[Federal Register Volume 67, Number 171 (Wednesday, September 4, 2002)]
[Notices]
[Pages 56608-56610]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-22461]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 3446422; File No. SRNASD200204]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the National Association of Securities Dealers, Inc. Relating 
to Amendments to Rule 3010(b)(2) and IM83102

August 28, 2002.

I. Introduction

    On January 7, 2002, the National Association of Securities Dealers, 
Inc. (``NASD''), through its wholly owned subsidiary, NASD Regulation, 
Inc. (''NASD Regulation'') filed with the Securities and Exchange 
Commission (''Commission'') a proposed rule change pursuant to section 
19(b)(1) of the Securities Exchange Act of 1934 (``Exchange Act'')\1\ 
and Rule 19b4 thereunder.\2\ On May 31, 2002, NASD filed Amendment No. 
1 to the proposed rule change.\3\ The proposal amends NASD Rule 
3010(b)(2), also known as the ``Taping Rule,'' and NASDIM83102. Notice 
of the proposed rule change, as amended, was published for comment in 
the Federal Register on June 18, 2002.\4\ The Commission received three 
comment letters regarding the proposal.\5\ This order approves the 
proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b4.
    \3\ See letter from Grace Yeh, Assistant General Counsel, NASD 
Regulation, to Katherine England, Assistant Director, Division of 
Market Regulation, Commission, dated May 31, 2002.
    \4\ See Securities Exchange Act Release No. 46067 (June 12, 
2002), 67 FR 41561.
    \5\ See letters to the Secretary, SEC, from Brad Bervert, 
President, Financial World Corporation, dated June 4, 2002 
(``Bervert Letter''), and William Perry, President and Chief 
Executive Officer, Pro-Integrity Securities, Inc., dated June 27, 
2002 (``Perry letter''); e-mail from James St. Claire, Chief 
Executive Officer, ViewTrade Securities, Inc., dated August 2, 2002 
(``St. Claire e-mail'').
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II. Description of the Proposed Rule Change

    NASD Rule 3010(b)(2) requires NASD members to adopt special 
supervisory procedures and to tape record all of their registered 
representatives' telephone calls with customers (or potential 
customers) when they meet specified threshold levels of representatives 
that have worked at disciplined firms. A firm is ``disciplined'' within 
the meaning of the Rule if, in connection with securities sales 
practices, it has been expelled from membership or participation in a 
securities self-regulatory organization, or is subject to an order of 
the

[[Page 56609]]

Commission revoking its registration as a broker or dealer.\6\
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    \6\ NASD Rule 3010(b)(2)(x).
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    NASD now proposes several changes to the Rule. First, NASD proposes 
to permit firms to avoid its application by reducing their staffing 
levels to fall below the specified threshold levels within 30 days of 
receiving notice or obtaining actual knowledge that they are subject to 
the Rule. Thereafter, the firm could not rehire the terminated 
individuals for at least 180 days. Firms could not hire additional 
registered representatives to fall below the thresholds; the rule only 
permits firms to reduce their population of registered representatives 
from disciplined firms. A firm would only be permitted to adjust its 
staffing levels once, and only the first time it becomes subject to the 
Taping Rule. NASD has represented that although a new entity resulting 
from a restructuring, such as a merger, would be allowed to take 
advantage of the new procedures even if a participant in the 
restructuring had previously done so, this would not be permitted where 
an entity was restructured in an attempt to avoid the Rule.
    NASD would also revise the criteria for determining whether a firm 
is subject to the Taping Rule. Specifically, persons who were 
registered with one or more disciplined firms for 90 days or less 
within the last three years and who have no disciplinary history, as 
defined in NASDIM10111, would not count as former associates of 
disciplined firms, although they would still count toward the firm's 
total number of registered persons.
    In addition to these changes, the proposal would extend the period 
that firms must maintain taping systems from two years to three years, 
extend the time for firms to install taping systems from 30 days to 60 
days, and revise the rule to state that exemptions will be available 
only in ``exceptional circumstances.''
    Several other changes are also proposed. Specifically, NASD would 
substitute ``associated with one or more Disciplined Firms in a 
registered capacity'' for ``employed by one or more Disciplined Firms'' 
in subparagraph (b)(2)(viii) of the Rule to reflect that the 
calculation of registered representatives from disciplined firms 
includes independent contractors previously registered with disciplined 
firms. NASD would also clarify that firms must both establish and 
``implement'' the required systems within the time set forth in the 
Rule, and that the compliance period begins on the date that the member 
establishes its special supervisory procedures and implements its 
taping system.
    Finally, NASD proposes to amend NASDIM83102 to allow investors and 
the general public to ascertain whether a particular firm is subject to 
the Taping Rule via the NASD Public Disclosure Program's toll-free 
telephone listing.

III. Summary of Comments

    The Commission received three comment letters regarding the 
proposed rule change. The commenters were generally supportive. 
However, two believed that NASD should have proposed to apply the 
amendments to firms already subject to the Taping Rule.\7\ One of the 
commenters opposed the extension of the taping period to three years as 
being unduly burdensome. This commenter also opposed disclosure of 
whether a particular firm was subject to the Taping Rule, on the 
grounds that the Rule was meant to be remedial in nature, and that the 
public might construe its application as a disciplinary sanction.\8\ 
The commenter also suggested that NASD should consider the level of 
experience of individual representatives and the reason their previous 
firm was disciplined in determining whether they should be counted 
toward the threshold levels, and that the rule should be modified to 
permit exemptions depending on whether NASD had particular concerns 
about a firm's population of former associates of disciplined firms.\9\ 
Another commenter suggested that NASD should define the circumstances 
where it would grant an exemption to include where an employee had been 
associated with a disciplined firm within the past three years, but had 
departed prior to the activities that led to the disciplinary 
action.\10\
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    \7\ See Bervert letter, Perry letter, supra, note 4.
    \8\ See Perry letter, supra n. 4.
    \9\ See Perry letter, supra n. 4.
    \10\ See St. Claire e-mail, supra n. 4.
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IV. Discussion

    After careful review, the Commission finds that the proposed rule 
change is consistent with the Act and the rules and regulations 
thereunder applicable to a national securities association.\11\ The 
Commission finds that the proposal is consistent with the requirements 
of section 15A(b)(6) of the Act,\12\ which requires that the rules of a 
registered national securities association be designed to prevent 
fraudulent and manipulative acts and practices, to promote just and 
equitable principles of trade, to foster cooperation and coordination 
with persons engaged in regulating, clearing, settling, processing 
information with respect to, and facilitating transactions in 
securities, to remove impediments to and perfect the mechanism of a 
free and open market and a national market system, and, in general, to 
protect investors and the public interest.
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    \11\ In approving the proposal, the Commission has considered 
the rule's impact on efficiency, competition, and capital formation. 
15 U.S.C. 78c(f).
    \12\ 15 U.S.C. 78o(b)(6).
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    Specifically, the Commission believes that the proposal to allow 
firms an opportunity to reduce staffing levels in order to fall below 
the Taping Rule's threshold levels is proper. This change should allow 
firms a degree of flexibility when they might inadvertently or 
unintentionally become subject to the Rule due, for example, to sudden 
turnover among registered persons or other events beyond the firm's 
control. At the same time, NASD's proposal includes measures to prevent 
firms from taking inappropriate advantage of the new provisions. The 
staff adjustment would only be permitted once, and only on the first 
occasion that the firm triggers the Rule. Moreover, it could not be 
accomplished by hiring more personnel, but only by reducing the number 
of employees from previously disciplined firms. Additionally, the 
member could not re-hire a terminated employee for 180 days. Finally, 
notwithstanding the inherent difficulty a firm would face if it sought 
to restructure and then terminate personnel for the sole purpose of 
avoiding the Taping Rule, NASD has stated that it will not allow a firm 
to evade the Rule through such a measure.
    The Commission also believes that NASD's proposal to change the 
calculation of the threshold levels by not counting persons that were 
short-term employees of disciplined firms as having worked at 
disciplined firms is proper. The Commission agrees with NASD that such 
employees are less likely to have received poor training or learned 
improper sales tactics, and are more likely to have any ``bad habits'' 
corrected by proper training and supervision at their new firm. As an 
additional safeguard, the proposed rule change provides that such 
short-term employees may not themselves have a relevant disciplinary 
history. These changes should adequately address the suggestions by one 
of the commenters that NASD should consider the histories and 
qualifications of individual personnel in evaluating whether a firm is 
subject to the Rule or should be exempted, while at the same time 
retaining clear, workable standards.

[[Page 56610]]

    NASD has also proposed to change the Rule to provide that 
exemptions will only be granted in ``exceptional circumstances.'' This 
change, coupled with those described above, should help to reduce the 
number of requests that might otherwise consume time and resources on 
the part of both NASD and firms subject to the Rule. Furthermore, 
NASD's proposal to extend the duration of the taping requirement from 
two years to three years from the date taping begins is proper. 
Although one commenter noted that this constitutes a higher compliance 
burden, it should reduce any confusion that might be caused by the 
difference between the Rule's current two-year taping requirement and 
the Rule's requirement that member firms must review the last three 
years of their employees' work history to determine whether they had 
worked at disciplined firms. The Commission also believes that the 
proposal to allow 60 days, instead of 30, for the installation of 
taping systems is appropriate. One commenter noted that it could take 
60 days to implement a taping system.
    The proposed clarifying changes to the Rule are also consistent 
with the Act. The substitution of ``associated with one or more 
Disciplined Firms in a registered capacity'' for ``employed by one or 
more Disciplined Firms'' in subparagraph (b)(2)(viii) of the Rule 
should eliminate any misconception that representatives that were 
independent contractors \13\ of disciplined firms do not count toward 
the threshold levels. Likewise, adding language to clarify that firms 
that become subject to the Rule must ``implement'' the required 
procedures within the allotted time period should make clear that the 
taping and supervisory procedures must be put into use within the 
prescribed time period. Finally, NASD's proposal to clarify that the 
taping compliance period begins on the date that the member implements 
its taping system should help to ensure that the Rule's requirements 
are easily understood.
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    \13\ The Commission notes that the issue of independent 
contractors was addressed in a letter from the Division of Market 
Regulation to NASD. See letter from Douglas Scarff, Director, 
Division of Market Regulation, Commission, to Gordon Macklin, 
President, NASD (June 18, 1982).
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    As noted above, NASD has also proposed to permit, upon request, 
public disclosure of whether a particular firm is subject to the Taping 
Rule. This disclosure would be made available through the toll-free 
telephone listing of NASD's Public Disclosure Program. Although one of 
the commenters asserted that the public might interpret the Rule's 
application as a disciplinary sanction, rather than a remedial measure, 
this does not mean that the disclosure should not be permitted. Rather, 
the Commission believes that this disclosure will benefit investors and 
the general public by providing information that will permit them to 
consider the level of experience and training of a firm's 
representatives. Therefore, this should allow investors a better 
opportunity to evaluate their choices in selecting a broker/dealer.
    Finally, the Commission believes that NASD's proposal to apply the 
changes prospectively is appropriate. Retroactive application would 
allow firms currently subject to the Rule to evade the requirements 
entirely, and thereby inappropriately restrict NASD's oversight of such 
firms' sales training and practices.

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,\14\ that the proposed rule change (SRNASD200204) is approved.
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    \14\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\15\
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    \15\ 17 CFR 200.303(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-22461 Filed 9302; 8:45 am]
BILLING CODE 801001P