[Federal Register Volume 68, Number 46 (Monday, March 10, 2003)]
[Notices]
[Pages 11430-11432]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-5572]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47434; File No. SR-NASD-2002-112]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change by the National Association of Securities Dealers, Inc., To 
Amend NASD Rule 3070 To Require Members To File Copies of Criminal and 
Civil Complaints and Arbitration Claims With NASD

March 3, 2003.

I. Introduction

    On August 15, 2002, the National Association of Securities Dealers, 
Inc. (``NASD'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') a proposed rule change pursuant to Section 
19(b)(1) of the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 
19b-4 thereunder \2\ to amend Rule 3070 of its rules to require members 
promptly to file copies with NASD of certain criminal and civil 
complaints and arbitration claims against a member or a person 
associated with a member. NASD amended the proposed rule change on 
December 9, 2002.\3\ Notice of the proposed rule change and Amendment 
No. 1 thereto was published for comment in the Federal Register on 
December 27, 2002.\4\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Patrice Gliniecki, Vice President and Deputy 
General Counsel, NASD, to Katherine A. England, Assistant Director, 
Division of Market Regulation, Commission, dated December 6, 2002, 
and enclosures (``Amendment No. 1''). Amendment No. 1 replaced the 
original rule filing in its entirety.
    \4\ See Securities Exchange Act Release No. 47060 (December 20, 
2002), 67 FR 79203.
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    The Commission received five comment letters regarding the 
proposal.\5\ On February 12, 2003, NASD filed a response to the comment 
letters.\6\ This order approves the proposed rule change as amended by 
Amendment No. 1.
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    \5\ See letter from Kevin L. Palmer, Legal Department, World 
Group Securities, Inc. (``World Group''), to Jonathan G. Katz, 
Secretary, Commission, dated September 19, 2002 (``World Group 
Letter'') (World Group commented on NASD Notice to Members 02-53 
concerning the proposed amendment to NASD Rule 3070 prior to the 
Commission's publication of the proposed rule filing); letter from 
Marc A. Cohn, Assistant Vice President, Metropolitan Life Insurance 
Company (``MetLife''), to Jonathan G. Katz, Secretary, Commission, 
dated December 27, 2002 (``MetLife Letter''); letter from Stephen G. 
Sneeringer, Senior Vice President & Counsel, A.G. Edwards & Sons, 
Inc. (``A.G. Edwards''), to Jonathan G. Katz, Secretary, Commission, 
dated January 17, 2002 (``A.G. Edwards Letter''), letter from Edward 
Turan, Chairman, Arbitration Committee, Securities Industry 
Association (``SIA'') and John Polanin, Jr., Chairman, Self-
Regulation and Supervisory Practices Committee, SIA, to Jonathan G. 
Katz, Secretary, Commission, dated January 24, 2003 (``SIA 
Letter''), and letter from David A. Weintraub, Attorney at Law, 
David A. Weintraub, P.A. (``Weintraub''), to Jonathan G. Katz, 
Secretary, Commission, dated February 6, 2003 (``Weintraub 
Letter''). The comment letters are described in Section III, infra.
    \6\ See letter from Philip A. Shaikun, Assistant General 
Counsel, NASD, to Katherine A. England, Assistant Director, Division 
of Market Regulation, Commission, dated February 11, 2003 (``NASD 
Response Letter''). The NASD Response Letter does not respond to the 
Weintraub Letter because the Weintraub Letter was received by the 
Commission after NASD filed the NASD Response Letter.
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II. Description of the Proposal

    The proposed rule change amends NASD Rule 3070 to require members 
to file promptly with NASD copies of certain criminal and civil 
complaints and arbitration claims against the member or a person 
associated with the member. The purpose of the rule proposal is to 
improve the quality and flow of information to NASD with respect to 
allegations of broker misconduct, so that NASD can enhance investor 
protection efforts by promptly taking appropriate regulatory action to 
address the specific alleged misconduct and to prevent similar or 
related misconduct in the future.
    Specifically, the proposed rule change requires members to file 
with NASD copies of (1) any criminal complaints filed against the 
member or plea agreements entered into by the member that are covered 
by the rule; (2) any securities or commodities-related private civil 
complaints filed against the member; (3) any arbitration claim against 
the member (except those claims that have already been filed with NASD 
Dispute Resolution, in which case NASD obtains copies of such claims 
directly from NASD Dispute Resolution); and (4) any criminal complaint 
or plea agreement, private civil complaint or arbitration claim against 
an associated person that is reportable under question 14 on Form U-4, 
irrespective of any dollar threshold requirements that question imposes 
for notification (except those arbitration claims that have already 
been filed with NASD Dispute Resolution). To avoid duplicative filing, 
the rule proposal also provides that members need not separately 
produce the above-referenced documents if they have already been the 
subject of a request by NASD's Registration and Disclosure staff. These 
amendments are discussed in greater detail in the Commission's notice 
soliciting public comment on this proposal.\7\
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    \7\ See supra, note 4.
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III. Summary of Comments

    The Commission received five comment letters on the proposed rule 
change.\8\ Although four of the commenters generally supported NASD's 
desire to obtain and collect information regarding broker misconduct, 
they each contended that the proposal was unduly burdensome for members 
and offered alternative suggestions for achieving NASD's stated 
objectives.\9\ The fifth comment letter was written in response to the 
SIA Letter and in support of the proposed rule change.\10\ World Group 
and A.G. Edwards stated that NASD would be unduly burdened by the 
volume of documents it would receive compared to the amount of new 
relevant information. MetLife and the SIA stated that the proposal was 
inconsistent with NASD's rule modernization initiative, which seeks to 
streamline NASD rules by maximizing regulatory efficiency while 
imposing the least regulatory burden.\11\
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    \8\ See supra, note 5.
    \9\ See World Group Letter, MetLife Letter, A.G. Edwards Letter 
and SIA Letter.
    \10\ See Weintraub Letter.
    \11\ See Special NASD Notice to Members 01-35.
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    In its response to commenters, NASD focused only on comments made 
in connection with this proposal. The World Group, MetLife and A.G. 
Edwards Letters also addressed a change in NASD's policy regarding 
letters NASD issues when a determination is made to close an 
investigation without disciplinary action (referred to as ``close-out 
letters''). While notice of the policy change with respect to close-out 
letters was contained in the same Notice to Members 02-53 that 
announced that NASD had filed with the SEC its proposal to amend Rule 
3070, that policy change is not part of this rule filing. Accordingly, 
this order does not address the policy change with respect to close-out 
letters.
    NASD disagrees that the proposal would impose duplicative filing 
requirements on members or be unduly

[[Page 11431]]

burdensome. NASD notes that members are not required under existing 
rules to routinely file with NASD the documents sought under the 
proposal. NASD believes that information contained in those complaints 
and arbitration claims will enhance its regulatory efforts and better 
protect investors through early detection of broker misconduct and 
identification of problem trends. As to the burden on NASD, NASD states 
that deference must be given to NASD's determination that, on balance, 
the value of information it will receive outweighs any additional work 
for the organization.
    NASD states that the rule proposal minimizes the burden on members, 
including duplicative filing requirements: it specifically carves out 
any arbitration claims that are originally filed in the NASD Dispute 
Resolution forum and those documents that have already been requested 
by NASD's Registration and Disclosure staff (provided such documents 
are produced to Registration and Disclosure within 30 days of the 
request). Moreover, the rule requires only the filing of those 
complaints and claims most likely to contain information relevant to 
NASD's regulatory mission, excluding, for example, private civil 
litigation complaints or arbitration claims that do not involve 
securities or commodities-related conduct.
    World Group stated that the current reporting system appears to be 
an effective means for monitoring the misconduct or alleged misconduct 
of brokers and representatives. They noted that NASD has spent 
significant resources on the development of Integrated National 
Surveillance and Information Technology Enhancements (INSITE) to aid in 
more effective firm examinations. World Group stated that it might be 
more efficient to amend Rule 3070 to require the reporting of the 
additional information required by the proposal in the current 
reporting system. NASD responded that it believes that the current 
reporting system fails to capture important information that could 
improve its regulatory efficacy.
    MetLife stated that the proposal required the reporting of 
information that is reportable through electronic filings on Forms U-4, 
U-5, BD and Rule 3070 reports with certain exclusions for certain 
events based on dollar amounts. They stated that the current system is 
already fractured, redundant and burdensome in that the same incident 
may have to be reported twice on different mediums such as a Form U-4, 
U-5 or BD amendment and a Rule 3070 filing. They suggested that NASD 
streamline the current reporting system by requiring member firms to 
report events to NASD only once through a new electronic medium. NASD 
responded that while MetLife's general proposal to develop a new system 
is worth long-term consideration, its feasibility is uncertain and, in 
any event, it does not now provide a viable alternative to the current 
proposal.
    A.G. Edwards stated that most of the information required to be 
reported in the proposal is already required to be reported by members 
on the CRD. A.G. Edwards suggested that NASD assume the responsibility 
to report to the CRD any required information based on its review of 
the complaints and arbitration claims. They thought this would relieve 
members from the regulatory burden of reporting these actions to the 
CRD and would relieve some of the questions that they believe have 
arisen in regard to the reliability of that reporting. NASD responded 
that its does not believe such steps are necessary or appropriate. NASD 
explained that the rule proposal requires different information for 
different regulatory purposes from that reported to the CRD, and NASD 
believes it has reasonably minimized the burden on members under the 
proposal.
    The SIA stated that the rule should be limited to copies of retail 
customer lawsuits and arbitrations that allege sales practice 
violations in accordance with current Form U-4 and U-5 reporting 
requirements and dollar thresholds. The SIA stated that such an 
approach would be more resource-efficient and would produce more 
targeted reviews of complaints by NASD. NASD noted in its response that 
the SIA seeks to exclude from the proposal complaints in ``nearly all 
class actions; non-retail civil litigation, including product failure, 
and operational complaints, and small claims involving relatively small 
dollar amounts.'' \12\ The proposal requires a member to file with NASD 
any criminal complaint or plea agreement, private civil complaint or 
arbitration claim against an associated person that is reportable under 
question 14 on Form U-4, irrespective of any dollar threshold 
requirements that question imposes for notification (except those 
arbitration claims that have already been filed with NASD Dispute 
Resolution).
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    \12\ See NASD Response Letter at 2, SIA Letter at 2.
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    The NASD Response Letter states the following in support of NASD's 
belief that the SIA proposal is too narrow in scope and could lead to 
confusion.\13\ First, under the SIA formulation to limit the proposal 
to retail customer complaints and claims, NASD would not receive 
complaints alleging egregious conduct between members (such as 
collusive market making) or involving institutional customers (such as 
a kickback scheme in the distribution of initial public offerings). 
Such allegations of misconduct constitute relevant regulatory 
information, so NASD sees no sound policy reason to limit the subject 
matter of complaints to those involving retail customers. Since these 
and other allegations sometimes first appear in criminal proceedings, 
NASD believes it appropriate to maintain the requirement in the 
proposal to file copies of such documents.
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    \13\ See NASD Response Letter at 2-3.
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    Second, limiting the proposal to complaints and claims alleging 
sales practice violations would undermine a significant purpose of the 
rule proposal, namely to detect securities or commodities-related 
patterns of conduct or emerging trends that might warrant regulatory 
action. The regulatory intent would be frustrated if members were 
permitted to parse the language of a potential filing to determine 
whether its substance technically comprised a sales practice violation. 
Furthermore, litigation and arbitrations that related to securities or 
commodities conduct, but do not amount to a sales practice violation, 
nevertheless may prove to correlate to other conduct injurious to the 
investors and markets. These determinations can only be reached if NASD 
has access to data that has not been filtered by application of nuance 
to a legal term of art.
    Third, with respect to associated persons, NASD believes it is 
important to receive copies of complaints and claims reportable under 
question 14 on Form U-4, even when they fall below specified dollar 
thresholds, because those actions can highlight patterns of conduct or 
emerging trends that might warrant regulatory actions.
    The Weintraub Letter was written in response to the SIA Letter with 
regard to the reporting of customer complaints. The SIA stated that the 
rule should be limited to copies of retail customer lawsuits and 
arbitrations that allege sales practice violations in accordance with 
current Form U-4 and U-5 reporting requirements. The Weintraub Letter 
stated that whether a customer-initiated arbitration is reportable on 
the Form U-4 or not has absolutely no connection to the seriousness of 
the underlying allegations, or the need for regulatory scrutiny.

[[Page 11432]]

IV. Discussion and Commission Findings

    After careful consideration, the Commission finds that the proposed 
rule change, as amended by Amendment No. 1, is consistent with the Act 
and the rules and regulations promulgated thereunder applicable to a 
registered securities association and, in particular, with the 
requirements of Section 15A(b)(6).\14\ Specifically, the Commission 
finds that approval of the proposed rule change is consistent with 
Section 15A(b)(6) of the Act in that it is 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.\15\
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    \14\ 15 U.S.C. 78o-3(b)(6).
    \15\ In approving this proposed rule change, the Commission has 
considered the proposal's impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).
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    The Commission believes that the proposed rule change will enhance 
NASD's regulatory efforts and investor protection mission. The proposal 
should improve NASD's ability to detect and prevent fraudulent and 
manipulative conduct and enable it to develop regulatory responses to 
problem areas at the earliest possible time. The Commission further 
believes the regulatory benefits of the proposed rule change outweigh 
the additional burden on members to file with NASD copies of the 
specified documents, and that the proposal minimizes that burden in 
that the rule requires only the filing of those complaints and claims 
most likely to reveal information that should assist NASD's regulatory 
mission.

V. Conclusion

    For the reasons discussed above, the Commission finds that the 
proposal is consistent with the Act and the rules and regulations 
thereunder.
    It is therefore ordered, pursuant to section 19(b)(2) of the Act, 
that the proposed rule change (SR-NASD-2002-112), as amended, be and 
hereby is approved.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-5572 Filed 3-7-03; 8:45 am]
BILLING CODE 8010-01-P