities products in 
proprietary positions, and the risks, volatility, degree of liquidity, 
and speculative nature of the products; and
    (F) any other activity that the Applicant will engage in that 
reasonably could have a material impact on net capital within the first 
twelve months of business operations.
    [(7)](8) The Applicant has financial controls to ensure compliance 
with the federal securities laws, the rules and regulations thereunder, 
and the Rules of the Association.
    [(8)](9) The Applicant has compliance, supervisory, operational, 
and internal control practices and standards that are consistent with 
practices and standards regularly employed in the investment banking or 
securities business, taking into account the nature and scope of 
Applicant's proposed business.
    [(9)](10) The Applicant has a supervisory system, including written 
supervisory procedures, internal operating procedures (including 
operational and internal controls), and compliance procedures designed 
to prevent and detect, to the extent practicable, violations of the 
federal securities laws, the rules and regulations thereunder, and the 
Rules of the Association. In evaluating the adequacy of a supervisory 
system, the Department shall consider the overall nature and scope of 
the Applicant's intended business operations and shall consider 
whether:
    (A) the number, location, experience, and qualifications of 
supervisory personnel are adequate in light of the number, location, 
experience, and qualifications of persons to be

[[Page 36866]]

supervised; the [disciplinary history of such] Central Registration 
Depository record or other disciplinary history of supervisory 
personnel and persons to be supervised; [any criminal, civil, 
administrative, or arbitration actions or written customer complaints 
against such persons;] and the number and locations of the offices that 
the Applicant intends to open and the nature and scope of business to 
be conducted at each office;
    (B) the Applicant has identified specific Associated Persons to 
supervise and discharge each of the functions in Applicant's business 
plan, and to supervise each of the Applicant's intended offices, 
whether or not such offices are required to be registered under the 
Rules of the Association;
    (C) the Applicant has identified the functions to be performed by 
each Associated Person and has adopted procedures to assure the 
registration with the Association and applicable states of all persons 
whose functions are subject to such registration requirements.
    [(C)](D) each Associated Person identified in the business plan to 
discharge a supervisory function [in the business plan] has at least 
one year of direct experience or two years of related experience in the 
subject area to be supervised;
    [(D)](E) the Applicant will solicit retail or institutional 
business;
    [(E)](F) the Applicant will recommend securities to customers;
    [(F)](G) the location or part-time status of a supervisor or 
principal will affect such person's ability to be an effective 
supervisor;
    [(G)](H) [the records of an Associated Person reflect: (i) 
disciplinary actions involving sales practice violations; (ii) customer 
complaints; or (iii) arbitrations that were resolved adversely to the 
Associated Person] the Applicant should be required to place one or 
more Associated Persons under heightened supervision pursuant to Notice 
to Members 97-19;
    [(H)](I) any remedial action, such as special training or 
continuing education requirements or heightened supervision, has been 
imposed on an Associated Person by a state or federal authority or 
self-regulatory organization; and
    [(I)](J) any other condition that will have a material impact on 
the Applicant's ability to detect and prevent violations of the federal 
securities laws, the rules and regulations thereunder, and the Rules of 
the Association.
    [(10)](11) The Applicant has a recordkeeping system that enables 
Applicant to comply with federal, state, and self-regulatory 
organization recordkeeping requirements and a staff that is sufficient 
in qualifications and number to prepare and preserve required records.
    [(11)](12) The Applicant has completed a training needs assessment 
and has a written training plan that complies with the continuing 
education requirements imposed by the federal securities laws, the 
rules and regulations thereunder, and the Rules of the Association.
    [(12)](13) The Association does not possess any information 
indicating that the Applicant may circumvent, evade, or otherwise avoid 
compliance with the federal securities laws, the rules and regulations 
thereunder, or the Rules of the Association.
    [(13)](14) The application and all supporting documents otherwise 
are consistent with the federal securities laws, the rules and 
regulations thereunder, and the Rules of the Association.
(b) Granting or Denying Application
    (1) If the Department determines that the Applicant meets each of 
the standards in paragraph (a), the Department shall grant the 
application for membership.
    (2) If the Department determines that the Applicant does not meet 
one or more of the standards in paragraph (a) in whole or in part, the 
Department [may] shall:
    (A) grant the application subject to one or more restrictions 
reasonably designed to address a specific financial, operational, 
supervisory, disciplinary, investor protection, or other regulatory 
concern based on the standards for admission in Rule 1014(a); or
    (B) deny the application.
[(c) Submission of Membership Agreement
    If the Department grants an application, with or without 
restriction, the Applicant's approval for membership shall be 
contingent upon the Applicant's submission of a written membership 
agreement, satisfactory to the Department, undertaking to:
    (1) engage only in the business set forth in the business plan and 
the membership agreement;
    (2) abide by any restriction specified in the Department's 
decision;
    (3) obtain the Department's prior approval of the removal or 
modification of such a restriction pursuant to Rule 1017; and
    (4) notify and obtain the Department's approval of a change in 
ownership or control or a material change in business operations 
pursuant to Rule 1018.

The Applicant shall not waive the right to file a written request for 
review under Rule 1015 by executing a membership agreement under this 
paragraph.]
[(d)](c) Decision
    (1) Time
    The Department shall [issue] serve a written decision on the 
membership application within 30 days after the conclusion of the 
membership interview or after the [submission] filing of additional 
information or documents, whichever is later.
    (2) Content
    If the Department denies the application, the decision shall 
explain in detail the reason for denial, referencing the applicable 
standard or standards in paragraph (a). If the Department grants the 
application subject to restrictions, the decision shall explain in 
detail the reason for each restriction, referencing the applicable 
standard or standards in paragraph (a) upon which the restriction is 
based and identify the specific financial, operational, supervisory, 
disciplinary, investor protection, or other regulatory concern that the 
restriction is designed to address and the manner in which the 
restriction is reasonably designed to address the concern.
    (3) Failure to [Issue] Serve Decision
    If the Department fails to [issue] serve a decision within 180 days 
after [receipt] the filing of an application or such later date as the 
Department and the Applicant have agreed in writing, the Applicant may 
file a written request with the NASD Board requesting that the NASD 
Board direct the Department to [issue] serve a decision. Within seven 
days after [receipt] the filing of such a request, the NASD Board shall 
direct the Department to serve its written decision immediately or to 
show good cause for an extension of time. If the Department shows good 
cause for an extension of time, the NASD Board may extend the 180 day 
time limit by not more than 90 days.

(d) Submission of Membership Agreement

    If the Department grants an application, with or without 
restriction, the Applicant's approval for membership shall be 
contingent upon the Applicant's filing of an executed written 
membership agreement, satisfactory to the Department, undertaking to: 
    (1) abide by any restriction specified in the Department's 
decision; and
    (2) obtain the Department's approval of a change in ownership, 
control, or business operations pursuant to Rule 1017, including the 
modification or

[[Page 36867]]

removal of a membership agreement restriction.

The Applicant shall not waive the right to file a written request for 
review under Rule 1015 by executing a membership agreement under this 
paragraph.
(e) Service and Effectiveness of Decision
    The Department shall serve its decision and the membership 
agreement on the Applicant in accordance with Rule 1012. The decision 
shall become effective upon service and shall remain in effect during 
the pendency of any review until a decision constituting final action 
of the Association is issued under Rule 1015 or 1016, unless otherwise 
directed by the National Adjudicatory Council, the NASD Board, or the 
Commission.
(f) Effectiveness of Restriction
    A restriction imposed under this Rule shall remain in effect and 
bind the Applicant and all successors to the ownership or control of 
the Applicant unless:
    (1) removed or modified by [the Department under Rule 1017] a 
decision constituting final action of the Association issued under Rule 
1015, 1016, or 1017;
    [(2) removed or modified by a decision constituting final action of 
the Association issued under Rule 1015 or 1016;] or
    [(3)](2) stayed by the National Adjudicatory Council, the NASD 
Board, or the Commission.
(g) Final Action
    Unless the Applicant files a written request for a review under 
Rule 1015, the Department's decision shall constitute final action by 
the Association.
1015. Review by National Adjudicatory Council
(a) Initiation of Review by Applicant
    [(1) Request by Applicant]
    Within 25 days after service of a decision under Rule 1014[,] or 
1017 [or 1018], an Applicant may file a written request for review with 
the National Adjudicatory Council. A request for review shall state 
with specificity why the Applicant believes that the Department's 
decision is inconsistent with the membership standards set forth in 
Rule 1014, or otherwise should be set aside, and state whether a 
hearing is requested. The Applicant simultaneously shall [send] file by 
first-class mail a copy of the request to the district office where the 
Applicant filed its [membership] application.
    [(2) Notice by National Adjudicatory Council
    A decision issued under Rule 1014, 1017, or 1018 shall be subject 
to a call for review by any member of the National Adjudicatory Council 
or the Review Subcommittee defined in Rule 9120 within 30 days after 
service of the decision. If the National Adjudicatory Council calls a 
decision for review, a written notice of review shall be served 
promptly on the Applicant by first-class mail. The written notice of 
review shall state the specific grounds for the review and whether a 
hearing is directed. If a decision is called for review by any member 
of the National Adjudicatory Council or the Review Subcommittee, the 
decision shall be reviewed by the National Adjudicatory Council. The 
National Adjudicatory Council simultaneously shall send by first-class 
mail a copy of the notice to the district office where the Applicant 
filed its membership application.]
(b) Transmission of Documents
    Within ten days after [receipt] the filing of a request for [or 
notice of] review, the Department shall:
    (1) transmit to the National Adjudicatory Council copies of all 
documents that were considered in connection with the Department's 
decision and an index to the documents; and
    (2) serve on the Applicant a copy of such documents (other than 
those documents originally submitted by Applicant) and a copy of the 
index.
(c) Membership Application Docket
    The Department shall promptly record in the Association's 
membership application docket each request for [or notice of] review 
filed with the National Adjudicatory Council under this Rule and each 
material subsequent event, filing, and change in the status of a 
membership proceeding.
(d) Appointment of Subcommittee
    The National Adjudicatory Council or the Review Subcommittee 
defined in Rule 9120 shall appoint a Subcommittee to participate in the 
review. The Subcommittee shall be composed of at least two members. One 
member shall be a current member of the National Adjudicatory Council. 
The remaining member or members shall be current or past Directors or 
past Governors.
(e) Powers of Subcommittee
    If a hearing is requested [or directed], the Subcommittee shall 
conduct the hearing. If a hearing is not requested, the Subcommittee 
may serve a notice directing that a hearing be held. If a hearing is 
not requested or directed, the Subcommittee shall conduct its review on 
the basis of the record developed before the Department and any written 
submissions made by the Applicant or the Department in connection with 
the request for review.
(f) Hearing
    (1) Notice
    If a hearing is requested or directed, the hearing shall be held 
within 45 days after the [receipt] filing of the request [or service of 
the notice by] with the National Adjudicatory Council or service of the 
notice by the Subcommittee. The National Adjudicatory Council shall 
[send] serve written notice of the date and time of the hearing to the 
Applicant by facsimile or [commercial] overnight courier not later than 
14 days before the hearing.
    (2) Counsel
    The Applicant and the Department may be represented by counsel at a 
hearing conducted pursuant to this Rule.
    (3) Evidence
    Formal rules of evidence shall not apply to a hearing under this 
Rule. Not later than five days before the hearing, the Applicant and 
the Department shall exchange copies of their proposed hearing exhibits 
and witness lists and provide copies of the same to the National 
Adjudicatory Council. If the Applicant or the Department fails to 
provide copies of its proposed hearing exhibits or witness list within 
such time, the Subcommittee shall exclude the evidence or witnesses 
from the proceeding, unless the Subcommittee determines that good cause 
is shown for failure to comply with the production date set forth in 
this subparagraph.
    (4) Transcript
    The hearing shall be recorded and a transcript prepared by a court 
reporter. A transcript of the hearing shall be available for purchase 
from the court reporter at prescribed rates. The Applicant, the 
Department, or a witness may seek to correct the transcript. A proposed 
correction of the transcript shall be submitted to the Subcommittee 
within a reasonable period of time prescribed by the Subcommittee. Upon 
notice to the Applicant and the Department, the Subcommittee may direct 
the correction to the transcript as requested or sua sponte.
    [(5) Failure to Appear at Hearing]
    [If an Applicant fails to appear at a hearing for which it has 
notice, the National Adjudicatory Council may dismiss the request for 
review as abandoned, and the decision of the Department shall become 
the final action of the Association. Upon a showing of good cause, the 
National

[[Page 36868]]

Adjudicatory Council may withdraw a dismissal entered pursuant to this 
subparagraph.]
(g) Additional Information, Briefs
    At any time during its consideration, the Subcommittee or the 
National Adjudicatory Council may direct the Applicant or the 
Department to [submit] file additional information [and to file] or 
briefs. Any additional information or brief [submitted] filed shall be 
provided to all parties before the National Adjudicatory Council 
renders its decision.
(h) Abandonment of Request for Review
    If an Applicant fails to specify the grounds for its request for 
review under Rule 1015(a)(1), appear at a hearing for which it has 
notice, or file information or briefs as directed, the National 
Adjudicatory Council or the Review Subcommittee may dismiss the request 
for review as abandoned, and the decision of the Department shall 
become the final action of the Association. Upon a showing of good 
cause, the National Adjudicatory Council or the Review Subcommittee may 
withdraw a dismissal entered pursuant to this paragraph.
[(h)](i) Subcommittee Recommendation The Subcommittee shall present a 
recommended decision in writing to the National Adjudicatory Council 
within 60 days after the date of the hearing held pursuant to paragraph 
(f), and not later than seven days before the meeting of the National 
Adjudicatory Council at which the membership proceeding shall be 
considered.
[(i)](j) Decision
    (1) Proposed Written Decision
    After considering all matters presented in the review and the 
Subcommittee's recommended written decision, the National Adjudicatory 
Council may affirm, modify, or reverse the Department's decision or 
remand the membership proceeding with instructions. The National 
Adjudicatory Council shall prepare a proposed written decision pursuant 
to subparagraph (2).
    (2) Contents
    The decision shall include:
    (A) a description of the Department's decision, including its 
rationale;
    (B) a description of the principal issues raised in the review;
    (C) a summary of the evidence on each issue; and
    (D) a statement whether the Department's decision is affirmed, 
modified, or reversed, and a rationale therefor that references the 
applicable standards in Rule 1014.
    (3) Issuance of Decision After Expiration of Call for Review 
Periods
    The National Adjudicatory Council shall provide its proposed 
written decision to the NASD Board. The NASD Board may call the 
membership proceeding for review pursuant to Rule 1016. If the NASD 
Board does not call the membership proceeding for review, the proposed 
written decision of the National Adjudicatory Council shall become 
final. The National Adjudicatory Council shall serve the Applicant with 
a written notice specifying the date on which the call for review 
period expired and stating that the final written decision will be 
served within 15 days after such date. The National Adjudicatory 
Council shall serve its final written decision within 15 days after the 
date on which the call for review period expired. The decision shall 
constitute the final action of the Association for purposes of SEC Rule 
19d-3, unless the National Adjudicatory Council remands the membership 
proceeding.
    (4) Failure to Issue Decision
    If the National Adjudicatory Council fails to serve its final 
written decision within the time prescribed in subparagraph (3), the 
Applicant may file a written request with the NASD Board requesting 
that the NASD Board direct the National Adjudicatory Council to serve 
its decision immediately or to show good cause for an extension of 
time. Within seven days after [receipt] the filing of such a request, 
the NASD Board shall direct the National Adjudicatory Council to serve 
its written decision immediately or to show good cause for an extension 
of time. If the National Adjudicatory Council shows good cause for an 
extension of time, the NASD Board may extend the 15 day time limit by 
not more than 15 days.
1016. Discretionary Review by NASD Board
(a) Call for Review by Governor
    A Governor may call a membership proceeding for review by the NASD 
Board if the call for review is made within the period prescribed in 
[sub]paragraph [(2)](b).
(b) 15 Day Period; Waiver
    A Governor shall make his or her call for review at the next 
meeting of the NASD Board that is at least 15 days after the date on 
which the NASD Board receives the proposed written decision of the 
National Adjudicatory Council. By unanimous vote of the NASD Board, the 
NASD Board may shorten the period to less than 15 days. By an 
affirmative vote of the majority of the NASD Board then in office, the 
NASD Board may, during the 15 day period, vote to extend the period to 
more than 15 days.
(c) Review At Next Meeting
    If a Governor calls a membership proceeding for review within the 
time prescribed in paragraph (b), the NASD Board shall review the 
membership proceeding not later than the next meeting of the NASD 
Board. The NASD Board may order the Applicant and the Department to 
file briefs in connection with review proceedings pursuant to this 
paragraph.
(d) Decision of NASD Board, Including Remand
    After review, the NASD Board may affirm, modify, or reverse the 
proposed written decision of the National Adjudicatory Council. 
Alternatively, the NASD Board may remand the membership proceeding with 
instructions. The NASD Board shall prepare a written decision that 
includes all of the elements described in Rule 1015[(i)(2)](j)(2).
(e) Issuance of Decision
    The NASD Board shall serve its written decision on the Applicant 
within 15 days after the meeting at which it conducted its review. The 
decision shall constitute the final action of the Association for 
purposes of SEC Rule 19d-3, unless the NASD Board remands the 
membership proceeding.
1017. [Removal or Modification of Business Restriction] Application for 
Approval of Change in Ownership, Control, or Business Operations
(a) Events Requiring Application
    [A member of the Association may seek modification or removal of a 
restriction on its business activities imposed pursuant to the Rule 
1010 Series by filing a written application with the Department at the 
district office for the district in which the member's principal place 
of business is located. The application shall present facts showing 
that the circumstances that gave rise to the restriction have changed 
and state with specificity why the restriction should be modified or 
removed in light of the standards set forth in Rule 1014 and the 
articulated rationale for the imposition of the restriction. A copy of 
the decision and membership agreement pertaining to such restriction 
shall be appended to the application.]
    A member shall file an application for approval of any of the 
following changes to its ownership, control, or business operations:

[[Page 36869]]

    (1) a merger of the member with another member, unless both are 
members of the New York Stock Exchange, Inc. or the surviving entity 
will continue to be a member of the New York Stock Exchange, Inc.;
    (2) a direct or indirect acquisition by the member of another 
member, unless the acquiring member is a member of the New York Stock 
Exchange, Inc.;
    (3) a direct or indirect acquisition of substantially all of the 
member's assets, unless the acquirer is a member of the New York Stock 
Exchange, Inc.; 
    (4) a change in the equity ownership or partnership capital of the 
member that results in one person or entity directly or indirectly 
owning or controlling 25 percent or more of the equity or partnership 
capital; or 
    (5) a material change in business operations as defined in Rule 
1011(i). 
(b) Filing and Content of Application
    (1) The member shall file the application with the Department at 
the district office in the district in which the member's principal 
place of business is located. If the application involves a merger 
between members with principal places of business in two or more 
districts, the application shall be filed and processed by the district 
office wherein the surviving firm's principal place of business will be 
located.
    (2) The application shall describe in detail the change in 
ownership, control, or business operations and include a business plan, 
pro forma financials, an organizational chart, and written supervisory 
procedures reflecting the change.
    (A) If the application requests approval of a change in ownership 
or control, the application also shall include the names of the new 
owners, their percentage of ownership, and the sources of their funding 
for the purchase and recapitalization of the member.
    (B) If the application requests the removal or modification of a 
membership agreement restriction, the application also shall:
    (i) present facts showing that the circumstances that gave rise to 
the restriction have changed; and
    (ii) state with specificity why the restriction should be modified 
or removed in light of the standards set forth in Rule 1014 and the 
articulated rationale for the imposition of the restriction.
    (C) If the application requests approval of an increase in 
Associated Persons involved in sales, offices, or markets made, the 
application shall set forth the increases in such areas during the 
preceding 12 months.

(c) Effecting Change and Imposition of Interim Restrictions

    (1) A member shall file an application for approval of a change in 
ownership or control at least 30 days prior to such change. A member 
may effect a change in ownership or control prior to the conclusion of 
the proceeding, but the Department may place new interim restrictions 
on the member based on the standards in Rule 1014, pending final 
Department action.
    (2) A member may file an application to remove or modify a 
membership agreement restriction at any time. An existing restriction 
shall remain in effect during the pendency of the proceeding.
    (3) A member may file an application for approval of a material 
change in business operations, other than the modification or removal 
of a restriction, at any time, but the member may not effect such 
change until the conclusion of the proceeding, unless the Department 
and the member otherwise agree.

(d) Rejection Of Application That Is Not Substantially Complete

    If the Department determines within 30 days after the filing of an 
application that the application is not substantially complete, the 
Department may reject the application and deem it not to have been 
filed. In such case, within the 30 day period, the Department shall 
serve a written notice on the Applicant of the Department's 
determination and the reasons therefor. If the Applicant determines to 
continue to apply for approval of a change in ownership, control, or 
business operations, the Applicant shall submit a new application under 
this Rule.
[(b)](e) Request for Additional Documents and Information
    Within 30 days after the [receipt] filing of an application [to 
remove or modify a restriction], the Department shall [determine 
whether the application is complete, and if not, shall] serve a request 
for any additional information or documents necessary to render a 
decision [under paragraph (e)] on the application. The Department may 
serve subsequent requests for additional information or documents at 
any time during the application process. Unless otherwise agreed by the 
Department and the Applicant, the Applicant shall file any additional 
information and documents with the Department within 30 days after 
service of a request.
[(c) Lapse]
    [(1) Absent a showing of good cause, an application to modify or 
remove a restriction shall lapse if an Applicant fails to:
    (A) respond fully within 30 days after a request for information or 
documents;
    (B) appear at or otherwise participate in a scheduled membership 
interview pursuant to paragraph (d); or
    (C) return an executed membership agreement under paragraph (e)(4) 
within 25 days after service of the agreement.
    (2) The lapse of an application shall require the Applicant to 
submit a new application to modify or remove a restriction under 
paragraph (a).]
[(d)](f) Membership Interview
    (1) The Department may require the Applicant to participate in a 
membership interview within 30 days after the [receipt] filing of the 
application, or if the Department requests additional information or 
documents, within 30 days after the filing of the additional 
information or documents by the Applicant.
    (2) At least seven days before the membership interview, the 
Department shall serve on the Applicant a written notice that specifies 
the date and time of the interview and [the representative or 
representatives of the Applicant] persons who are required to 
participate in the interview. The Department shall serve the notice by 
facsimile or [commercial] overnight courier. The Applicant and the 
Department may agree to a shorter or longer period for notice or a 
different method of service.
    (3) Unless the Department and the Applicant otherwise agree, the 
membership interview shall be conducted in the district office for the 
district in which the Applicant has its principal place of business.
    (4) During the membership interview, the Department shall review 
the application and the considerations for the Department's decision 
set forth in paragraph [(e)(1)](g)(1). The Department shall provide to 
the Applicant's representative or representatives any information or 
document that the Department has obtained from the Central Registration 
Depository or a source other than the Applicant and upon which the 
Department intends to base its decision under paragraph [(e)](g). If 
the Department receives such information or document after the 
membership interview or decides to base its decision on such 
information after the membership interview, the Department shall 
promptly serve the information or document and an explanation thereof 
on the Applicant.
[(e)](g) Department Decision
    (1) [In evaluating an application submitted under paragraph (a)] 
The

[[Page 36870]]

Department shall consider the application, the membership interview, 
other information and documents provided by the Applicant or obtained 
by the Department, the public interest, and the protection of 
investors.
    (A) In rendering a decision on an application for approval of a 
change in ownership or control, or an application for approval of a 
material change in business operations that does not involve 
modification or removal of a membership agreement restriction, the 
Department shall determine if the Applicant would continue to meet the 
standards in Rule 1014(a) upon approval of the application.
    (B) In rendering a decision on an application requesting the 
modification or removal of a membership agreement restriction, the 
Department shall consider whether maintenance of the restriction is 
appropriate in light of:
    [(A)](i) the standards set forth in Rule 1014;
    [(B)](ii) the circumstances that gave rise to the imposition of the 
restriction;
    [(C)](iii) the Applicant's operations since the restriction was 
imposed;
    [(D)] (iv) [a] any change in ownership or control or supervisors 
and principals; and
    [(E)](v) any new evidence submitted in connection with the 
application.
    (2) The Department shall [issue] serve a written decision on the 
application within 30 days after the conclusion of the membership 
interview or the [submission] filing of additional information or 
documents, whichever is later. If the Department does not require the 
Applicant to participate in a membership interview or request 
additional information or documents, the Department shall [issue] serve 
a written decision within 45 days after the [receipt] filing of the 
application under paragraph (a). The decision shall state whether the 
application [to modify or remove the restriction] is granted or denied 
in whole or in part, and shall provide a rationale for the Department's 
decision, referencing the applicable standard in Rule 1014.
    (3) If the Department fails to [issue] serve a decision within 180 
days after [receipt] filing of an application or such later date as the 
Department and the Applicant have agreed in writing, the Applicant may 
file a written request with the NASD Board requesting that the NASD 
Board direct the Department to issue a decision. Within seven days 
after [receipt] the filing of such a request, the NASD Board shall 
direct the Department to issue a written decision immediately or to 
show good cause for an extension of time. If the Department shows good 
cause for an extension of time, the NASD Board may extend the time 
limit for issuing a decision by not more than 30 days.
    (4) If the Department [modifies or removes a restriction on the 
Applicant's business activities, the] approves an application under 
this Rule in whole or part, the Department shall require an Applicant 
to file an executed membership agreement [submitted under Rule 1014 
shall be modified accordingly].
[(f)](h) Service and Effectiveness of Decision
    The Department shall serve its decision on the Applicant in 
accordance with Rule 1012. The decision shall become effective upon 
service and shall remain in effect during the pendency of any review 
until a decision constituting final action of the Association is 
[issued] served under Rule 1015 or 1016, unless otherwise directed by 
the National Adjudicatory Council, the NASD Board, or the Commission.
[(g)](i) Request for Review; Final Action
    An Applicant may file a written request for review of the 
Department's decision with the National Adjudicatory Council pursuant 
to Rule 1015. The procedures set forth in Rule 1015 shall apply to such 
review, and the National Adjudicatory Council's decision shall be 
subject to discretionary review by the NASD Board pursuant to Rule 
1016. If the Applicant does not file a request for a review, the 
Department's decision shall constitute final action by the Association.
[(h)](j) Removal or Modification of Restriction on Department's 
Initiative
    The Department shall modify or remove a restriction on its own 
initiative if the Department determines such action is appropriate in 
light of the considerations set forth in paragraph [(e)(1)](g)(1). The 
Department shall notify the member in writing of the Department's 
determination and inform the member that it may apply for further 
modification or removal of a restriction by filing an application under 
paragraph (a).

(k) Lapse or Denial of Application for Approval of Change in Ownership

    If an application for approval of a change in ownership lapses, or 
is denied and all appeals are exhausted or waived, the member shall, no 
more than 60 days after the lapse or exhaustion or waiver of appeal:
    (1) submit a new application;
    (2) unwind the transaction; or
    (3) file a Form BDW.

For the protection of investors, the Department may shorten the 60 day 
period. For good cause shown by the member, the Department may lengthen 
the 60 day period. The Department shall serve written notice on the 
Applicant of any change in the 60-day period and the reasons therefor. 
During the 60-day or other imposed period, the Department may continue 
to place interim restrictions on the member for the protection of 
investors.
[1018. Change in Ownership, Control, or Operations]
[(a) Notice
    At least 30 days prior to the occurrence of any of the following 
changes in ownership, control, or operations, a member shall file a 
written notice and application for continuance in membership with the 
Department at the district office in the district in which the member's 
principal place of business is located:
    (1) a merger of the member with another member;
    (2) an acquisition by the member of another member;
    (3) an acquisition of substantially all of the member's assets;
    (4) a change in the equity ownership or partnership capital of the 
member that results in one person or entity owning or controlling 25 
percent or more of the equity or partnership capital; or
    (5) a material change in the member's business operations.]
[(b) Review and Imposition of Interim Restrictions
    The Department shall review a change in ownership, control, or 
operations described in paragraph (a) prior to the change taking 
effect. The Department may maintain existing restrictions on the 
member's business activities and place new interim restrictions on the 
member based on the standards in Rule 1014, pending final Department 
action.]
[(c) Request for Information
    Within 30 days after receipt of the notice and application under 
paragraph (a), the Department shall request any additional information 
or documents necessary to render a decision under paragraph (f). Unless 
otherwise agreed by the Department and the Applicant, the Applicant 
shall file such additional information or documents with the Department 
within 30 days after the Department's request. The Department may 
request additional information and documents at any time during the 
application process; unless the Applicant and the Department agree 
otherwise, the Applicant shall file such

[[Page 36871]]

information or documents within 30 days after the Department's 
request.]
[(d) Lapse
    (1) Absent a showing of good cause, an application for continuance 
in membership shall lapse if an Applicant fails to:
    (A) respond fully within 30 days after a request for information or 
documents;
    (B) appear at or otherwise participate in a scheduled membership 
interview pursuant to paragraph (e); or
    (C) return an executed membership agreement under paragraph (g) 
within 25 days after service of the agreement.
    (2) The lapse of an application shall require the Applicant to 
submit a new application under paragraph (a).]
[(e) Membership Interview
    (1) The Department may require the Applicant to participate in a 
membership interview. The membership interview shall be held within 30 
days after the receipt of the application, or if the Department 
requests additional information or documents, within 30 days after the 
filing of such additional information or documents by the Applicant.
    (2) At least seven days before the membership interview, the 
Department shall serve on the Applicant a written notice that specifies 
the date and time of the interview and the representative or 
representatives of the Applicant who are required to participate in the 
interview. The Department shall serve the notice by facsimile or 
commercial courier. The Applicant and the Department may agree to a 
shorter or longer period for notice or a different method of service.
    (3) Unless the Department and the Applicant otherwise agree, the 
membership interview shall be conducted in the district office for the 
district in which the Applicant has or intends to have its principal 
place of business.
    (4) During the membership interview, the Department shall review 
the application and the considerations for the Department's decision 
set forth in paragraph (f). The Department shall provide to the 
Applicant's representative or representatives any information or 
document that the Department has obtained from the Central Registration 
Depository or a source other than the Applicant and upon which the 
Department intends to base its decision under paragraph (f). If the 
Department receives such information or document after the membership 
interview or decides to base its decision on such information after the 
membership interview, the Department shall promptly serve the 
information or document and an explanation thereof on the Applicant.]
[(f) Department Decision
    (1) In evaluating an application submitted under paragraph (a), the 
Department shall consider whether the Applicant continues to meet the 
standards set forth in Rule 1014 in light of the change in ownership, 
control, or operations, and whether current restrictions, if any, or 
new restrictions are necessary for the Applicant to continue to meet 
such standards.
    (2) The Department shall issue a written decision within 30 days 
after the membership interview or the submission of additional 
information or documents, whichever is later. If the Department does 
not require the Applicant to participate in a membership interview or 
submit additional information or documents, the Department shall issue 
a written decision within 45 days after receipt of an application under 
paragraph (a). The decision shall state the terms for continuance in 
NASD membership, whether current restrictions, if any, are maintained 
or new restrictions are imposed, and shall provide a rationale for the 
Department's decision, referencing the applicable standard in Rule 
1014.
    (3) If the Department fails to issue a decision within 180 days 
after receipt of an application or such later date as the Department 
and the Applicant have agreed in writing, the Applicant may file a 
written request with the NASD Board requesting that the NASD Board 
direct the Department to issue a decision. Within seven days after 
receipt of such a request, the NASD Board shall direct the Department 
to issue a written decision immediately or to show good cause for an 
extension of time. If the Department shows good cause for an extension 
of time, the NASD Board may extend the time limit for issuing a 
decision by not more than 30 days.]
[(g) Submission of Membership Agreement
    The Department may condition approval of an application for 
continuance in membership on the Applicant's submission of a new 
written membership agreement pursuant to Rule 1014(c).]
[(h) Service and Effectiveness of Decision
    The Department shall serve its decision on the Applicant in 
accordance with Rule 1012. The decision shall become effective upon 
service and shall remain in effect during the pendency of any review 
until a decision constituting final action of the Association is issued 
under Rule 1015 or 1016, unless otherwise directed by the National 
Adjudicatory Council, the NASD Board, or the Commission.]
[(i) Request for Review; Final Action
    An Applicant may file a written request for review of the 
Department's decision with the National Adjudicatory Council pursuant 
to Rule 1015. The procedures set forth in Rule 1015 shall apply to such 
a review, and the National Adjudicatory Council's decision shall be 
subject to discretionary review by the NASD Board pursuant to Rule 
1016. If the Applicant does not file a request for review, the 
Department's action shall constitute the final action of the 
Association.]

1018. Stay of Application During Pendency of Criminal or Other 
Proceeding

    (a) The Department may stay an application filed under Rule 1013 or 
1017 if:
    (1) a state or federal authority files criminal charges against the 
Applicant or a principal or proposed principal of the Applicant;
    (2) the Commission files a complaint or a request for injunctive 
relief against the Applicant or a principal or proposed principal of 
the Applicant; or
    (3) the Association, another self-regulatory organization, or a 
state files a disciplinary complaint against the Applicant or a 
principal or proposed principal of an Applicant alleging a violation of 
a law or rule listed in IM-1011-1 (or a comparable state law, rule, or 
regulation). 

In such case, the application shall be stayed during the pendency of 
the proceeding. If the Department has imposed interim restrictions 
under Rule 1017(c), the restrictions shall remain in effect during the 
stay.
    (b) If the Applicant or principal or proposed principal prevails in 
the proceeding, the stay shall be lifted automatically.
    (c) If there is a material change in the circumstances that gave 
rise to the stay, the Applicant may file a written request with the 
Department to lift the stay. The Department shall serve a written 
response on the Applicant within 14 days after the filing of the 
request by the Applicant. If the Department denies the request, the 
Applicant may file a written request for review with the National 
Adjudicatory Council. The National Adjudicatory Council or the Review 
Subcommittee shall serve a written

[[Page 36872]]

response on the Applicant within 30 days.
1019. Application to Commission for Review
    No change.
* * * * *
Rule 1140. Electronic Filing Rules
    (a) Filing Requirement
    Except as provided in Rule 1013(a)(2), all [All] forms required to 
be filed by the By-Laws shall be filed through an electronic process or 
such other process the Association may prescribe to the Central 
Registration Depository.
* * * * *

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
    NASD Regulation proposes to amend the Rule 1010 Series, which 
governs NASD membership. NASD Regulation staff worked with the Member 
Admission Review Committee (Committee), \4\ an ad-hoc committee 
convened in August 1998, to develop the proposed changes. The purpose 
of the proposed rule change is to streamline the Rules and make them 
more efficient while preserving their investor protection function.
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    \4\ Members of the Committee are: Faith Colish, New York, New 
York; Linda Lerner, All-Tech Investment Group, Inc., Montvale, New 
Jersey; Brian T. Shea, Pershing, Jersey City, New Jersey; Theodore 
W. Urban, Ferris, Baker & Watts, Incorporated, Washington, D.C.; and 
Richard P. Woltman, Spelman & Co., Inc., San Diego, California. Mr. 
Urban chairs the Committee.
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    The most significant changes are as follows:
     reorganizing and consolidating some of the current rules 
to make them easier to use;
     clarifying the rules and policies that apply to business 
expansions by--
     adopting a policy of building expansion plans into 
membership agreements,
     defining in the rules what kinds of ``material changes in 
business operations'' require a member to file an application for 
approval with NASD Regulation, and
     providing a safe harbor for modest expansions that will 
not require an application,
which together are intended to provide more even-handed treatment among 
members for various business expansions, provide more certainty 
regarding which expansions require approval, and eliminate unnecessary 
applications;
     permitting the staff to stay membership applications if a 
firm or one of its principals is the subject of a disciplinary action;
     permanently rescinding the National Adjudicatory Council's 
authority to review membership decisions that are not appealed by an 
Applicant;
     simplifying administrative procedures for submitting an 
application and calculating the various time limits that apply to the 
process; and
     permitting the staff to reject immediately applications 
that are not substantially complete.
    A detailed explanation of the proposed rule change follows.
a. Proposed Rule 1011
    The definition of ``Associated Person'' is amended to clarify that 
it includes only natural persons.
    The term ``material change in business operations'' is defined for 
the first time. The definition is significant because it triggers a 
requirement for a member to apply to the district office for approval 
of the change under proposed Rule 1017. The term is defined to include 
removing or modifying a membership agreement restriction;\5\ market 
making, underwriting, or acting as a dealer for the first time; or 
adding business activities that require a higher minimum net capital.
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    \5\ NASD Regulation included removing or modifying a restriction 
in this definition to effect the consolidation of current Rules 1017 
and 1018. The rationale for the consolidation is set forth in the 
section titled ``Proposed Rule 1017,'' below.
---------------------------------------------------------------------------

    NASD Regulation does not believe that it is possible to develop an 
exhaustive definition of the term ``material change in business 
operations.'' If a change in a member's business falls outside of the 
definition, or the safe harbor described below (e.g., because it 
exceeded the safe harbor limits or the member has disciplinary 
history), then the member may contact the district office to determine 
if the district would deem the change to be material. A member is not 
required to contact the district office if the member believes the 
change is not material. However, if the staff later determines that the 
change is indeed material, then the member potentially could be subject 
to disciplinary action for failure to file an application under 
proposed Rule 1017.
    Proposed Interpretive Material 1011-1 (IM-1011-1) is added to 
create a safe harbor for certain changes that are presumed not to be 
material and therefore do not require a member to submit an application 
for approval of the change. The safe harbor would not be available to 
members that have a ``disciplinary history.'' The term ``disciplinary 
history'' shall mean a finding of a violation by the member or a 
principal of the member in the past five years by the Commission, a 
self-regulatory organization, or a foreign financial regulatory 
authority of one or more of the following provisions (or comparable 
foreign provisions) or rules or regulations thereunder: Sections 
15(b)(4)(E) and 15(c) of the Act (failure to supervise; fraud and 
manipulation); Section 17(a) of the Securities Act of 1933 (fraudulent 
interstate transactions); Exchange Act 10b-5 (fraud and manipulation), 
and 15g-1 through 15g-9 (penny stock rules); NASD Rules 2110 (just and 
equitable principles of trade), 2120 (fraud and manipulation), 2310 
(suitability), 2330 (protection of customer securities and funds), 2440 
(fair prices and commissions), 3010 (failure to supervise only), 3310 
(manipulative and deceptive quotations), and 3330 (payments to 
influence market prices); and MSRB Rules G-19 (suitability), G-30 
(prices and commissions), and G-37(b) and (c) (political 
contributions).
    The term ``principal place of business'' is defined for the first 
time. An Applicant's principal place of business determines which 
district office will process its application. ``Principal place of 
business'' means the location where the officers, partners, or managers 
direct and control the activities of the Applicant, unless NASD 
Regulation staff designates a different location. That location may be 
where the largest number of associated persons are located or where the 
books and records are kept. This definition is designed to prevent an 
Applicant from trying to select a particular district office to process 
its application through its designation of a principal place of 
business.

[[Page 36873]]

    NASD Regulation proposes to redefine ``sales practice violations'' 
as ``sales practice event'' because the definition includes not only 
proven violations, but also unproven allegations.\6\ The proposed 
definition includes any customer complaint, arbitration, or civil 
litigation that has been or is required to be reported to the Central 
Registration Depository (``CRD'') or otherwise is required to be 
reported to the Association (e.g., via Rule 3070).
---------------------------------------------------------------------------

    \6\ NASD Regulation is not proposing any change to the 
definition of sales practice violation on the Form U-4.
---------------------------------------------------------------------------

    The terms ``Applicant'' and ``Interested Association Staff'' are 
amended to make them consistent with other rule changes.
b. Proposed Rule 1012
    NASD Regulation proposes to amend the service and filing provisions 
to permit additional methods of delivery and to use consistent 
terminology for calculating deadlines. The term ``commercial courier'' 
is replaced with ``overnight courier'' to clarify that Applicants and 
NASD Regulation staff may use the overnight delivery service offered by 
the United States Post Office. NASD Regulation interprets the term 
``overnight courier'' to refer to any entity that regularly provides 
such overnight delivery services, such as Federal Express, DHL, or the 
United States Post Office. Use of the term ``overnight courier'' is not 
intended to imply that only actual overnight delivery may be used under 
the Rule. Overnight delivery should be used if it is available. 
However, if overnight delivery is not available for a particular 
location, the Applicant or NASD Regulation staff may use the most rapid 
delivery option available (e.g., two day service) from the overnight 
courier and still be in compliance with the proposed Rule.
    Throughout the proposed rules, the term ``file'' is used uniformly 
to refer to submissions by an Applicant, and the term ``serve'' is used 
uniformly to refer to delivery of requests, decisions, and the like by 
the Association; other terminology, such as ``issuance'' or ``receipt'' 
is deleted.\7\ These changes provide greater clarity in calculating 
deadlines in accordance with proposed Rule 1012(a).
---------------------------------------------------------------------------

    \7\ See, e.g., proposed Rules 1013(a)(5), (b)(1), and 
1014(c)(3).
---------------------------------------------------------------------------

    The lapse of application provisions are consolidated and moved from 
Rules 1013(b), 1017(c), and 1018(d) to proposed Rule 1012(b) for ease 
of reference. The lapse rule, which is discussed in greater detail in 
the next section, permits the staff to discontinue processing an 
application if an Applicant does not timely provide requested 
information or documents. The only changes to the lapse rule are to 
permit the staff and the Applicant to agree on a submission date for 
the membership agreement, rather than requiring that all agreements be 
submitted within 25 days, and clarify that fees are not refunded for 
lapsed applications.
    The subparagraphs of Rule 1012(c) are reordered for ease of 
reading.
c. Proposed Rule 1013
    One of the major changes to this Rule is to simplify application 
submission procedures. Currently, this Rule requires Applicants to 
submit their applications in two parts. Part One, which includes 
primarily forms and fees (e.g., the initial Forms BD and U-4), is sent 
directly to the CRD in Rockville, Maryland, for processing. Part Two, 
which includes all remaining documents required for member admission, 
is sent to the district office that will review the application. At the 
time the rule was adopted, the staff thought it would be more efficient 
to send each part to the location where it would be processed. In 
practice, this has created problems when both parts of the application 
are not submitted at the same time, or one or both parts are 
incomplete, making it difficult to determine when the application 
should be treated as filed and when the staff should begin reviewing 
it. The application filing date is critical because the 180-day 
limitation placed on the staff for rendering a decision on the 
application is measured from this date.
    To alleviate these problems, NASD Regulation recommends one point 
of entry for the entire application, the district office. District 
staff will review the entire application to determine if it is 
substantially complete. If so, they will forward any documents that 
need to go to CRD and continue processing the application.
    NASD Regulation proposes a new rule for dealing with applications 
that are not substantially complete at the time of submission. 
Currently, the staff does not have any authority to refuse to begin 
processing an inadequately prepared application. Instead, they attempt 
to begin processing such an application by sending a request for 
further information to the Applicant. If the Applicant does not timely 
provide the requested information, then the rules permit the staff to 
``lapse'' the application. The staff then notifies the Applicant that 
the application has lapsed, all fees are forfeited, and the Applicant 
is required to start over with the application process if it still 
wants to become an NASD member. These procedures can consume as much as 
90 days and a considerable amount of staff and Applicant resources, but 
still result in a rejected application.
    Under the proposed rule, if an application is so deficient upon 
initial submission that the staff cannot begin processing it (e.g., it 
is missing major components of the application, such as written 
supervisory procedures or a business plan), then the staff may reject 
the application. The staff would have no more than 30 days after 
submission to do this, and would be required to provide reasons for its 
action in writing. NASD Regulation proposes a $350 processing fee for 
the rejection of an application that is not substantially complete. 
NASD Regulation considered but rejected defining the term 
``substantially complete'' because the determination will vary 
depending on the type and complexity of the proposed business, among 
other things. The lapse rules will still apply to those situations 
where an Applicant stops providing information in the middle of the 
application process.
    Rule 1013 also is simplified by removing requirements for 
Applicants to submit information that has already been submitted to 
CRD. The district staff has full access to CRD and can obtain the 
information they need directly from it. This change will make the 
application process simpler for Applicants by eliminating duplicative 
submissions to NASD Regulation.
    Under the proposed Rule 1013(a)(2), an Applicant will continue to 
submit only its initial Forms BD and U-4 in paper along with the rest 
of the application. The Applicant also will submit a Web CRD 
entitlement request form with its application. Under proposed Rule 
1013(a)(3), upon approval of the Web CRD entitlement request form by 
NASD Regulation, the Applicant must make all subsequent Form filings 
and amendments electronically via Web CRDsm. A conforming 
change is proposed for Rule 1140. This process will be in conformity 
with Commission requirements for the submission of Form BD and 
amendments to it.\8\ Similarly, the initial Member Contact 
Questionnaire and user access request form also are submitted on paper; 
upon approval of a membership application, the member may update the 
Member Contact Questionnaire electronically.
---------------------------------------------------------------------------

    \8\ See Exchange Act Release No. 41594 (July 2, 1999), 64 FR 
37586 (July 12, 1999).
---------------------------------------------------------------------------

    The proposed rule adds new requirements for Applicants to submit 
information concerning their ability to

[[Page 36874]]

ensure business continuity, including information about the capacity of 
their communications and operational systems, contingency plans, 
disaster recovery plans, and the like. NASD Regulation also proposes a 
new standard for admission that requires that such systems, plans, and 
procedures be adequate in proposed Rule 1014(a)(6). The staff would not 
be required to investigate the adequacy themselves; rather, the 
Applicant would certify that the systems, plans, and procedures are 
adequate for the Applicant's business. The Applicant may self-certify 
or may rely on a third party (e.g., a vendor of such a system) to 
provide the certification if the Applicant so chooses.
    NASD Regulation also wishes to clarify that under Rule 1013(b)(4), 
the Applicant and the staff may agree to hold the membership interview 
at the Applicant's place of business.
    Rule 1013 is amended by adding new subparagraph (b)(5) to require 
Applicants to provide updated financial information at the time of 
their membership interview.
d. Proposed Rule 1014
    NASD Regulation proposes few changes with respect to the standards 
for admission. NASD Regulation proposes a new standard with respect to 
business continuity, as described above. NASD Regulation also proposes 
that the Applicant's supervisory procedures must specifically include 
procedures to ensure proper registrations are obtained by the firm. All 
other changes to the standards for admission are conforming changes.\9\
---------------------------------------------------------------------------

    \9\ NASD Regulation also wishes to provide some guidance on how 
it treats unadjudicated violations under Rule 1014. The Rule permits 
the staff to consider unadjudicated violations as part of a decision 
on a membership application. In most cases, an unadjudicated 
violation by itself will not result in a restriction or a denial, 
but depending on the circumstances, may require heightened 
supervision. However, a particularly egregious allegation, e.g., a 
criminal charge involving a large number of customers, may cause the 
staff to consider a restriction or denial.
---------------------------------------------------------------------------

    NASD Regulation also considered the requirement of Rule 
1014(a)(9)(C) that prospective supervisors have at least one year of 
direct experience or at least two years of related experience in the 
subject area to be supervised. NASD Regulation believes that this 
requirement should continue to be imposed and has published 
interpretive guidance on this subject in How To Become A Member, which 
is available at www.nasdr.com/4700_toc.htm. NASD Regulation does not 
believe that supervisory experience requirements should be increased.
    Rule 1014(c), which concerns the submission of membership 
agreements, is amended by deleting the requirement that any member with 
a membership agreement obtain approval from NASD Regulation of any 
change in business outside the terms of the agreement. NASD Regulation 
believes that this provision is too restrictive, particularly for firms 
with no disciplinary history. The provision also puts members with a 
membership agreement at a disadvantage vis-aacute;-vis members that do 
not have a membership agreement.\10\ Therefore, this provision is 
deleted. When the proposed rule change becomes effective, to ensure 
that members are treated equally, NASD Regulation will permit members 
that are eligible for the safe harbor to use it, even if their 
membership agreement includes a general requirement to obtain approval 
from NASD Regulation of any change in business outside the terms of the 
agreement. When NASD Regulation examines a member, it will update the 
membership agreement to reflect the new rule. As part of the proposed 
rule change, paragraphs 1014(c) and (d) also are reordered for ease of 
reading.
---------------------------------------------------------------------------

    \10\ In 1984, the SEC approved a codification of the NASD's 
member admission procedures, which included a requirement that any 
restriction on a member's business be included in a membership 
agreement executed by the member. See Exchange Act Release No. 21159 
(July 20, 1984), 49 FR 30268 (July 27, 1984) (File No. SR-NASD-82-
24). Thus, a member admitted before 1984 or a member admitted 
without any restriction from 1984 to 1997 may not have a membership 
agreement. In 1997, NASD Regulation began requiring all new members 
to execute a membership agreement, regardless of whether NASD 
Regulation imposed any restriction. See NASD Rule 1014(c); Exchange 
Act Release. No. 38908 (Aug. 7, 1997), 62 FR 43385 (Aug. 13, 1997) 
(File No. SR-NASD-97-28).
---------------------------------------------------------------------------

    In addition, upon adoption of the proposed rules, NASD Regulation 
will begin including business expansions plans in membership agreements 
to the extent practicable.
e. Proposed Rule 1015
    Under current Rule 1015, the NAC or the Review Subcommittee may 
call for review a district decision on a membership application, even 
if the Applicant does not appeal the decision. NASD Regulation 
considered at length whether a procedure or policy could be developed 
to implement this provision effectively, but ultimately determined that 
it is unworkable. NASD Regulation has temporarily suspended calls for 
review of membership decisions and proposes to delete this provision 
altogether for the reasons set forth in Exchange Act Release No. 41311 
(Apr. 20, 1999), 64 FR 20347 (Apr. 26, 1999) (File SR-NASD-99-15).
    NASD Regulation believes that the oversight function envisioned for 
the call for review provision, which has proved to be unworkable, is 
performed through a variety of other existing mechanisms. The Home 
Office of the Member Regulation Department employs a full time 
Membership Manager to coordinate and oversee the national program. Part 
of the manager's responsibility includes a quality control function. 
This function is carried out in several ways: maintenance of a 
Membership Procedures Manual; periodic advice memoranda sent to 
District Office staff (``MAP Bulletins''); regularly scheduled 
telephone conferences with District Office staff to discuss procedural 
and substantive issues arising in the program; and periodic training 
sessions for new and incumbent staff. To supplement these tools, Member 
Regulation's Office of Quality Assurance conducts periodic peer reviews 
of the membership admission program, most recently in 1998 and 1999. 
The purpose of these peer reviews was to assess the District Offices' 
application of the membership rules and procedures. The reviews 
included an examination of 265 files in recently-issued membership 
decisions. The reviews included spot checks of source documents to 
confirm the facts underlying the decisions. In addition, peer reviews 
of the membership program will be conducted in the future.
    NASD Regulation also proposes a new paragraph (h) for dismissing 
appeals that are abandoned by an applicant, which includes failing to 
appear at a hearing as set forth in current Rule 1015(f)(5), among 
other things.
f. Proposed Rule 1017
    Current Rule 1017, which addresses applications for removal or 
modification of a business restriction, and Rule 1018, which addresses 
applications for approval of changes in ownership, control, or 
operations, are consolidated in proposed Rule 1017. Sometimes a member 
initiates business changes that involve both rules, which creates 
confusion as to which rule should be used. Therefore, NASD Regulation 
proposes to consolidate these rules to make them easier for staff and 
applicants to use and to eliminate any confusion that may arise from 
overlapping provisions.
    This consolidation is achieved in part by defining the term 
``material change in business operations'' in proposed Rule 1011(i) to 
include the removal or modification of a business restriction. All 
material changes in business operations would trigger a review under 
proposed Rule 1017. Members should

[[Page 36875]]

note that a ``restriction'' is specifically labeled as such in the 
membership agreement, and NASD Regulation issues a decision that states 
the rationale for the restriction.
    A restriction is distinct from other limitations that a member may 
set forth in its business plan that may be recited as part of the 
``Business Activities'' section of a membership agreement. For example, 
an applicant may include in its business plan that it intends to have 
10-20 registered representatives and make markets in no more than 10 
stocks. If the NASD approves the application, these self-imposed 
limitations, which have been considered as part of the application, may 
be included in the ``Business Activities'' section of the membership 
agreement. These types of limitations are not considered 
``restrictions'' under the Rules because they are not imposed by NASD 
Regulation, and therefore NASD Regulation does not have to include a 
rationale for them in the decision in the application. Under the 
proposed Rules, a member that has such limitations in its membership 
agreement may expand beyond those limitations to the extent permitted 
in the safe harbor in IM-1011-1.
    In contrast, for example, NASD Regulation may specifically restrict 
the number of markets a member makes because NASD Regulation determines 
and issues a decision stating that the member cannot adequately 
supervise a large number of markets. In such a case, the restricted 
member cannot take advantage of the safe harbor in proposed Rule 1011 
and must apply under proposed Rule 1017 to lift the restriction.
    Another type of change that triggers an application under proposed 
Rule 1017 is a change in the equity ownership or partnership capital of 
the member that results in one person or entity owning or controlling 
25 percent or more of the equity or partnership capital. NASD 
Regulation wishes to clarify that a group of individuals acting in 
concert to obtain control of 25 percent or more of the equity or 
partnership capital of a member will be deemed to be an ``entity'' 
under the Rule, and as such, trigger the requirement to submit an 
application to obtain approval of the ownership change.
    NASD Regulation proposes to discontinue its review of certain 
changes. Under proposed Rule 1017, NASD Regulation would discontinue 
review of member mergers and acquisitions that are reviewed by the New 
York Stock Exchange, thereby eliminating duplication by self-regulatory 
organizations.
    Proposed Rule 1017 also sets forth for the first time what type of 
information should be included in an application and the content of the 
staff's decision on an application under this Rule. The Rule also 
clarifies when the application should be filed and what changes can be 
effected prior to obtaining NASD Regulation's approval.
    NASD Regulation proposes a new paragraph (k) to clarify what 
happens if a change in ownership application lapses or is denied. The 
proposed rule change provides that if the ownership change application 
lapses or is denied, then the member has a fixed period of time to 
submit a new application,\11\ unwind the transaction, or file a Form 
BDW. Of course, as under the current rules, a member could continue to 
operate with the approved owners if the transaction has not closed. The 
Department may shorten the 60-day period for the protection of 
investors or lengthen it upon good cause shown by the Applicant. The 
Department may continue to place interim restrictions on the member 
during the 60-day (or other imposed) period. NASD Regulation's practice 
has been to inform Applicants of these options, but not impose 
particular deadlines. The purpose of the proposed rule change is to 
provide more structure to this process and ensure that members who do 
not timely obtain approvals of ownership changes are not doing business 
with the public.
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    \11\ A lapsed Applicant may propose the same owners; a denied 
Applicant must propose new owners.
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    As part of its review of the Rule 1010 Series, NASD Regulation 
considered whether the time frames in Rule 1017 could be shortened so 
that the overall process would be completed in 90 days. NASD Regulation 
determined not to shorten the time frames at this time because other 
rule revisions (e.g., defining material change in operations and 
listing the documents required for the application), should speed up 
processing of applications. NASD Regulation also intends to publish on 
its Web site further guidance to members on what types of documents and 
information the staff will require if a member requests approval to 
engage in certain specialized areas of the securities or investment 
banking business. NASD Regulation believes that these changes should be 
given a chance to work before any time frames are shortened. NASD 
Regulation will reconsider the issue one year after the rule revisions 
have become effective and more information is available about the 
processing time for applications.
g. Proposed Rule 1018
    NASD Regulation proposes to adopt a new NASD Rule 1018, which would 
permit the staff to stay a membership application under NASD Rule 1013 
or 1017 if a state or federal authority files criminal charges against 
the Applicant or a principal or proposed principal of the Applicant; 
the SEC files a complaint or a request for injunctive relief against 
the Applicant or a principal or proposed principal of the Applicant; or 
the NASD, another self-regulatory organization, or a state files a 
complaint alleging a violation of one of the laws or rules listed in 
IM-1011-1 (or a comparable state provision).
    Under the proposed rule, the stay would be lifted automatically if 
the Applicant prevailed in the disciplinary action. The staff also 
would be authorized to lift the stay if circumstances changed. If the 
staff denied the request to lift the stay, the Applicant could appeal 
to the National Adjudicatory Council.
2. Statutory Basis
    NASD Regulation believes that the proposed rule change is 
consistent with the provisions of Section 15A(b)(6) of the Act,\12\ 
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. Section 15A(b)(8) of the Act 
\13\ requires that a national securities association establish rules 
providing a fair procedure for the denial of membership in such 
association. NASD Regulation believes that the proposed rule change is 
consistent with these sections because it provides better notice to 
applicants about the various requirements of the application process, 
simplifies and clarifies the rules, and better protects investors by 
circumscribing expansions by members with disciplinary histories and by 
permitting the Association in certain circumstances to stay 
applications by members who are subject to disciplinary action. The 
proposed rule change also provides better notice to applicants whose 
change in ownership is denied by informing them of their options once 
the denial is final.
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    \12\ 15 U.S.C. 78o-3(b)(6).
    \13\ 15 U.S.C. 78o-3(b)(8).

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[[Page 36876]]

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

    NASD Regulation does not believe that 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

    The proposed rule change was published for comment in NASD Notice 
to Members 99-67. Two comments were received in response to the Notice.
    The commenters raised several issues. One commenter, the Jeffrey 
Matthews Financial Group LLC, stated that the staff has been given too 
much time to review an Applicant's submission and request additional 
information. As part of its deliberations on the proposed rules, NASD 
Regulation considered shortening certain deadlines. NASD Regulation 
determined not to shorten the time frames at this time because other 
rule revisions (e.g., defining material change in operations and 
listing the documents required for the application) should speed up 
processing of applications. NASD Regulation also has provided 
additional guidance to members on what types of documents and 
information the staff will require if a member requests approval to 
engage in certain specialized areas of the securities or investment 
banking business. This guidance is posted at www.nasdr.com/
cm__apps__1.htm. NASD Regulation concluded that these changes should be 
given a chance to work before any time frames are shortened. NASD 
Regulation will reconsider the issue one year after the rule revisions 
have become effective and more information is available about the 
processing time for applications. In the meantime, NASD Regulation will 
make every effort to respond promptly and within the time limits to 
each submission of information.
    This same commenter also suggested that a member should be 
permitted to add business activities without approval from NASD 
Regulation if the revenues from the activity are less than five percent 
of total revenue. Certain types of business expansions (adding a 
limited numbers of sales personnel, offices, and markets) are permitted 
under the proposed safe harbor. After further consideration of this 
comment by the Board, NASD Regulation determined to revise the 
definition of material change in business operations as proposed in 
Notice To Members 99-67 so that the definition would not apply to 
adding any new type of business, but only to adding market making, 
underwriting, or acting as a dealer for the first time.
    The California Association of Independent Broker-Dealers 
(``CAIBD'') also submitted a comment letter. CAIBD stated that: (1) the 
staff has too much discretion in determining whether a member should be 
permitted to expand; (2) NASD Regulation does not need to ask for lease 
arrangement information or descriptions of communications and 
operations systems; (3) supervisory experience should not be required; 
(4) membership interviews should be waived in certain circumstances; 
(5) a list of persons to be registered should not be required; and (6) 
an Applicant should not be required to describe the volatility of its 
products.
    First, NASD Regulation does not believe that the staff has too much 
discretion in rendering a decision on a member's application to expand 
its business. Indeed, the criteria for approval of membership 
applications is set forth in detail in Rule 1014. To the extent a 
decision on an application is denied in whole or in part or approved 
subject to restrictions, the rules require that the reason for the 
denial or imposition of restrictions be specifically explained, 
referencing the applicable standard for membership upon which the 
decision is based.
    Furthermore, as part of its proposal, NASD Regulation is creating a 
safe harbor that will permit members to undertake certain types of 
business expansions without obtaining NASD Regulation approval. NASD 
Regulation believes that it is appropriate to continue exercising 
discretion in reviewing expansions outside of the safe harbor because 
such expansions could be material.
    Second, NASD Regulation has routinely required Applicants to 
provide information about their lease arrangements. This permits NASD 
Regulation to verify certain aspects of an application. For example, an 
Applicant that proposed to have a very small number of registered 
persons in most cases would lease space commensurate with staffing. If 
that Applicant instead leased a very large space, NASD Regulation would 
most likely request further information about the business purpose for 
the lease and to ensure that the Applicant was not planning an 
unapproved expansion. Likewise, if an applicant proposed to employ a 
large number of associated people in a relatively small space, NASD 
Regulation would question the Applicant's ability to support the number 
of personnel proposed from both a supervisory and operational 
standpoint.
    Third, NASD Regulation determined that it should begin asking 
Applicants for information about their ability to ensure business 
continuity, including information about the capacity of their 
communications and operational systems, contingency plans, disaster 
recovery plans, and the like. The staff would not be required to 
investigate the adequacy themselves; rather, the applicant would 
certify that the systems, plans, and procedures are adequate for the 
applicant's business. The applicant may rely on a third party (e.g., a 
vendor of such a system) to provide the certification if the applicant 
so chooses. This review will be less extensive in the case of an 
introducing broker-dealer that is relying on the systems of a clearing 
broker.
    Fourth, NASD Regulation staff, as well as the NAC and the District 
Committees, have expressed the view that the experience requirement for 
supervisors is appropriate. In some cases, NASD Regulation has 
appropriately denied membership or a business expansion application 
where the Applicant has not demonstrated any experience in the proposed 
business line.\14\ NASD Regulation believes that this experience 
requirement serves an important investor protection function.
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    \14\ In the Matter of Sierra Nevada Securities, Inc., Exchange 
Act Release No. 41330, 1999 SEC LEXIS 833, Apr. 26, 1999.
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    Fifth, NASD Regulation believes that membership interviews are 
essential for new member Applicants under NASD Rule 1013. The in-person 
interview plays an important role in determining whether the Applicant 
and its principals are knowledgeable about the legal and regulatory 
requirements of operating a broker-dealer and can demonstrate that they 
are capable of complying with all laws and regulations, as required by 
the membership standard in proposed NASD Rule 1014(a)(3). Interviews 
with a current member applying to remove a restriction or expand its 
business are not required by the rules, but may be held at the election 
of staff under proposed NASD Rule 1017.
    Sixth, a list of prospective registered persons is also essential 
to rendering a decision under proposed Rule 1014. NASD Regulation must 
check the disciplinary history of all such persons in determining 
whether an Applicant meets the standards set forth in proposed Rule 
1014(a)(3) and (10).
    Finally, NASD Regulation believes taking the volatility of a firm's 
products into consideration is necessary in order to assess a firm's 
ability to maintain an adequate net capital level under

[[Page 36877]]

Exchange Act Rule 15c3-1 and the adequacy of the firm's procedures for 
supervising its financial and operational functions.
    NASD Regulation requested, but did not receive, comment on several 
issues in NTM 99-67. NASD Regulation has determined to retain the safe 
harbor numbers as proposed in the Notice. However, NASD Regulation has 
determined that the definition of disciplinary history should be 
amended to include violations by officers or principals of the member. 
NASD Regulation also has determined that restrictions in a membership 
agreement should not automatically sunset after a fixed period (e.g., 
five years) if the applicant does not have any disciplinary history; 
instead, restrictions will continue to be individually reviewed. 
Finally, NASD Regulation determined that it should clarify what happens 
if a change in ownership is denied and has proposed Rule 1017(k) to 
address this situation.

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 the proposed rule 
change is consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549-
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 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-99-67 and should 
be submitted by July 3, 2000.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\
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    \15\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-14718 Filed 6-9-00; 8:45 am]
BILLING CODE 8010-01-P