[Federal Register Volume 68, Number 107 (Wednesday, June 4, 2003)]
[Notices]
[Pages 33548-33554]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-13945]


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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47925; File No. SR-NASD-98-80]


Self-Regulatory Organizations; Order Granting Approval to the 
Proposed Rule Change and Notice of Filing and Order Granting 
Accelerated Approval to Amendment Nos. 3, 4, and 5 to the Proposed Rule 
Change by the National Association of Securities Dealers, Inc. to 
Establish a Two-Year Pilot Program Relating to the Issuance of 
Temporary Cease and Desist Orders

May 23, 2003.
    On October 28, 1998, 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\ Under its proposal, NASD establishes 
procedures to enable it to issue temporary cease and desist orders. The 
proposed rule change and Amendment No. 1 \3\ to the proposal were 
published for comment in the Federal Register on December 30, 1998.\4\ 
The Commission received five comment letters on the proposal.\5\ On May 
17, 1999, August 19,

[[Page 33549]]

2002, and April 15, 2003, the NASD filed Amendment Nos. 3, 4 and 5 
respectively.\6\ The Commission is approving the proposed rule change, 
and is publishing notice of, and granting accelerated approval to, 
Amendment Nos. 3, 4, and 5 to the proposed rule change.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ The first amendment to the proposal included changes to the 
evidentiary standard and the tenure of a temporary cease and desist 
order. See Letter from Alden S. Adkins, Senior Vice President and 
General Counsel, NASD, to Katherine A. England, Assistant Director, 
Division of Market Regulation (``Division''), Commission, dated 
December 15, 1998 (``Amendment No. 1'').
    \4\ Securities Exchange Act Release No. 40826 (December 22, 
1998), 63 FR 71984. On December 22, 1998, the NASD submitted a 
written extension of time for the public comment period as Amendment 
No. 2. The amendment is not subject to notice and comment. See 
Letter from Alden S. Adkins, Senior Vice President and General 
Counsel, NASD, to Katherine A. England, Assistant Director, 
Division, Commission, dated December 21, 1998.
    \5\ See Letters to Jonathan G. Katz, Secretary, Commission, 
from: Dan Jamieson, dated December 29, 1998 (``Jamieson Letter''); 
Sam Scott Miller, Orrick, Herrington & Sutcliffe, dated February 9, 
1999 (``Orrick Letter''); Peter C. Hildreth, President, North 
American Securities Administrators Association, Inc., dated March 2, 
1999 (``NASAA Letter''); Barbara M.G. Lynn, Chair, Section of 
Litigation, and James H. Cheek III, Chair, Section of Business Law, 
Ad Hoc Task Force of the American Bar Association's Sections of 
Litigation and Business Law, dated March 8, 1999 (``ABA Sections 
Letter''); and Lee B. Spencer, Chairman, Federal Regulation 
Committee, R. Gerald Baker, Chairman, Self Regulation & Supervisory 
Practices Committee, and James Tricarico, President, Compliance & 
Legal Division, Securities Industry Association, dated March 5, 1999 
(``SIA Letter'').
    \6\ See Letters to Katherine A. England, Assistant Director, 
Division, Commission, from Alden S. Adkins, Sr. Vice President and 
General Counsel, NASD Regulation, dated May 14, 1999 (``Amendment 
No. 3''), from Patrice M. Gliniecki, Vice President and Deputy 
General Counsel, NASD, dated August 16, 2002 (``Amendment No. 4''), 
and from Sarah J. Williams, Associate General Counsel, NASD, dated 
April 14, 2003 (``Amendment No. 5''). In Amendment No. 3, the NASD 
responded to comments and clarified the context in which the NASD 
would seek a permanent cease and desist order. In Amendment No. 4, 
the NASD (i) proposed that the rule change operate for a two-year 
period, unless extended or permanently adopted before the expiration 
of the two-year period; (ii) extended the minimum amount of time 
between service of notice of a hearing and the hearing from four to 
seven days; (iii) supplemented the discussion of the applicability 
of Section 19(d) of the Act to a temporary cease and desist order; 
(iv) made certain technical changes to the rule language to conform 
the proposal to current NASD practices; and (v) made further non-
substantive changes to the discussion of the proposed rule change. 
In Amendment No. 5, the NASD responded to comments and clarified the 
discussion of Rule 9850 in which a respondent may seek to have a 
temporary cease and desist order modified, set aside, limited or 
suspended and how a respondent may seek to challenge the order, and, 
in recognition of the U.S. Court of Appeals for the District of 
Columbia's denial of reconsideration of the SEC's decision against 
KPMG, LLP, the NASD provided clarifying discussion of the context in 
which a permanent cease and desist order would be sought.
---------------------------------------------------------------------------

I. Description of the Proposal

    NASD is proposing to establish, for a two-year period, procedures 
to enable NASD to issue temporary cease and desist orders. The proposal 
also would provide NASD with the authority to issue permanent cease and 
desist orders. Furthermore, the proposed rule change would grant NASD 
authority to initiate non-summary proceedings when temporary or 
permanent cease and desist orders are violated.

1. Due Process Procedures

    NASD recognizes that temporary cease and desist orders are powerful 
measures that should be used very cautiously. Consequently, the NASD 
states that it has designed the rules to ensure that the proceedings 
are used to address only the most serious types of misconduct and that 
the interests of respondents are protected. For example, to ensure that 
temporary cease and desist proceedings are used appropriately and that 
the decision to initiate a proceeding is made only at the highest staff 
levels, the proposed rules require the President of NASD Regulatory 
Policy and Oversight or the Executive Vice President for NASD 
Regulatory Policy and Programs to issue written authorization before 
NASD Department of Enforcement (``Enforcement'') or the Department of 
Market Regulation (``Market Regulation'') can institute a temporary 
cease and desist proceeding.
    In addition, NASD has proposed limiting use of this tool to what it 
views as the most serious offenses. Under the proposal, a temporary 
cease and desist proceeding can be initiated only with respect to 
alleged violations of certain sections of the securities laws and 
certain NASD rules.\7\
    Moreover, the proposed rules are based upon the rules that govern 
NASD disciplinary proceedings, with certain modifications made to 
reflect that temporary cease and desist proceedings are expedited 
proceedings. The NASD believes, therefore, that the proposed rules 
provide respondents with many procedural protections.
---------------------------------------------------------------------------

    \7\ The sections and rules are specified in proposed NASD Rule 
9810(a) and are limited to alleged violations of Section 10(b) of 
the Act and Rule 10b-5 thereunder; Rules 15g-1 through 15g-9 under 
the Act; or NASD Rules 2110, 2120, or 2330. The alleged violations 
of NASD rules for which a temporary cease and desist proceeding can 
be initiated are further limited. For NASD Rule 2110, which governs 
standards of commercial honor and just and equitable principles of 
trade, the alleged violations are limited to violations of Section 
17(a) of the Securities Act of 1933 or circumstances involving 
unauthorized trading or misuse or conversion of customer assets. For 
NASD Rule 2330, which governs members' use of customers' securities 
or funds, the alleged violations for which a temporary cease and 
desist proceeding can be initiated are limited to circumstances 
involving misuse or conversion of customer assets.
---------------------------------------------------------------------------

    In addition, once the initiation of a temporary cease and desist 
proceeding has been authorized, Enforcement or Market Regulation must 
file a notice with the Office of Hearing Officers and serve the 
respondent with a copy of the notice. The notice must set forth the 
rule or statutory provision the respondent is alleged to have violated, 
must include a declaration of facts that specifies the acts or 
omissions that constitute the alleged violation,\8\ and must include a 
proposed order that contains the required elements of a temporary cease 
and desist order.\9\ In addition, if Enforcement or Market Regulation 
has not already issued a complaint under NASD Rule 9211 against the 
respondent relating to the subject matter of the temporary cease and 
desist proceeding and alleging violations of the rule or statutory 
provisions specified in the notice initiating the temporary cease and 
desist proceeding, Enforcement or Market Regulation must serve the 
complaint with the notice initiating the temporary cease and desist 
proceeding.
---------------------------------------------------------------------------

    \8\ The declaration of facts must be signed by a person with 
knowledge of the facts contained in the declaration.
    \9\ The required elements of a temporary cease and desist order 
are set forth in proposed Rule 9840(b).
---------------------------------------------------------------------------

    Further, a hearing to determine whether a temporary cease and 
desist order should be issued must be held within 15 days after service 
of the notice (unless a Hearing Officer or Hearing Panelist is recused 
or disqualified or the parties agree to extend the 15-day period for 
good cause shown),\10\ and the respondent must be served with notice of 
the date, time, and location of the hearing not later than seven days 
before the hearing, unless the Hearing Officer orders otherwise.\11\
    Each hearing panel would be appointed by NASD's Chief Hearing 
Officer, and would be comprised of a hearing officer and two panelists. 
The two panelists would be selected from a roster of candidates that is 
comprised of current or former members of the National Adjudicatory 
Council, NASD Board of Governors, or NASD Regulation Board of 
Directors, and at least one panelist would have to be an associated 
person. A hearing officer, who is an attorney and an employee of NASD, 
would preside over each proceeding and would have the authority to do 
all things necessary and appropriate to discharge his or her duties as 
set forth in NASD Rule 9235.
---------------------------------------------------------------------------

    \10\ See Proposed Rule 9830(a).
    \11\ See Amendment No. 4.
---------------------------------------------------------------------------

    The proposed rules also set a specific standard that must be met 
before a hearing panel can issue an order. A hearing panel must find by 
a preponderance of the evidence that the alleged violation has 
occurred, which is the same evidentiary standard used in the underlying 
disciplinary proceeding. The hearing panel also must find that the 
violative conduct or the continuation thereof is likely to result in 
significant dissipation or conversion of assets or other significant 
harm to investors before completion of the disciplinary proceeding 
under the Rule 9200 and 9300 Series. The NASD states that this standard 
is designed to ensure

[[Page 33550]]

that a temporary cease and desist order cannot be issued for technical 
violations of rules; it can be issued only if the violative conduct or 
the continuation thereof is likely to result in significant dissipation 
or conversion of assets or other significant harm to investors before 
completion of the underlying disciplinary proceeding.
    A hearing panel must issue a written decision within ten days of 
receiving the transcript of the hearing, unless otherwise extended by 
the Hearing Officer with the consent of the Parties upon a showing of 
good cause. If a hearing panel decides that a temporary cease and 
desist order should be issued, the order must direct the respondent to 
cease and desist from violating a specific rule or statutory 
provisions, and, where applicable, to cease and desist from dissipating 
or converting assets or causing other harm to investors. The order also 
must set forth the alleged violation and the significant dissipation or 
conversion of assets or other significant harm to investors that is 
likely to result without the issuance of the order, and it must 
describe in reasonable detail the act or acts the respondent is to take 
or refrain from taking. A temporary cease and desist order issued to 
stop unauthorized trading, for example, would order a respondent to 
cease and desist from violating NASD Rule 2110 by directing the 
respondent to stop the practice of executing unauthorized trades for 
customers' accounts. The order would not instruct the respondent to 
cease and desist conducting business with customers.

2. Publicizing Issuance of a Temporary Cease and Desist Order

    If a hearing panel issues a temporary cease and desist order, NASD 
would publicize the issuance of the order, just as it publicizes the 
issuance of decisions in disciplinary proceedings that result in 
significant sanctions. Accordingly, the proposed rule change modifies 
IM-8310-2 to permit the release of this information. When issuance of a 
temporary cease and desist order is made public, if applicable, a 
statement would accompany the public release indicating that the 
decision could still be appealed to the SEC or that the appeal is 
pending.

3. Duration of Temporary Cease and Desist Orders

    Once a temporary cease and desist order has been issued, it will 
remain in effect until a decision is issued in the underlying 
disciplinary proceeding.\12\ In any disciplinary proceeding for which a 
temporary cease and desist order has been issued, every hearing shall 
be held and every decision shall be rendered at the earliest possible 
time.
---------------------------------------------------------------------------

    \12\ The Hearing Panel issuing the decision in the underlying 
disciplinary proceeding, however, may issue a permanent cease and 
desist order as part of any sanctions imposed pursuant to the 
underlying disciplinary proceeding. NASD will not stay the 
effectiveness of a permanent cease and desist order if the 
respondent appeals the decision in the underlying disciplinary 
proceeding.
---------------------------------------------------------------------------

    In addition, if a respondent believes the underlying disciplinary 
proceeding is not being conducted on an expedited basis, the respondent 
may seek to have the order modified, set aside, limited or suspended 
under proposed Rule 9850.\13\
---------------------------------------------------------------------------

    \12\ See Amendment No. 5.
---------------------------------------------------------------------------

    Further, the respondent may seek to challenge a temporary cease and 
desist order by filing an application for review with the SEC pursuant 
to Section 19 of the Act.\14\ A respondent's application to challenge 
an order, however, will not stay the effectiveness of the order, unless 
otherwise ordered by the Commission.\15\
---------------------------------------------------------------------------

    \14\ Section 19 of the Act provides for the appeal of final 
disciplinary sanctions imposed by self-regulatory organizations 
(``SROs'').
    \15\ See Amendment No. 5.
---------------------------------------------------------------------------

4. Enforcement of Cease and Desist Orders

    The proposed rule change provides the NASD with the authority to 
suspend or cancel a respondent's membership or association if it is 
found, after a proceeding pursuant to the Rule 9510 Series,\16\ that a 
respondent violated a temporary cease and desist order or a permanent 
cease and desist order. The proposed rule change provides that a 
proceeding to suspend or cancel a respondent's association or 
membership for violating an order cannot be initiated unless it is 
authorized in writing by the President of NASD Regulatory Policy and 
Oversight or the Executive Vice President for NASD Regulatory Policy 
and Programs. NASD believes that this provision ensures that decisions 
that can have a significant impact on a respondent are made only at the 
highest staff level.
---------------------------------------------------------------------------

    \16\ The Rule 9510 Series sets forth the procedures for summary 
and non-summary suspension, cancellation, bar, limitation, or 
prohibition. Pursuant to the proposed amendment to Rule 9511, the 
sanctions for a violation of a temporary or permanent cease and 
desist order are limited to suspension or cancellation of the 
membership of a member or the registration of a person.
---------------------------------------------------------------------------

    In addition, in any proceeding initiated pursuant to the Rule 9510 
Series to sanction a member or associated person for violating a 
temporary or permanent cease and desist order, NASD would be required 
to specifically identify in the notice initiating the proceeding the 
provision of the temporary or permanent cease and desist order that is 
alleged to have been violated, and the notice must contain a statement 
of facts specifying the alleged violation.

5. Two-Year Trial Period for Proposed Rule Change

    NASD recognizes that temporary cease and desist orders are new and 
powerful enforcement tools. Therefore, NASD believes the proposed rule 
change should be adopted on a trial basis, for a two-year period.\17\ 
At the expiration of the two-year period, NASD will review its 
experience with temporary cease and desist orders, and, if it believes 
the proposed rule change should be extended or adopted on a permanent 
basis, NASD will file a proposed rule change with the Commission 
seeking an extension or adoption. The proposed rule change will 
describe the staff's experience with the rule and its basis for seeking 
extension or adoption.
---------------------------------------------------------------------------

    \17\ See Amendment No. 4.
---------------------------------------------------------------------------

6. Context in Which Permanent Cease and Desist Orders Will Be Sought

    NASD staff does not anticipate seeking permanent cease and desist 
orders on a routine basis. Factors that NASD staff will consider in 
determining whether a permanent cease and desist order is appropriate 
include whether the party's violation was isolated or part of a 
pattern, whether the violation was flagrant and deliberate or merely 
technical in nature, and whether the party's business will present 
opportunities to engage in future violative conduct.\18\
---------------------------------------------------------------------------

    \18\ See Amendment No. 3. Cf. In Re KPMG, Exchange Act Release 
No. 43862 (Jan. 12, 2001), petition denied, 289 F.3d 109 (D.C. Cir. 
2002), where the SEC indicated that in determining whether a cease 
and desist order is appropriate, it would consider factors that 
provide some showing of risk of future violation, although such 
showing need not be as great as that required for the imposition of 
an injunction. The NASD staff states that nothing in this proposed 
rule change is intended to impose any standards on NASD staff in 
exercising its prosecutorial discretion in any particular matter, 
nor is it intended to require that Hearing Officers find that the 
standards advocated by the SEC in the KPMG litigation described 
above are met in imposing a permanent cease and desist order. See 
Amendment No. 5.
---------------------------------------------------------------------------

II. Summary of Comments

    The Commission received five comment letters on the proposed rule 
change.\19\ While all of the commenters applauded the NASD's objective 
of effective enforcement and fair regulation

[[Page 33551]]

of the securities industry, especially in the area of microcap 
securities fraud, only NASAA generally supported the proposal. The 
remaining commenters expressed a number of concerns regarding certain 
provisions of the proposed rule change. The comments submitted to the 
Commission, and the NASD's response to the comments, are summarized by 
issue below.
---------------------------------------------------------------------------

    \19\ See supra note 5.
---------------------------------------------------------------------------

1. Consistent with the Act

    NASAA stated its belief that the proposed rule change would be 
consistent with the provisions of the Act relating to member 
enforcement, promotion of fair practices and appropriate disciplinary 
actions by an SRO against its members.\20\ Three commenters disagreed, 
questioning the existence of statutory authority for a grant of 
temporary cease and desist power to NASD.\21\ Two of these commenters 
argued that this authority falls outside the definition of the term 
``sanction'' under Section 15A of the Act,\22\ with one of these 
commenters contending that temporary cease and desist orders are quasi-
judicial powers primarily intended to preserve the status quo pending a 
formal decision, not sanctions.
---------------------------------------------------------------------------

    \20\ See 15 U.S.C. 78o-3(b)(2), (6) and (7). See NASAA Letter, 
p. 2.
    \21\ See Jamieson Letter, p. 1, Orrick Letter, p. 5, and SIA 
Letter, p. 2.
    \22\ See Orrick Letter, p. 5, and SIA Letter, p. 2.
---------------------------------------------------------------------------

    NASD responded that several provisions of the Act provide SROs with 
the authority to issue temporary cease and desist orders. Section 
15A(b)(2) of the Act, among other things, requires that an association 
of brokers and dealers have the capacity to be able to carry out the 
purposes of the Act and to enforce compliance by its members and 
persons associated with its members with the Act, the rules and 
regulations thereunder, and the rules of the association. In addition, 
Section 15A(b)(6) of the Act requires that the rules of an association 
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. Finally, section 15A(b)(7) 
of the Act permits an association to sanction its members and persons 
associated with members through the imposition of any ``fitting 
sanction,'' and Section 15A(b)(8) of the Act, among other things, 
requires that the rules of an association, in general, provide a fair 
procedure for disciplining members and persons associated with members. 
The NASD contends, therefore, that the proposed rules are consistent 
with NASD's obligations under Section 15A(b)(2), (6), (7) and (8) of 
the Act because temporary cease and desist orders are fitting sanctions 
designed to stop violative conduct that is likely to cause significant 
dissipation or conversion of assets or other significant harm to 
investors.

2. Justification for Temporary Cease and Desist Powers

    The Commission specifically requested public comment on whether the 
NASD has sufficiently justified the need for temporary cease and desist 
powers. NASAA responded that the exponential growth of the securities 
markets and in the number of participants, particularly in the area of 
microcap securities, justifies the need for regulators to utilize all 
of the enforcement tools available, including the authority to issue a 
temporary cease and desist order.\23\ Three commenters contend, 
however, that the NASD has not sufficiently justified the need for the 
extraordinary power to issue temporary cease and desist orders.\24\ One 
commenter noted that no other SRO has ever requested temporary cease 
and desist authority and the Commission has used its cease and desist 
authority only once in eight years, thereby casting doubt on its 
usefulness as an enforcement tool.\25\ Two commenters questioned why 
the NASD could not refer any matter for which a temporary cease and 
desist order may be appropriate, along with the supporting 
documentation required to be recited in the notice and underlying 
complaint, to the Commission or appropriate state regulator.\26\
---------------------------------------------------------------------------

    \23\ See NASAA Letter, p. 3.
    \24\ See ABA Sections Letter, pgs. 6-7, Orrick Letter, p. 3, SIA 
Letter, p. 1.
    \25\ See ABA Sections Letter, p. 2.
    \26\ See Orrick Letter, p. 3, and SIA Letter, p.
---------------------------------------------------------------------------

    In response, the NASD stated that there is a clear need for an 
additional tool to stop members' or associated persons' misconduct 
where NASD believes significant dissipation or conversion of assets or 
other significant harm to investors is likely to occur before a 
disciplinary proceeding under NASD Rules 9100-9300 is concluded. The 
NASD notes that, under its current rules, it takes a minimum of four 
months to complete a disciplinary proceeding. Without a temporary cease 
and desist rule, NASD believes it has no immediate remedy to order 
cessation of egregious, ongoing violative conduct.
    With respect to its current authority, the NASD notes that it can 
summarily suspend a member or associated person only in the limited 
situations that are described in Section 15A(h)(3) of the Act, which do 
not include the types of situations NASD is attempting to address with 
the temporary cease and desist rules. Similarly, the NASD's non-summary 
suspension rules \27\ are designed to limit or stop a member's or 
associated person's ability to conduct business, whereas temporary 
cease and desist orders are designed to stop ongoing, violative conduct 
while an underlying disciplinary proceeding is being litigated.
---------------------------------------------------------------------------

    \27\ NASD Rules 9511(a)(2) and 9513.
---------------------------------------------------------------------------

    With respect to referring cases to the SEC or a state regulatory 
authority for prosecution where an emergency exists, NASD responds that 
its experience demonstrates that this is not a viable alternative to 
the proposed rule. Even though NASD, the SEC and other regulators have 
made great strides in coordinating their respective enforcement 
efforts, this is not a substitute for temporary cease and desist 
authority. The NASD believes that there are situations where it is in 
the best position to take immediate action, based on its preexisting 
investigation and access to case-specific information. In such 
situations, having to refer the case to another regulatory authority 
might result in unacceptable delay and would not be an efficient use of 
NASD's or other regulators' resources.

3. Scope of Predicate Violations

    The Commission specifically requested public comment on whether the 
scope of possible violations should be narrowed. NASAA responded that 
the scope of predicate violations should not be limited beyond the 
current restrictions in the proposed rule change because all of the 
possible violations raise concerns of fraudulent or manipulative 
conduct or the need for preservation of investor assets and funds.\28\
---------------------------------------------------------------------------

    \28\ See NASAA Letter, p. 2.
---------------------------------------------------------------------------

    Three commenters believe, however, that the predicate rule 
violations are overly broad. Two of these commenters argued that the 
predicate violations are broad enough to encompass virtually any 
alleged violation of securities laws and rules because the proposed 
violations include basic anti-fraud and manipulation provisions.\29\ 
One of the commenters argued that, if the purpose is primarily to 
protect against potential customer losses, the predicate violations 
should be limited to alleged violations involving microcap 
securities.\30\ In particular, this commenter felt that many alleged 
cases of unauthorized

[[Page 33552]]

trading and fraudulent markups are inappropriate for temporary cease 
and desist proceedings.
---------------------------------------------------------------------------

    \29\ See SIA Letter, p. 3 and Orrick Letter, p. 3.
    \30\ See ABA Sections Letter, pgs. 7-8.
---------------------------------------------------------------------------

    In response, the NASD noted that the proposal does not permit it to 
seek a temporary cease and desist order for any securities law 
violation because Rule 10b-5 under the Act requires a showing of fraud. 
In addition, the NASD believes the proposed rule only addresses the 
forms of misconduct most likely to result in rapid dissipation of 
investor funds, such as unauthorized trading and charging fraudulent, 
excessive markups.

4. Due Process

    While NASAA believes the proposed rule change contains sufficient 
safeguards to ensure adequate due process,\31\ Orrick contends that the 
timetable for a hearing on a temporary cease and desist order fails to 
give the respondent an adequate amount of time to prepare for the 
hearing.\32\ In response to Orrick's concerns, the NASD extended the 
minimum amount of time between service of notice of a hearing and the 
hearing date from four to seven days.\33\
---------------------------------------------------------------------------

    \31\ See NASAA Letter, p. 2.
    \32\ See Orrick Letter, p. 4.
    \33\ See Amendment No. 4.
---------------------------------------------------------------------------

5. Standard for Issuance of a Temporary Cease and Desist Order

    Two commenters believe that the ``preponderance of evidence'' 
standard, alone, is an inadequate basis for granting the extraordinary 
relief of a temporary cease and desist order.\34\ These commenters 
contend that there should be a finding that investors will be 
irreparably harmed or that their chances of subsequent recovery will be 
damaged by the standard disciplinary process. One commenter further 
believes that, in cases that do not involve potential investor losses, 
there should be a finding that there is a substantial likelihood that 
respondents will engage in future violations. Another commenter 
contends that the standard for issuance of a temporary cease and desist 
order invites arbitrary imposition of orders based on subjective 
interpretation of the standard.\35\
---------------------------------------------------------------------------

    \34\ See ABA Sections Letter, p. 9, and Orrick Letter, p. 4.
    \35\ See SIA Letter, p. 4.
---------------------------------------------------------------------------

    NASD responds that the ``likelihood of success'' standard is an 
inappropriate standard in the context of the other required showings, 
and that an irreparable harm standard would frustrate its attempt to 
stop ongoing fraudulent activity. Under such a standard, as long as a 
member could show that it is solvent and, at the time the disciplinary 
action is proceeding, could pay any potential arbitration or mediation 
awards, NASD would be unable to stop the ongoing fraudulent activity 
until the completion of the regular disciplinary proceeding. The NASD 
notes that the member's financial condition often significantly changes 
after the conclusion of the disciplinary proceeding. Finally, NASD 
believes that once it has been shown that the violative conduct or the 
continuation thereof is likely to result in significant dissipation or 
conversion of assets or other significant harm to investors, the 
potential harm to the respondent if an order is issued is overshadowed 
by the harm that is likely to occur if the order is not issued.

6. Review of Temporary Cease and Desist Order

    Two commenters noted that, unlike a temporary cease and desist 
order issued by the Commission, entry of a temporary cease and desist 
order issued by the NASD cannot be immediately appealed to a U.S. 
District Court. These commentators raised a concern about the ability 
of a respondent to appeal decisions issuing temporary cease and desist 
orders to the SEC because it was unclear whether temporary cease and 
desist orders are final disciplinary decisions of NASD.\36\
---------------------------------------------------------------------------

    \36\ See SIA Letter, p. 4, and Orrick Letter, p. 4.
---------------------------------------------------------------------------

    NASD responded that it believes a temporary cease and desist order 
should be considered a final disciplinary sanction of NASD under 
Section 19(d) of the Act and, therefore, should be appealable to the 
SEC as soon as the order is issued. A temporary cease and desist order 
is issued after notice and an opportunity for a hearing and upon a 
finding by a preponderance of the evidence that a violation of a 
statutory provision or rule has occurred. The temporary cease and 
desist order is an ``other fitting sanction'' under Section 15A(b)(7) 
of the Act because the order directs a respondent to cease violating a 
rule, to cease specified violative conduct, and, as appropriate, to 
cease and desist dissipating or converting assets. In addition, NASD 
notes that a temporary cease and desist order is immediately effective 
and enforceable and, moreover, a respondent that violates the terms of 
a temporary cease and desist order can have its membership or 
registration suspended or canceled.\37\
---------------------------------------------------------------------------

    \37\ NASD believes that its view that temporary cease and desist 
orders are subject to Commission review under Section 19(d) of the 
Act is further supported by the Commission's Order Accepting 
Jurisdiction issued In the Matter of the Application of Martin Lee 
Eng, Release No. 42962 (June 20, 2000). NASD states that the 
Commission found that it had jurisdiction to review NASD's 
imposition of a letter of caution in a disciplinary action because 
the letter of caution constituted a ``sanction'' under Section 
19(d). The NASD contends that the Commission based its finding of 
jurisdiction on the fact that the letter of caution resulted from a 
finding in a formal NASD disciplinary proceeding that the respondent 
violated an NASD rule and that the letter of caution had been 
reported to the Central Registration Depository (``CRD'').
---------------------------------------------------------------------------

7. Permanent Cease and Desist Authority

    One commenter strongly opposed the provision that allows the NASD 
to impose a permanent cease and desist order on the grounds that the 
industry and other interested parties had not been provided adequate 
notice of the provision.\38\ This commenter further stated that the 
NASD has not articulated either a purpose or need for permanent cease 
and desist powers, a compelling justification for the authority, the 
circumstances in which a permanent cease and desist order would be 
sought, or the evidentiary standard for issuance.
---------------------------------------------------------------------------

    \38\ See ABA Sections Letter, pgs. 17-19.
---------------------------------------------------------------------------

    The NASD responded that it did not highlight the issue of permanent 
cease and desist authority because it believes it already has the 
authority to issue them as an ``other fitting sanction'' under NASD 
Rule 8310. In response to the commenter's concerns, however, the NASD 
added language that it does not anticipate seeking permanent cease and 
desist orders on a routine basis, and listed the factors the NASD will 
consider in determining whether a permanent cease and desist order is 
appropriate.\39\
---------------------------------------------------------------------------

    \39\ See Amendment Nos. 3 and 5.
---------------------------------------------------------------------------

8. Collateral Consequences

    The Commission solicited comments on what impact, if any, the 
issuance of a temporary cease and desist order will have on other laws 
(other than the federal securities laws). Two commenters responded that 
the proposal did not contain any consideration of the potential 
collateral consequences of a temporary cease and desist order.\40\ 
These commenters contend that the NASD should evaluate the potential 
collateral consequences of the issuance of a temporary cease and desist 
order and report the results before Commission approval of the proposed 
rule change.
---------------------------------------------------------------------------

    \40\ See ABA Sections Letter, pgs. 14-15, and SIA Letter, pgs. 
4-5.
---------------------------------------------------------------------------

    NASD responded that it believes the use of temporary cease and 
desist authority will have limited collateral effects. The NASD 
reviewed the state securities laws and did not find any state statute 
that would mandate the denial, suspension, or revocation of a broker-
dealer's registration based on the

[[Page 33553]]

imposition of a cease and desist order by the NASD.\41\ In addition, 
the NASD does not believe that respondents will be collaterally 
estopped from contesting issues in customer disputes because 
arbitrators are not required to apply the same legal standards as the 
courts. Finally, the NASD stated that it would work with other 
regulators in coordinating the use of the cease and desist authority as 
an enforcement tool to help prevent regulators from ``piling'' 
sanctions on respondents.
---------------------------------------------------------------------------

    \41\ See Amendment No. 3.
---------------------------------------------------------------------------

III. Discussion

    The Commission finds that the proposed rule change is consistent 
with the provisions of Section 15A(b) \42\ of the Act, in general, and 
furthers the objectives of Section 15A(b)(6),\43\ in particular, 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.\44\ The 
Commission believes that the proposed rule change will protect 
investors and the public interest by improving the NASD's capability to 
prevent fraudulent and manipulative acts and practices, such as 
unauthorized trading in a customer's account.
---------------------------------------------------------------------------

    \42\ 15 U.S.C. 78o-3(b).
    \43\ 15 U.S.C. 78o-3(b)(6).
    \44\ In approving this rule, the Commission has considered the 
proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
---------------------------------------------------------------------------

    The Commission further finds that the proposed rule change is a 
``fitting sanction'' under Section 15A(b)(7) of the Act. One 
commenter's argument that temporary cease and desist orders are 
``quasi-judicial powers primarily intended to preserve the status quo'' 
and are ``not designed to function as sanctions'' is not accurate in 
this context. For the Commission to issue a temporary cease and desist 
order under Section 21C of the Act, it must only find that an alleged 
or threatened violation specified in the permanent cease-and-desist 
complaint is likely to result in significant dissipation or conversion 
of assets, significant harm to investors, or substantial harm to the 
public interest before completion of the permanent cease-and-desist 
proceeding. Thus, unlike a NASD issued temporary cease and desist 
order, the Commission does not have to find an actual violation before 
issuing a temporary cease and desist order.
    The NASD's proposal requires the NASD to prove its case by finding 
an actual violation by a preponderance of the evidence; in other words, 
there is a ruling on the merits. Accordingly, the imposition of a 
temporary cease and desist order can be a ``sanction'' for the finding 
of wrongdoing under Section 15A(b)(7) of the Act.
    The Commission further finds that the proposed rule change is 
consistent with Section 15A(b)(8) of the Act in that it provides for a 
fair procedure for disciplining members and persons associated with 
members. Temporary cease and desist proceedings are designed to occur 
on an expedited basis to help stop ongoing violations that are likely 
to result in a significant dissipation or conversion of assets or other 
significant harm to investors. In response to a commenter's concerns 
that there was inadequate time to prepare for a hearing, however, the 
NASD extended the minimum amount of time between service of notice of a 
hearing and the hearing date from four to seven days. This should give 
respondents sufficient time to prepare a response to the NASD's 
detailed allegations set forth in the notice.
    Commenters also believe that the ``preponderance of evidence'' 
standard, alone, is an inadequate basis for granting a temporary cease 
and desist order. The preponderance of the evidence standard, however, 
is consistent with the standard in civil actions generally, including 
Commission actions.\45\
---------------------------------------------------------------------------

    \45\ See Steadman v. Securities and Exchange Commission, 450 
U.S. 91 (1981); Seaton v. Securities and Exchange Commission, 670 
F.2d 309 (D.C. Cir. 1982).
---------------------------------------------------------------------------

    With respect to the ability of the NASD to impose a permanent cease 
and desist order, the NASD has articulated the factors it will consider 
before imposing an order. The Commission notes in In Re KPMG that, in 
determining whether a cease and desist order is appropriate, it would 
consider factors that provide some showing of risk of future violation, 
although such showing need not be as great as that required for the 
imposition of an injunction.\46\
---------------------------------------------------------------------------

    \46\ See also footnote 18.
---------------------------------------------------------------------------

IV. Accelerated Approval of Amendment Nos. 3, 4 and 5

    The Commission finds good cause for approving Amendment Nos. 3, 4 
and 5 prior to the thirtieth day after publication in the Federal 
Register. The Commission believes that NASD has responded adequately to 
commenters' concerns and suggestions by incorporating certain 
commenters' recommendations into the proposed rule language and 
discussion in Amendment Nos. 3, 4 and 5, and by explaining why it was 
not incorporating others. Further, the Commission notes that there were 
no language changes to the rule in Amendment Nos. 3 and 5, and the only 
substantive changes to the rule language in Amendment No. 4 are the 
implementation of the proposal relating to the temporary cease and 
desist orders as a two-year pilot program and the extension of the 
minimum amount of time between the notice of the hearing and the 
hearing date. Both of these changes were made in response to 
commenters' concerns. Thus, the substance of the proposed rule change 
was provided in the Notice and has been the subject of a full comment 
period. Accordingly, the Commission believes that there is good cause, 
consistent with Section 19(b) of the Act,\47\ to approve Amendment Nos. 
3, 4 and 5 to the proposal on an accelerated basis.
---------------------------------------------------------------------------

    \47\ 15 U.S.C. 78f(b) and 78s(b).
---------------------------------------------------------------------------

V. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment Nos. 3, 4 and 5, including whether the 
proposed rule change, as amended, 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 at the Commission's Public 
Reference Room. Copies of the 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-98-80 and should be 
submitted by June 25, 2003.

VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (SR-NASD-98-80) as amended by Amendment 
No. 1 be, and it hereby is, approved, and that Amendment Nos. 3, 4 and 
5 to the proposed rule change be, and they hereby are, approved on an 
accelerated basis. With respect to the NASD's authority to issue a 
temporary cease and desist order, it is hereby approved on an 
accelerated basis as a two-year pilot

[[Page 33554]]

program. The NASD will publish a Notice to Members announcing the 
effectiveness of the temporary cease and desist order pilot. The pilot 
will expire two years after the date of publication of Notice to 
Members.\48\
---------------------------------------------------------------------------

    \48\ See Amendment No. 4.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\49\
---------------------------------------------------------------------------

    \49\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Jill M. Peterson,
Assistant Secretary.
[FR Doc. 03-13945 Filed 6-3-03; 8:45 am]
BILLING CODE 8010-01-P