[Federal Register Volume 65, Number 141 (Friday, July 21, 2000)]
[Notices]
[Pages 45414-45416]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-18493]


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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43030; File No. SR-NASD-99-42]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc. Relating 
to Performance Fee Arrangements

July 12, 2000.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on September 2, 1999, the National Association of Securities Dealers, 
Inc. (``NASD'' or ``Association''), through its wholly owned subsidiary 
NASD Regulation, Inc. (``NASD'' or ``Association''), through its wholly 
owned subsidiary NASD Regulation, Inc. (``NASD Regulation'') filed with 
the Securities and Exchange Commission (``SEC'' or ``Commission'') a 
proposed rule change as described in Items I, II, and III below, which 
Items have been prepared by NASD Regulation. The Commission is 
publishing this notice to

[[Page 45415]]

solicit comments on the proposed rule change from interested persons.
---------------------------------------------------------------------------

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

I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    NASD Regulation is proposing to amend NASD Rule 2330(f)(2), in 
order to make it consistent with recent amendments by the Commission to 
Rule 205-3 under the Investment Advisers Act of 1940 (``Advisers 
Act''). Below is the text of the proposed rule change. Proposed new 
language is in italics; proposed deletions are in brackets.
* * * * *

Rules of the Association

* * * * *

2300. Transactions With Customers

2330. Customers' Securities or Funds
    (a) through (e) (No change).
    (f) Sharing in Accounts; Extent Permissible.
    (1)(A) and (B) (No change).
    (2) Notwithstanding the prohibition of paragraph (f)(1), a member 
or person associated with a member may receive compensation based on a 
share in profits or gains in an account if [all of] the following 
conditions are satisfied:\*\
---------------------------------------------------------------------------

    \*\ It is the position of the Division of Investment Management 
of the Commission that compensation received by a member or person 
associated with a member under t his Rule would constitute ``special 
compensation'' for purposes of th e broker/dealer exception to the 
definition of ``investment adviser'' in Section 202(a)(11)(C) of the 
Investment Advisers Act of 1940 (Advisers Act). Any member or person 
associated with a member, required to be registered under the 
Advisers Act, or state law, who receives compensation based on a 
share of profits or capital appreciation of a customer's account 
must comply with Section 205(1) and Rule 205-3 under the Advisers 
Act, or applicable state law, with respect to such compensation. 
(SEC Release 34-24355, 52 FR 13778, April 24, 1987).
---------------------------------------------------------------------------

    (A) The member or person associated with a member seeking such 
compensation obtains prior written authorization from the member 
carrying the account; and
    (B) The compensation arrangement complies with the conditions set 
forth in any applicable rule promulgated by the Commission.
    [(B) The customer has at the time the account is opened either a 
net worth which the member or person associated with a member 
reasonably believes to be not less than $1,000,000, or the minimum 
amount invested in the account is not less than $500,000;
    (C) The member or person associated with a member reasonably 
believes the customer is able to understand the proposed method of 
compensation and its risks prior to entering into the arrangement;
    (D) The compensation arrangement is set forth in a written 
agreement executed by the customer and the member;
    (E) The member or person associated with a member reasonably 
believes, immediately prior to entering into the arrangement, that the 
agreement represents an arm's-length arrangement between the parties;
    (F) The compensation formula takes into account both gains and 
losses realized or accrued in the account over a period of at least one 
year; and
    (G) The member has disclosed to the customer all material 
information relating to the arrangement including the method of 
compensation and potential conflicts of interest which may result from 
the compensation formula.]
* * * * *

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

I. Purpose
    Description of Proposed Rule Change. NASD Rule 2330(f) prohibits 
members and persons associated with members form sharing in customer 
account profits and gains except under certain conditions. Subparagraph 
(f)(1)(A) permits sharing in customer account profits and gains where 
the firm has authorized it and the sharing is proportionate to the 
member's or associated person's contributions to the account. 
Subparagraph (f)(2) permits, under certain conditions, members or 
registered representatives to charge a performance fee (an advisory fee 
based on a percentage of the capital gains or capital appreciation of 
an account). Currently, NASD Rule 2330(f)(2) permits the receipt of a 
performance fee only if: (1) The member or associated person reasonably 
believes that the customer account meets certain minimum net worth 
($1,000,000) or amount invested ($500,000) requirements; (ii) the 
member or associated person obtains the prior written authorization of 
the arrangement from the member carrying the account; (iii) the member 
or associated person reasonably believes that the customer is able to 
understand the compensation arrangement and its risks; (iv) the 
compensation agreement is in writing; (v) the member or associated 
person reasonably believes that the agreement is an arm's length 
agreement; (vi) the compensation formula takes into account realized 
and accrued gains and losses over a period of at least one year; and 
(vii) the member discloses all material information relating to the 
agreement, including method of compensation and potential conflicts of 
interest.
    The requirements of NASD Rule 2330(f)(2) have always closely 
tracked the requirements of Rule 205-3 under the Advisers Act. However, 
effective August 20, 1998, the Commission amended Rule 205-3 to provide 
greater flexibility in structuring performance fee arrangements with 
clients who are financially sophisticated or have the resources to 
obtain sophisticated financial advice regarding these arrangements.\3\ 
The amendments to Rule 205-3 changed and eliminated many of the 
requirements tracked in NASD Rule 2330(f)(2). As a result of these 
changes, NASD Rule 2330(f)(2) is now inconsistent with Rule 205-3 under 
the Advisers Act. In order to restore consistency, the proposed rule 
change will permit members and their associated persons to share in 
customer account profits and gains subject to the provisions of Rule 
205-3 under the Advisers Act. Thus, in the future, the proposed rule 
will conform to any subsequent amendments by the Commission to Rule 
205-3.
---------------------------------------------------------------------------

    \3\ See Investment Advisors Act Release No. 1731 (July 15, 
1998), 63 FR 39022 (July 21, 1998).
---------------------------------------------------------------------------

2. Statutory Basis
    NASD Regulation believes that the proposed rule change is 
consistent with the provisions of Section 15A(b)(6) of the Act,\4\ 
which requires, among other things, that the Association's rules 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. NASD Regulation believes 
that the proposed rule change will protect investors and the public 
interest by ensuring that performance fee arrangements are consistent 
with Commission rules and are structured with clients who are

[[Page 45416]]

financially sophisticated or have the resources to obtain sophisticated 
financial advice regarding the terms of these arrangements.
---------------------------------------------------------------------------

    \4\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

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

    No written comments were solicited or received with respect to the 
proposed rule change.

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 NASD Regulation consents, the Commission will:
    (A) By order approve such proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. In particular, the Commission seeks 
comment on how a broker-dealer can best meet its fiduciary obligation 
to ensure that its customers fully understand the performance fee 
arrangement. In formulating comments on this proposal, commenters are 
advised to refer to Advirsors Act Release No. 1731.\5\ Persons making 
written submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, 
DC 20549-0609. Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the NASD. All submissions should refer to the File 
No. SR-NASD-99-42 and should be submitted by August 11, 2000.
---------------------------------------------------------------------------

    \5\ 63 FR 39022 (July 21, 1998).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\6\
Jonathan G. Katz,
Secretary.
---------------------------------------------------------------------------

    \6\ 17 CFR 200.30-3(a)(12)
---------------------------------------------------------------------------

[FR Doc. 00-18493 Filed 7-20-00; 8:45 am]
BILLING CODE 8010-01-M