[Federal Register Volume 66, Number 38 (Monday, February 26, 2001)]
[Notices]
[Pages 11623-11624]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-4594]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43973; File No. SR-NASD-99-42]


Self-Regulatory Organizations; Order Approving a Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval of 
Amendment No. 1 Thereto by the National Association of Securities 
Dealers, Inc. Relating to Performance Fee Arrangements

February 15, 2001.

I. Introduction

    On September 2, 1999, the National Association of Securities 
Dealers, Inc. (``NASD'' or ``Association''), through its wholly owned 
subsidiary, NASD Regulation, Inc. (``NASD Regulation''), submitted to 
the Securities and Exchange Commission (``Commission''), pursuant to 
Section 19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\ 
and Rule 19b-4 thereunder,\2\ a proposed rule change relating to 
performance fee arrangements.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    The Federal Register published the proposed rule change for comment 
on July 21, 2000.\3\ The Commission received no comments on the 
proposed rule change. On January 31, 2001, the Association submitted an 
amendment to the proposed rule change.\4\ This order approves the 
proposed rule change and grants accelerated approval to Amendment No. 
1. The Commission is also soliciting comment on Amendment No. 1 to the 
proposed rule change.
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    \3\ Securities Exchange Act Release No. 43030 (July 12, 2000), 
65 FR 45414.
    \4\ Letter from Alden S. Adkins, Senior Vice President and 
General Counsel, NASD Regulation, to Katherine A. England, Assistant 
Director, Division of Market Regulation, Commission, dated January 
30, 2001 (``Amendment No. 1''). Amendment No. 1 amends NASD Rule 
2330(f)(2) to clarify that the rule applies to members or persons 
associated with members that act as investment advisers, whether or 
not registered as such, and to add a cross-reference to Rule 205-3 
of the Investment Advisers Act of 1940 (``Advisers Act''). Amendment 
No. 1 also states that NASD Regulation will notify its members of 
amendments to Rule 205-3 within 90 days through a Notice to Members.
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II. Description of the Proposed Rule Change

    NASD Rule 2330(f) prohibits members and persons associated with 
members from 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 receipts of a performance fee only if: (i) 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.
    According to NASD Regulation, 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.\5\ Because the NASD had 
incorporated the requirements of Rule 205-3 into NASD Rule 2330(f)(2), 
when the Commission amended Rule 205-3, NASD Rule 2330(f)(2) was no 
longer consistent with Rule 205-3.
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    \5\ See Investment Advisers Act Release No. 1731 (July 15, 
1998), 63 FR 39022 (July 21, 1998).
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    In order to restore consistency, the proposed rule change would 
permit members and their associated persons

[[Page 11624]]

that act as investment advisers to share in customer account profits 
and gains subject to the provisions of Rule 205-3 under the Advisers 
Act. The NASD amended Rule 2330(f)(2), to eliminate the conditions set 
forth in the rule and to incorporate the terms of Rule 205-3, as may be 
amended from time to time. The NASD stated that this approach 
represents a decision by the Board to incorporate whatever performance-
based standard the Commission may adopt from time to time.\6\ Thus, in 
the future, the proposed rule will conform to any subsequent amendments 
by the Commission to Rule 205-3. NASD Regulation will notify its 
members of any subsequent amendments to Rule 205-3 in a Notice to 
Members within 90 days of the amendment.\7\
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    \6\ Telephone conversation between Alden S. Adkins, Senior Vice 
President and General Counsel, NASD Regulation, and Katherine A. 
England, Assistant Director, Commission (October 27, 2000).
    \7\ See Amendment No. 1, supra note 4.
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III. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities association,\8\ and, in 
particular, the requirements of Section 15A(b)(6) of the Act.\9\ The 
Commission believes that proposed rule change should continue to ensure 
that NASD members enter into performance fee arrangements only with 
clients who are financially sophisticated or have the resources to 
obtain sophisticated financial advice regarding performance fee 
arrangements. The Commission also believes that cross-referencing 
Advisers Act Rule 205-3, rather than duplicating the specific 
provisions of Rule 205-3 in NASD Rule 2330(f)(2), will ensure that NASD 
Rule 2330(f)(2) remains consistent with Advisers Act Rule 205-3. The 
Commission notes that otherwise, NASD members acting as investment 
advisers might be subject to conflicting rules on the same subject. 
Finally, the Commission believes that NASD Regulation's commitment to 
issue a Notice to Members within 90 days of any amendments to Advisers 
Act Rule 205-3 should ensure that members remain aware of the 
requirements for performance fee arrangements.
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    \8\ In approving the proposal, the Commission has considered its 
impact on efficiency, competition, and capital formation. 15 U.S.C. 
78c(f).
    \9\ 15 U.S.C. 78o-3(b)(6).
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    The Commission finds good cause for approving Amendment No. 1 to 
the proposed rule change prior to the thirtieth day after publication 
in the Federal Register. The Commission notes that Amendment No. 1 
clarifies that the proposal applies to members acting as investment 
advisers and cross-references Advisers Act Rule 205-3. The Commission 
believes that Amendment No. 1 will make the requirements of NASD Rule 
2330(f)(2) more clear and, therefore, should help to ensure that 
members comply with the rule. Accordingly, the Commission finds good 
cause to accelerate approval of Amendment No. 1 to the proposed rule 
change, consistent with Sections 15A(b)(6) \10\ and 19(b) \11\ of the 
Act.
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    \10\ 15 U.S.C. 78o-3(b)(6).
    \11\ 15 U.S.C. 78s(b).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether Amendment No. 1 
is consistent with the Act. Persons making written submissions should 
file six copies thereof with the Secretary, Securities and Exchange 
Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. Copies of 
the submission, all subsequent amendments, all written statements with 
respect to the proposed rule change that are filed with the Commission, 
and all written communications relating to the proposed rule change 
between the Commission and any person, other than those that may be 
withheld from the public in accordance with the provisions of 5 U.S.C. 
552, will be available for inspection and copying in the Commission's 
Public Reference Room. Copies of 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 March 19, 2001.

V. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change is consistent with the requirements of the Act and the 
rules and regulations thereunder.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\12\ that the amended proposed rule change (SR-NASD-99-42) is 
approved.
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    \12\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-4594 Filed 2-23-01; 8:45 am]
BILLING CODE 8010-01-M