[Federal Register Volume 68, Number 156 (Wednesday, August 13, 2003)]
[Notices]
[Pages 48421-48429]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-20601]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48298; File No. SR-NASD-2002-162]


Self-Regulatory Organizations; Notice of Filing of Amendment Nos. 
1 and 2 to Proposed Rule Change by National Association of Securities 
Dealers, Inc. Relating to Supervisory Control Amendments

August 7, 2003.
    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 November 4, 2002, the National Association of Securities Dealers, 
Inc. (``NASD''), filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change. The proposed rule 
change was published for comment in the Federal Register on November 
27, 2002.\3\ On August 5, 2003, the NASD filed Amendment No. 1 to the 
proposed rule change.\4\ On August 7, 2003, the NASD filed Amendment 
No. 2 to the proposed rule change.\5\ Amendment Nos. 1 and 2 are 
described in Items I, II, and III below, which Items have been prepared 
by NASD. The Commission is publishing this notice to solicit comments 
on Amendment Nos. 1 and 2 to the proposed rule change from interested 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 46859 (November 20, 
2002), 67 FR 70990.
    \4\ Amendment No. 1 replaces and supercedes the original filing 
in its entirety.
    \5\ See letter from Patrice M. Gliniecki, Senior Vice President 
and Deputy General Counsel, NASD, to Katherine A. England, Assistant 
Director, Division of Market Regulation, Commission, dated August 7, 
2003 (``Amendment No. 2''). In Amendment No. 2, among other things, 
NASD clarified the term ``heightened supervision'' as the term is 
used in proposed NASD Rule 3012, and the term ``heightened 
inspection procedures'' as that term is used in proposed NASD Rule 
3010.

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[[Page 48422]]

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

    NASD is proposing to adopt new NASD Rule 3012 and amend other rules 
regarding the supervisory and supervisory control procedures of member 
firms. Below is the amended text of the proposed rule change. Proposed 
new language is in italics; proposed deletions are in brackets.
* * * * *
2510. Discretionary Accounts
    (a) through (c) No change.
(d) Exceptions
    This Rule shall not apply to:
    (1) discretion as to the price at which or the time when an order 
given by a customer for the purchase or sale of a definite amount of a 
security shall be executed, except that the authority to exercise time 
and price discretion will be considered to be in effect only until the 
end of the business day on which the customer granted such discretion, 
absent a specific, written contrary indication signed and dated by the 
customer. This limitation shall not apply to time and price discretion 
exercised for orders effected with or for an institutional account, as 
defined in Rule 3110(c)(4), pursuant to valid Good-Till-Cancelled 
instructions issued on a ``not-held'' basis;
    (2) No Change.
    Any exercise of time and price discretion must be reflected on the 
customer order ticket.
* * * * *
3010. Supervision
(a) Supervisory System
    Each member shall establish and maintain a system to supervise the 
activities of each registered representative and associated person that 
is reasonably designed to achieve compliance with applicable securities 
laws and regulations, and with applicable NASD Rules [the Rules of this 
Association]. Final responsibility for proper supervision shall rest 
with the member. A member's supervisory system shall provide, at a 
minimum, for the following:
    (1) through (7) No change.
    [(8) Each member shall designate and specifically identify to the 
Association one or more principals who shall review the supervisory 
system, procedures, and inspections implemented by the member as 
required by this Rule and take or recommend to senior management 
appropriate action reasonably designed to achieve the member's 
compliance with applicable securities laws and regulations, and with 
the Rules of this Association.]
    (b) No change.
(c) Internal Inspections
    (1) Each member shall conduct a review, at least annually, of the 
businesses in which it engages, which review shall be reasonably 
designed to assist in detecting and preventing violations of, and 
achieving compliance with, applicable securities laws and regulations, 
and with applicable NASD rules [the Rules of this Association]. Each 
member shall review the activities of each office, which shall include 
the periodic examination of customer accounts to detect and prevent 
irregularities or abuses [and at least an annual inspection of each 
office of supervisory jurisdiction].
    (A) Each member shall inspect at least annually every office of 
supervisory jurisdiction and any branch office that supervises one or 
more non-branch locations. [Each branch office of the member shall be 
inspected according to a cycle which shall be set forth in the firm's 
written supervisory and inspection procedures.]
    (B) Each member shall inspect at least every three years every 
branch office that does not supervise one or more non-branch locations. 
In establishing how often to inspect each non-supervisory branch office 
[such cycle], the firm shall [give consideration to] consider whether 
the nature and complexity of the securities activities for which the 
location is responsible, the volume of business done, and the number of 
associated persons assigned to the location require the non-supervisory 
branch office to be inspected more frequently than every three years. 
The non-supervisory branch office examination cycle and an explanation 
of the factors the member used in determining the frequency of the 
examinations in the cycle shall be set forth in the member's written 
supervisory and inspection procedures.
    (C) Each member shall inspect on a regular periodic schedule every 
non-branch location. In establishing such schedule, the firm shall 
consider the nature and complexity of the securities activities for 
which the location is responsible and the nature and extent of contact 
with customers. The schedule and an explanation regarding how the 
member determined the frequency of the examination schedule shall be 
set forth in the member's written supervisory and inspection 
procedures.
    Each member shall retain a written record of the dates upon which 
each review and inspection is conducted.
    (2) An office inspection and review by a member pursuant to 
paragraph (c)(1) must be reduced to a written report and kept on file 
by the member for a minimum of three years, unless the inspection is 
being conducted pursuant to paragraph (c)(1)(C) and the regular 
periodic schedule is longer than a three-year cycle, in which case the 
report must be kept on file at least until the next inspection report 
has been written. The written inspection report must also include, 
without limitation, the testing and verification of the member's 
policies and procedures, including supervisory policies and procedures 
in the following areas:
    (A) Safeguarding of customer funds and securities;
    (B) Maintaining books and records;
    (C) Supervision of customer accounts serviced by branch office 
managers;
    (D) Transmittal of funds between customers and registered 
representatives and between customers and third parties;
    (E) Validation of customer address changes; and
    (F) Validation of changes in customer account information.
    (3) An office inspection by a member pursuant to paragraph (c)(1) 
may not be conducted by the branch office manager or any person within 
that office who has supervisory responsibilities or by any individual 
who is supervised by such person(s). A member must have in place 
procedures that are reasonably designed to provide heightened office 
inspections if the person conducting the inspection reports to the 
branch office manager's supervisor or works in an office supervised by 
the branch manager's supervisor and the branch office manager generates 
20% or more of the income of the branch office manager's supervisor. 
For the purposes of this subsection only, the term ``heightened 
inspection'' shall mean those inspection procedures that are designed 
to avoid conflicts of interest that serve to undermine complete and 
effective inspection because of the economic, commercial, or financial 
interests that the branch manager's supervisor holds in the associated 
persons and businesses being inspected.
* * * * *
(g) Definitions
    (1) No change.
    (2) (A) ``Branch Office'' means any location identified by any 
means to the public or customers as a location at which the member 
conducts an investment banking or securities business, excluding:
    (A) through (D) renumbered as (i) through (iv).

[[Page 48423]]

    (B) Notwithstanding the exclusions provided in paragraph (2)(A), 
any location that is responsible for supervising the activities of 
persons associated with the member at one or more non-branch locations 
of the member is considered to be a branch office.
    (3) No change.

3012. Supervisory Control System

(a) General Requirements

    (1) Each member shall designate and specifically identify to NASD 
one or more principals who shall establish, maintain, and enforce a 
system of supervisory control policies and procedures that (A) test and 
verify that the member's supervisory procedures are reasonably designed 
with respect to the activities of the member and its registered 
representatives and associated persons, to achieve compliance with 
applicable securities laws and regulations, and with applicable NASD 
rules and (B) create additional or amend supervisory procedures where 
the need is identified by such testing and verification. The designated 
principal or principals must submit to the member's senior management 
no less than annually, a report detailing each member's system of 
supervisory controls, the summary of the test results and significant 
identified exceptions, and any additional or amended supervisory 
procedures created in response to the test results.
    (2) The establishment, maintenance, and enforcement of written 
supervisory control policies and procedures pursuant to paragraph (a) 
shall include:
    (A) procedures that are reasonably designed to review and supervise 
the customer account activity conducted by the member's branch office 
mangers, sales managers, regional or district sales managers, or any 
person performing a similar supervisory function. A person who is 
senior to the producing manager must perform such supervisory reviews. 
However, if a member does not conduct a public business, or has a 
capital requirement of $5,000 or less, or employs 10 or fewer 
representatives, and its business is conducted in a manner necessitated 
by a limitation of resources that includes fewer than two layers of 
supervisory personnel, a person in another office who is in the same or 
similar position to the producing manager may conduct the supervisory 
reviews, provided that the person in the same or similar position does 
not have supervisory responsibility over the activity being reviewed, 
reports to his supervisor his supervision and review of the producing 
manager, and has not performed a review of the producing manager in the 
last two years;
    (B) procedures that are reasonably designed to review and monitor 
the following activities:
    (i) all transmittals of funds (e.g., wires or checks, etc.) or 
securities from customers and third party accounts (i.e., a transmittal 
that would result in a change of beneficial ownership); from customer 
accounts to outside entities e.g., banks, investment companies, etc.); 
from customer accounts to locations other than a customer's primary 
residence (e.g., post office, ``in care of'' accounts, alternate 
address, etc.); and between customers and registered representatives, 
including the hand-delivery of checks;
    (ii) customer changes of address and the validation of such changes 
of address; and
    (iii) customer changes of investment objectives and the validation 
of such changes of investment objectives.
    The policies and procedures established pursuant to paragraph 
(a)(2)(B) must include a means or method of customer confirmation, 
notification, or follow-up that can be documented; and
    (C) procedures that are reasonably designed to provide heightened 
supervision over the activities of each producing manager who is 
responsible for generating 20% or more of the income of the producing 
manager's supervisor. For the purposes of this subsection only, the 
term ``heightened supervision'' shall mean those supervisory procedures 
that evidence supervisory activities that are designed to avoid 
conflicts of interest that serve to undermine complete and effective 
supervision because of the economic, commercial, or financial interests 
that the supervisor holds in the associated persons and businesses 
being supervised.

(b) Dual Member

    Any member in compliance with substantially similar requirements of 
the New York Stock Exchange, Inc. shall be deemed to be in compliance 
with the provisions of this Rule.
* * * * *
3110. Books and Records
    (a) through (b) No change.
(c) Customer Account Information
    (1) through (3) No change.
    (4) For purposes of this Rule [and], and Rule 2510 the term 
``institutional account'' shall mean the account of:
    (A) through (C) No change.

(d) Changes in Account Name or Designation

    Before any customer order is executed, there must be placed upon 
the memorandum for each transaction, the name or designation of the 
account (or accounts) for which such order is to be executed. No change 
in such account name(s) (including related accounts) or designation(s) 
(including error accounts) shall be made unless the change has been 
authorized by a member or a person(s) designated under the provisions 
of NASD rules. Such person must, prior to giving his or her approval of 
the account designation change, be personally informed of the essential 
facts relative thereto and indicate his or her approval of such change 
in writing on the order or other similar record of the member. The 
essential facts relied upon by the person approving the change must be 
documented in writing and preserved for a period of not less than three 
years, the first two years in an easily accessible place, as the term 
``easily accessible place'' is used in SEC Rule 17a-4.
    For purposes of this paragraph (d), a person(s) designated under 
the provisions of NASD rules to approve account name or designation 
changes must pass a qualifying principal examination appropriate to the 
business of the firm.
* * * * *
IM-3110. Customer Account Information
    (a) through (h) No Change.

(i) Holding of Customer Mail

    Upon the written instructions of a customer, a member may hold mail 
for a customer who will not be at his or her usual address for the 
period of his or her absence, but (A) not to exceed two months if the 
member is advised that such customer will be on vacation or traveling 
or (B) not to exceed three months if the customer is going abroad.
* * * * *
9610. Application
(a) Where To File
    A member seeking an exemption from Rule 1021, 1022, 1070, 2210, 
2320, 2340, 2520, 2710, 2720, 2810, 2850, 2851, 2860, Interpretive 
Material 2860-1, 3010(b)(2), 3020, 3210, 3230, 3350, 8211, 8212, 8213, 
11870, or 11900, Interpretive Material 2110-1, or Municipal Securities 
Rulemaking Board Rule G-37 shall file a written application with the 
appropriate department or staff of NASD [the Association] and provide a 
copy of the

[[Page 48424]]

application to the Office of General Counsel of NASD [Regulation].
    (b) through (c) No Change.
* * * * *

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

    In its filing with the Commission, NASD included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the original proposed rule 
change. The text of these statements may be examined at the places 
specified in Item IV below. NASD 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

1. Purpose
    a. Background. On November 4, 2002, NASD filed with the Commission 
proposed rule change SR-NASD-2002-162. The rule change proposed new 
NASD Rule 3012 to require members to develop general and specific 
supervisory control procedures that independently test and verify and 
modify, where necessary, the members' supervisory procedures. In 
addition, the rule change proposed amendments to: (1) NASD Rule 3010(c) 
to require that office inspections be conducted by independent persons 
and include, at a minimum, the testing and verification of certain 
supervisory procedures; \6\ (2) NASD Rule 3110 to expand upon a 
members' supervisory and recordkeeping requirements with respect to 
changes in customer account name or designation in connection with 
order executions; (3) NASD IM-3110 to provide guidance regarding when a 
member may hold mail for a customer who will be absent for a period of 
time; (4) NASD Rule 2510(d) to clarify the time limit on time-and-price 
discretionary authority; and (5) NASD Rule 9610 to incorporate into 
NASD Procedural Rules the ability of members to request an exemption 
from amended NASD Rule 3010(c).
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    \6\ NASD has filed with the Commission a separate proposed rule 
change to Rule 3010(g)(2) that addresses other situations where a 
location of a member may be considered a ``branch office'' and 
affects only the content of what is now being renumbered as 
paragraph (2)(A) of Rule 3010(g). See SR-NASD-2003-104. If the SEC 
approves the proposed rule change in No. SR-NASD-2003-104 prior to 
approving the rule change proposed in this filing, NASD will file an 
amendment to this proposal updating the rule language in the new 
Rule 3010(g)(2). Alternatively, if the SEC approves the proposed 
rule change in this rule filing prior to approving the proposed rule 
change in SR-NASD-2003-104, NASD will file an amendment to SR-NASD-
2003-104 reflecting the changes set forth in this filing.
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    The Commission received 72 comment letters in response to the 
Federal Register publication of SR-NASD-2002-162.\7\ The comments 
submitted to the Commission are summarized and responded to by issue 
below. Additional proposed rule changes are also discussed below.
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    \7\ List of comment letters has been prepared as Exhibit 2. 
Exhibit 2 is available in the Commission's Public Reference Room.
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    b. General Comments on the Rule Change. Many commenters stated that 
the effective enforcement of existing supervisory rules should be 
sufficient to protect investors.\8\ These commenters frequently added 
that they viewed the proposed rules as an overreaction to the 
Gruttadauria case, which involved a producing branch manager who 
misappropriated millions of dollars in customer funds over a 15-year 
period. The commenters stated that the Gruttadauria case was not a 
result of inadequate supervisory systems but, instead, was a case of a 
single individual intent on defrauding customers.\9\
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    \8\ 1st Global, Inc., Stephen Batman, CEO (12/18/02); AIG 
Advisor Group, Inc., Bridget M. Gaughan, EVP (12/30/02); Cambridge 
Investment Research, Inc., Terry L. Lister, General Counsel (12/20/
02); Charles Schwab & Co., Inc., Selwyn J. Noteliovitz, SVP (2/25/
03); Clark/Bardes Financial Services, Inc., Kevin Ballou, President 
(3/17/03); Commonwealth Financial Network, Peter T. Wheeler, 
President (12/17/02); CUNA Brokerage Services, Inc., Marcia L. 
Martin, President (12/19/02); FFP Securities, Inc., Craig A. 
Junkins, President/CEO (12/18/02); First Allied Securities, Inc., 
Adam Antoniades, President/COO (12/18/02); Invest Financial 
Corporation, Lynn R. Niedermeier, President/CEO (12/17/02); 
Investment Centers of America, Inc., Greg Gunderson, President (12/
16/02); Lesko Securities, Inc., Charles Lesko, Jr., President (12/
18/02); Mutual Service Corp., Dennis S. Kaminski, EVP/CAO (12/18/
02); MWA Financial Services, Robert M. Roth, President (12/18/02); 
Princor Financial Services Corp., Minoo Spellerberg, Compliance 
Officer (12/16/02); Rhodes Securities, Inc., Sandra T. Masek, EVP/
COO (12/17/02); Securities America, Inc., Bryan R. Hill, President 
(12/16/02); Securities Industry Association, Self-Regulation and 
Supervisory Practices Group, Christopher R. Franke, Chairman--Self-
Regulation and Supervisory Practices Committee (12/18/02); 
Transamerica Financial Advisors, Inc., Sandy Brown, President/COO 
(12/16/02); United Planners' Financial Services of America, Thomas 
H. Oliver, President, CEO, (12/13/02); USAllianz Securities, Inc., 
Michael D. Burns, CCO (12/16/02); Waterstone Financial Group, Inc., 
Thomas A. Hopkins, Chairman, (12/16/02); World Group Securities, 
Inc., Leesa M. Easley, Chief Legal Officer (12/19/02).
    \9\ Id.; see also Associated Securities Corp., Neal K. Nakagiri, 
President/CEO (12/19/02); AXA Advisors, John M. Lefferts, President 
(12/18/02); Cadaret, Grant & Co., Arthur F. Grant, President (12/17/
02); Commonwealth Financial Network, Peter T. Wheeler, President 
(12/17/02); Equity Services, Inc., Gregory D. Teese, VP (12/18/02); 
Linsco/Private Ledger, Corp., James F. McGuire, SVP & CCO (1/16/03); 
National Society of Compliance Professionals, Inc., Joan Hinchman, 
Executive Director, President & CEO (1/8/03); Pacific Select 
Distributors, Inc., John L. Dixon, President (12/18/02).
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    While NASD understands industry concerns that regulators not 
overreact to one case of violative conduct, NASD does not view the 
proposed rule change as a reaction to any particular legal or 
regulatory event. Rather, NASD believes that the proposed rule change 
is designed to enhance the current rules and examination efforts by 
specifically requiring members to establish adequate supervisory 
control systems. NASD also believes that the proposed rule change will 
strengthen its ability to fulfill its ongoing obligation to protect 
investors.
    A majority of the commenters also suggested that implementing the 
proposed rule change would require firms to hire a large number of 
additional personnel to conduct the supervisory activities required by 
the proposed rules, thereby placing a significant financial burden on 
firms.\10\ Many commenters believed that this cost would destroy the 
business model of independent contractors located in

[[Page 48425]]

small branch offices.\11\ One commenter suggested that the proposed 
rule change be adopted in the form of ``principles for effective 
supervision'' or ``best practices'' that could be tailored to various 
business models rather than rules that would apply to all firms.\12\
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    \10\ 1st Global, Inc., Stephen Batman, CEO (12/18/02); AIG 
Advisor Group, Inc., Bridget M. Gaughan, EVP (12/30/02); American 
Express Financial Advisors, Inc., Beth E. Weimer, VP & CCO (1/17/
03); Cambridge Investment Research, Inc., Terry L. Lister, General 
Counsel (12/20/02); Clark/Bardes Financial Services, Inc., Kevin 
Ballou, President (3/17/03); CUNA Brokerage Services, Inc., Marcia 
L. Martin, President (12/19/02); Equity Services, Inc., Gregory D. 
Teese, VP (12/18/02); FFP Securities, Inc., Craig A. Junkins, 
President/CEO (12/18/02); Financial Network Investment Corp., Jack 
R. Handy, Jr., President (12/13/02); First Allied Securities, Inc., 
Adam Antoniades, President/COO (12/18/02); IFG Network Securities, 
Inc., R. Jack Conley, President/CEO (12/18/02); Invest Financial 
Corporation, Lynn R. Niedermeier, President/CEO (12/17/02); 
Investment Centers of America, Inc., Greg Gunderson, President (12/
16/02); John Hancock Financial Services, Inc., Robert H. Watts, SVP/
CCO, (12/17/02) & Another Letter (1/16/03) (additional comments); 
Lesko Securities, Inc., Charles Lesko, Jr., President (12/18/02); 
Linsco/Private Ledger, Corp., James F. McGuire, SVP & CCO (1/16/03); 
Locust Street Securities, Inc., Jacqueline C. Conley, VP, Compliance 
(12/13/02); Multi-Financial Securities Corp., Patrick H. McEvoy, 
President/CEO (12/16/02); Mutual Service Corp., Dennis S. Kaminski, 
EVP/CAO (12/18/02); MWA Financial Services, Robert M. Roth, 
President (12/18/02); PrimeVest Financial Services, Inc., Kevin P. 
Maas, VP, (No Date on Letter); Princor Financial Services Corp., 
Minoo Spellerberg, Compliance Officer (12/16/02); Rhodes Securities, 
Inc., Sandra T. Masek, EVP/COO (12/17/02); Securities America, Inc., 
Bryan R. Hill, President (12/16/02); Transamerica Financial 
Advisors, Inc., Sandy Brown, President/COO (12/16/02); United 
Planners' Financial Services of America, CEO (12/13/02); USAllianz 
Securities, Inc., Michael D. Burns, CCO (12/16/02); Vestax 
Securities Corp., R. Jack Conley, President/CEO (12/17/02); 
Washington Square Securities, Inc., Tom K. Rippberger, VP/CCO (No 
Date on Letter); Waterstone Financial Group, Inc., Thomas A. 
Hopkins, Chairman, (12/16/02).
    \11\ Associated Securities Corp., Neal K. Nakagiri, President/
CEO (12/19/02); AXA Advisors, John M. Lefferts, President (12/18/
02); Mutual Service Corp., Dennis S. Kaminski, EVP/CAO (12/18/02); 
Pacific Select Distributors, Inc., John L. Dixon, President (12/18/
02); Securities Industry Association, Self-Regulation and 
Supervisory Practices Group, Christopher R. Franke, Chairman--Self-
Regulation and Supervisory Practices Committee (12/18/02); Woodbury 
Financial Services, Inc., Michael G. Brennan, Associate Counsel/
Assistant Secretary (12/18/02).
    \12\ 1st Global, Inc., Stephen Batman, CEO (12/18/02); 
Securities Industry Association, Self-Regulation and Supervisory 
Practices Group, Christopher R. Franke, Chairman--Self-Regulation 
and Supervisory Practices Committee (12/18/02).
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    NASD does not agree that the proposed rule change should be adopted 
in the form of ``principles or best practices.'' NASD believes that the 
degree of authority carried by the proposed rules is necessary to 
encourage the conduct intended by the rule changes. However, as 
discussed in detail below, NASD agrees that greater flexibility is 
needed in certain respects to account for variations in members' 
business models.
    i. Comments on Proposed NASD Rule 3012 (Supervisory Controls) and 
Proposed Changes. As originally proposed, NASD Rule 3012 requires that 
each member establish supervisory control procedures that (a) test and 
verify that the member's supervisory procedures are reasonably designed 
to comply with the federal securities laws and regulations and NASD 
rules and (b) amend the supervisory procedures where testing and 
verification identifies the need to do so. NASD Rule 3012 also requires 
that the supervisory control procedures be performed by persons who are 
``independent'' from those activities being tested and verified and the 
persons who directly supervise those activities.
    In addition, NASD Rule 3012 requires that written policies and 
procedures to administer the supervisory controls specifically address 
transmittals of funds between accounts, changes of customers' 
addresses, and changes in customers' investment objectives. These 
designated policies and procedures must include a means or method of 
customer confirmation, notification, or follow-up that can be 
documented.
    Many commenters requested clarification regarding who would be 
sufficiently ``independent'' to perform the supervisory control 
procedures required under proposed NASD Rule 3012.\13\ A large number 
of commenters contended that restricting senior supervisory personnel 
from performing and/or overseeing the review of a firm's supervisory 
control procedures could compromise the quality of the review. The 
commenters stated that the alternative approach of assigning someone 
from another division of the firm, such as Marketing or Operations, to 
perform the review could result in a supervisory review that is less 
sensitive to compliance requirements.\14\ At least one commenter stated 
that the ``independence'' requirement in NASD Rule 3012 appears to 
refer to someone outside of the firm.\15\
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    \13\ 1st Global, Inc., Stephen Batman, CEO (12/18/02); AIG 
Advisor Group, Inc., Bridget M. Gaughan, EVP (12/30/02); Cambridge 
Investment Research, Inc., Terry L. Lister, General Counsel (12/20/
02); Charles Schwab & Co., Inc., Selwyn J. Noteliovitz, SVP (2/25/
03); Clark/Bardes Financial Services, Inc., Kevin Ballou, President 
(3/17/03); Commonwealth Financial Network, Peter T. Wheeler, 
President (12/17/02); CUNA Brokerage Services, Inc., Marcia L. 
Martin, President (12/19/02); FFP Securities, Inc., Craig A. 
Junkins, President/CEO (12/18/02); First Allied Securities, Inc., 
Adam Antoniades, President/COO (12/18/02); Invest Financial 
Corporation, Lynn R. Niedermeier, President/CEO (12/17/02); 
Investment Centers of America, Inc., Greg Gunderson, President (12/
16/02); Lesko Securities, Inc., Charles Lesko, Jr., President (12/
18/02); Midland National Life Insurance, P.M. Phalen, Assistant Vice 
President (12/17/02); MML Investors Services, Inc., Michael L. 
Kerley, VP/Chief Legal Officer (12/17/02); Mutual Service Corp., 
Dennis S. Kaminski, EVP/CAO (12/18/02); MWA Financial Services, 
Robert M. Roth, President (12/18/02); Princor Financial Services 
Corp., Minoo Spellerberg, Compliance Officer (12/16/02); Rhodes 
Securities, Inc., Sandra T. Masek, EVP/COO (12/17/02); Securities 
America, Inc., Bryan R. Hill, President (12/16/02); Securities 
Industry Association, Self-Regulation and Supervisory Practices 
Group, Christopher R. Franke, Chairman `` Self-Regulation and 
Supervisory Practices Committee (12/18/02); United Planners'' 
Financial Services of America, President, CEO (12/13/02); USAllianz 
Securities, Inc., Michael D. Burns, CCO (12/16/02); Waterstone 
Financial Group, Inc., Thomas A. Hopkins, Chairman, (12/16/02); 
World Group Securities, Inc., Leesa M. Easley, Chief Legal Officer 
(12/19/02).
    \14\ 21st Century Financial Services, Inc., Charles Mazziotti, 
President (12/17/02); AIG Advisor Group, Inc., Bridget M. Gaughan, 
EVP (12/30/02); Brookstreet Securities Corporation, Stanley C. 
Brooks, President, CEO (12/4/02); Cambridge Investment Research, 
Inc., Terry L. Lister, General Counsel (12/20/02); CUNA Brokerage 
Services, Inc., Marcia L. Martin, President (12/19/02); Duerr 
Financial Corporation, William Partin, President (11/27/02); Eagle 
One Investments, LLC, Steven J. Svoboda, President (12/16/02); 
Financial Network Investment Corp., Jack R. Handy, Jr., President 
(12/13/02); Financial Northeastern Companies, Dominick Del Duca, CCO 
(12/12/02); First Allied Securities, Inc., Adam Antoniades, 
President/COO (12/18/02); First Heartland Capital, Inc., Julius J. 
Anderson, Vice President (12/27/02); FMN Capital Corporation, David 
W. Schofield, Director of Operations and Compliance 12/18/02); IFG 
Network Securities, Inc., R. Jack Conley, President/CEO (12/18/02); 
Invest Financial Corporation, Lynn R. Niedermeier, President/CEO 
(12/17/02); Investment Centers of America, Inc., Greg Gunderson, 
President (12/16/02); Iron Street Securities Inc., Robert L. Hamman, 
President (12/24/02); JKR & Company, Inc., J. Kemp Richardson, 
President (12/10/02); John Hancock Financial Services, Inc., Robert 
H. Watts, SVP/CCO, (12/17/02) & Another Letter (1/16/03) (additional 
comments); Kyson & Co., Kao Sheng Lin, President (11/25/02); Lesko 
Securities, Inc., Charles Lesko, Jr., President (12/18/02); Liberty 
Life Securities, LLC, John T. Treece, President (1/15/03); Locust 
Street Securities, Inc., Jacqueline C. Conley, VP, Compliance (12/
13/02); Main Street Securities, LLC, David L. Meckenstock, VP/CCO 
(12/13/02); Monitor Capital, Inc., Hsiao-wen, President (11/25/02); 
Multi-Financial Securities Corp., Patrick H. McEvoy, President/CEO 
(12/16/02); Mutual Securities, Inc., William L. Sabol, President 
(11/26/02); Mutual Service Corp., Dennis S. Kaminski, EVP/CAO (12/
18/02); MWA Financial Services, Robert M. Roth, President (12/18/
02); National Planning Corporation, M. Shawn Dreffein, President 
(12/2/02); Pacific West Securities, Inc., Philip A. Pizelo, 
President (1/14/03); PrimeVest Financial Services, Inc., Kevin P. 
Maas, VP, Director of Compliance (no date); Princor Financial 
Services Corp., Minoo Spellerberg, Compliance Officer (12/16/02); 
Quest Securities, Inc., Robert J. Schoen, President (11/22/02); 
Rhodes Securities, Inc., Sandra T. Masek, EVP/COO (12/17/02); Rhodes 
Securities, Inc., Sandra T. Masek, EVP/COO (12/17/02); Securities 
America, Inc., Bryan R. Hill, President (12/16/02); The Leaders 
Group, Inc., Z. Jane Riley, Compliance Officer (12/13/02); 
Transamerica Financial Advisors, Inc., Sandy Brown, President/COO 
(12/16/02); United Planners' Financial Services of America, Thomas 
H. Oliver, President/CEO (12/13/02); USAllianz Securities, Inc., 
Michael D. Burns, CCO (12/16/02); Vestax Securities Corp., R. Jack 
Conley, President/CEO (12/17/02); Washington Square Securities, 
Inc., Tom K. Rippberger, VP/CCO (no date on letter); Waterstone 
Financial Group, Inc., Thomas A. Hopkins, Chairman, (12/16/02); 
Wharton Equity Corp., Malcom A. Morrison, President (1/10/03); World 
Group Securities, Inc., Leesa M. Easley, Chief Legal Officer (12/19/
02); World Trade Financial Corporation, Rod P. Michel, President 
(12/31/02).
    \15\ See Woodbury Financial Services, Inc., Michael G. Brennan, 
Associate Counsel/Assistant Secretary (12/18/02).
---------------------------------------------------------------------------

    NASD agrees with commenters' concerns and is amending proposed NYSE 
Rule 3012 to eliminate the requirement that persons establishing, 
maintaining, and enforcing supervisory control policies and procedures 
be ``independent.'' The proposed rule now will require that a member 
designate and specifically identify to NASD one or more principals who 
will establish, maintain, and enforce supervisory control procedures 
that will test and verify that the members' supervisory procedures are 
sufficient and create additional or amend supervisory procedures where 
the need is identified by such testing and verification. Of course, 
NASD expects that the designated principals will test and verify the 
adequacy of the supervisory control procedures in a manner that is 
independent of a member's countervailing business considerations.
    Importantly, as stated in proposed NYSE Rule 3012, these policies 
and procedures must include procedures that are reasonably designed to 
review and supervise the customer account activity conducted by the 
member's branch office managers, sales managers,

[[Page 48426]]

regional or district sales managers, or any person performing a similar 
supervisory function. Proposed NYSE Rule 3012 provides that a person 
who is senior to the producing manager must perform these supervisory 
reviews; however, if a member does not conduct a public business, or 
has a capital requirement of $5,000 or less, or employs ten or fewer 
representatives, and its business is conducted in a manner necessitated 
by a limitation of resources that includes fewer than two layers of 
supervisory personnel, a person in another office who is in the same or 
similar position to the producing manager may conduct the supervisory 
review, provided that the person does not have supervisory 
responsibility over the activity being reviewed, reports to his 
supervisor his supervision and review of the producing manager, and has 
not performed a review of the producing manager in the last two years.
    The supervisory policies and procedures required under proposed 
Rule 3012 also must include procedures reasonably designed to provide 
heightened supervision over the activities of each producing manager 
who is responsible for generating 20% or more of the income of the 
producing manager's supervisor. The proposed rule does not mandate the 
contents of such heightened supervisory procedures, in recognition of 
the fact that such procedures will vary depending on the business 
models and needs of each particular member. In establishing such 
heightened supervisory procedures, however, members should consider 
such elements as unannounced supervisory reviews, an increased number 
of supervisory reviews by different reviewers within a certain period, 
a broader scope of activities reviewed, and/or having one or more 
principals approve the supervisory review of such producing managers. 
These examples are meant to illustrate the type of procedures a member 
may want to include in its heightened supervisory procedures and are 
not meant to be an exclusive or exhaustive list of heightened 
supervisory procedures a member may need to put in place. NASD believes 
that proposed Rule 3012, as amended herein, should allow members 
sufficient flexibility to create the supervisory control procedures 
mandated by the rule without creating undue burdens and costs.
    Several commenters mentioned that the requirements in proposed NASD 
Rule 3012 to test and verify a member's supervisory procedures and make 
any changes identified through the testing and verification procedures 
appear to be substantially similar to NASD Rule 3010(a)(8), which 
requires a member to review the supervisory system and make any 
appropriate changes. Commenters stated that it would be redundant to 
require a member to conduct two separate, yet very similar, reviews of 
the member's supervisory procedures to determine if changes need to be 
made.\16\
---------------------------------------------------------------------------

    \16\ Clark/Bardes Financial Services, Inc., Kevin Ballou, 
President (3/17/03); Financial Network Investment Corp., Jack R. 
Handy, Jr., President (12/13/02); Financial Northeastern Companies, 
Dominick Del Duca, CCO (12/12/02); IFG Network Securities, Inc., R. 
Jack Conley, President/CEO (12/18/02); Locust Street Securities, 
Inc., Jacqueline C. Conley, VP, Compliance (12/13/02); MML Investors 
Services, Inc., Michael L. Kerley, VP/Chief Legal Officer (12/17/
02); Multi-Financial Securities Corp., Patrick H. McEvoy, President/
CEO (12/16/02); PrimeVest Financial Services, Inc., Kevin P. Maas, 
VP, Director of Compliance (no date on letter); Vestax Securities 
Corp., R. Jack Conley, President/CEO (12/17/02); Washington Square 
Securities, Inc., Tom K. Rippberger, VP/CCO.
---------------------------------------------------------------------------

    NASD is aware of the similarity of the two supervisory review 
requirements. Accordingly, NASD is amending the proposed rule change to 
combine the two supervisory review requirements into proposed NASD Rule 
3012 and eliminate NASD Rule 3010(a)(8) altogether.
    One commenter stated that proposed NASD Rule 3012's requirement 
that specific supervisory controls be in place to address the 
transmittal of funds between accounts, changes of customers' addresses, 
and changes in customers' investment objectives should apply only to 
retail customer activity and not to institutional customer activity. An 
institutional exemption is sought because much of that business is done 
on a delivery-versus-payment or receipt-versus-payment basis or via 
prime brokerage arrangements that involve system and controls that are 
markedly different from retail account servicing.\17\ NASD, however, 
believes that it is reasonable and appropriate that regulatory 
oversight in the sensitive areas designated in proposed NASD Rule 3012 
extend to institutional account activity.
---------------------------------------------------------------------------

    \17\ 1st Global, Inc., Stephen Batman, CEO (12/18/02); 
Securities Industry Association, Self-Regulation and Supervisory 
Practices Group, Christopher R. Franke, Chairman--Self-Regulation 
and Supervisory Practices Committee (12/18/02).
---------------------------------------------------------------------------

    NASD is retaining NASD Rule 3012's originally proposed provision 
that any member in compliance with substantially similar requirements 
of the New York Stock Exchange, Inc. (``NYSE'') shall be deemed to be 
in compliance with NASD Rule 3012. NASD believes that this provision 
helps promote consistency between NASD's and the NYSE's supervisory 
control requirements.
    ii. Comments on NASD Rule 3010 (Supervision) and Proposed Changes. 
As originally proposed, the changes to NASD Rule 3010 require that 
office inspections be conducted by a person who is ``independent'' from 
the activities being performed at the office and the people providing 
supervision to that office. In addition, office inspections must 
include, without limitation, the testing and verification of the 
member's supervisory policies and procedures in the areas of: 
Safeguarding customer funds and securities; maintaining books and 
records; supervision of customer accounts serviced by branch office 
managers; transmittal of funds between customers and registered 
representatives and between customers and third parties; validation of 
customer address changes; and validation of changes in customer account 
information.
    Many commenters requested clarification regarding who would be 
sufficiently ``independent'' to conduct the office inspections required 
in NASD Rule 3010.\18\ At least one commenter stated that the 
``independence'' requirement in NASD Rule 3010 appears to refer to 
someone within the firm who does not receive compensation based on 
sales.\19\ Many commenters stated that the ``independence'' requirement 
in NASD Rule 3010(c)

[[Page 48427]]

would severely reduce the number of principals eligible to conduct 
branch exams and would put enormous pressure on home office exam 
personnel to conduct more office inspections.\20\ Commenters suggested 
that if home office exam personnel had to conduct more office 
inspections, the audit cycle would have to be extended to multiple-year 
durations and the quality of the audits would decline.\21\
---------------------------------------------------------------------------

    \18\ 1st Global, Inc., Stephen Batman, CEO; AIG Advisor Group, 
Inc., Bridget M. Gaughan, EVP (12/30/02); Cambridge Investment 
Research, Inc., Terry L. Lister, General Counsel (12/20/02); Charles 
Schwab & Co., Inc., Selwyn J. Noteliovitz, SVP (2/25/03); Clark/
Bardes Financial Services, Inc., Kevin Ballou, President (3/17/03); 
Commonwealth Financial Network, Peter T. Wheeler, President (12/17/
02); CUNA Brokerage Services, Inc., Marcia L. Martin, President (12/
19/02); FFP Securities, Inc., Craig A. Junkins, President/CEO (12/
18/02); First Allied Securities, Inc., Adam Antoniades, President/
COO (12/18/02); Invest Financial Corporation, Lynn R. Niedermeier, 
President/CEO (12/17/02); Investment Centers of America, Inc., Greg 
Gunderson, President (12/16/02); Lesko Securities, Inc., Charles 
Lesko, Jr., President (12/18/02); Midland National Life Insurance, 
P.M. Phalen, Assistant Vice President (12/17/02); MML Investors 
Services, Inc., Michael L. Kerley, VP/Chief Legal Officer (12/17/
02); Mutual Service Corp., Dennis S. Kaminski, EVP/CAO (12/18/02); 
MWA Financial Services, Robert M. Roth, President (12/18/02); 
Princor Financial Services Corp., Minoo Spellerberg, Compliance 
Officer (12/16/02); Rhodes Securities, Inc., Sandra T. Masek, EVP/
COO (12/17/02); Securities America, Inc., Bryan R. Hill, President 
(12/16/02); Securities Industry Association, Self-Regulation and 
Supervisory Practices Group, Christopher R. Franke, Chairman--Self-
Regulation and Supervisory Practices Committee (12/18/02); United 
Planners' Financial Services of America, Thomas H, President, CEO 
(12/13/02); USAllianz Securities, Inc., Michael D. Burns, CCO (12/
16/02); Waterstone Financial Group, Inc., Thomas A. Hopkins, 
Chairman, (12/16/02); World Group Securities, Inc., Leesa M. Easley, 
Chief Legal Officer (12/19/02).
    \19\ See Woodbury Financial Services, Inc., Michael G. Brennan, 
Associate Counsel/Assistant Secretary (12/18/02).
    \20\ 1st Global, Inc., Stephen Batman, CEO (12/18/02); AIG 
Advisor Group, Inc., Bridget M. Gaughan, EVP (12/30/02); American 
Express Financial Advisors, Inc., Beth E. Weimer, VP & CCO (1/17/
03); Cambridge Investment Research, Inc., Terry L. Lister, General 
Counsel (12/20/02); Clark/Bardes Financial Services, Inc., Kevin 
Ballou, President (3/17/03); CUNA Brokerage Services, Inc., Marcia 
L. Martin, President (12/19/02); Equity Services, Inc., Gregory D. 
Teese, VP (12/18/02); FFP Securities, Inc., Craig A. Junkins, 
President/CEO (12/18/02); Financial Network Investment Corp., Jack 
R. Handy, Jr., President (12/13/02); First Allied Securities, Inc., 
Adam Antoniades, President/COO (12/18/02); IFG Network Securities, 
Inc., R. Jack Conley, President/CEO (12/18/02); Invest Financial 
Corporation, Lynn R. Niedermeier, President/CEO (12/17/02); 
Investment Centers of America, Inc., Greg Gunderson, President (12/
16/02); John Hancock Financial Services, Inc., Robert H. Watts, SVP/
CCO, (12/17/02); Lesko Securities, Inc., Charles Lesko, Jr., 
President (12/18/02); Linsco/Private Ledger, Corp., James F. 
McGuire, SVP & CCO (1/16/03); Locust Street Securities, Inc., 
Jacqueline C. Conley, VP, Compliance (12/13/02); Multi-Financial 
Securities Corp., Patrick H. McEvoy, President/CEO (12/16/02); 
Mutual Service Corp., Dennis S. Kaminski, EVP/CAO (12/18/02); MWA 
Financial Services, Robert M. Roth, President (12/18/02); PrimeVest 
Financial Services, Inc., Kevin P. Maas, VP, Director of Compliance 
(No Date on Letter); Princor Financial Services Corp., Minoo 
Spellerberg, Compliance Officer (12/16/02); Rhodes Securities, Inc., 
Sandra T. Masek, EVP/COO (12/17/02); Securities America, Inc., Bryan 
R. Hill, President (12/16/02); Transamerica Financial Advisors, 
Inc., Sandy Brown, President/COO (12/16/02); United Planners' 
Financial Services of America, Thomas H. Oliver, President/CEO (12/
13/02); USAllianz Securities, Inc., Michael D. Burns, CCO (12/16/
02); Vestax Securities Corp., R. Jack Conley, President/CEO (12/17/
02); Washington Square Securities, Inc., Tom K. Rippberger, VP/CCO 
(No Date on Letter); Waterstone Financial Group, Inc., Thomas A. 
Hopkins, Chairman, (12/16/02).
    \21\ 21st Century Financial Services, Inc., Charles Mazziotti, 
President (12/17/02); AIG Advisor Group, Inc., Bridget M. Gaughan, 
EVP (12/30/02); Brookstreet Securities Corporation, Stanley C. 
Brooks, President, CEO (12/4/02); Cambridge Investment Research, 
Inc., Terry L. Lister, General Counsel (12/20/02); Clark/Bardes 
Financial Services, Inc., Kevin Ballou, President (3/17/03); CUNA 
Brokerage Services, Inc., Marcia L. Martin, President (12/19/02); 
Duerr Financial Corporation, William Partin, President (11/27/02); 
Eagle One Investments, LLC, Steven J. Svoboda, President (12/16/02); 
FFP Securities, Inc., Craig A. Junkins, President/CEO (12/18/02); 
Financial Network Investment Corp., Jack R. Handy, Jr., President 
(12/13/02); First Allied Securities, Inc., Adam Antoniades, 
President/COO (12/18/02); First Heartland Capital, Inc., Julius J. 
Anderson, Vice President; (12/27/02); FMN Capital Corporation, David 
W. Schofield, Director of Operations (12/18/02); IFG Network 
Securities, Inc., R. Jack Conley, President/CEO (12/18/02); Invest 
Financial Corporation, Lynn R. Niedermeier, President/CEO (12/17/
02); Investment Centers of America, Inc., Greg Gunderson, President 
(12/16/02); Iron Street Securities Inc., Robert L. Hamman, President 
(12/24/02); JKR & Company, Inc., J. Kemp Richardson, President (12/
10/02); Kyson & Co., Kao Sheng Lin, President (11/25/02); Lesko 
Securities, Inc., Charles Lesko, Jr., President (12/18/02); Liberty 
Life Securities, LLC, John T. Treece, President (1/15/03); Locust 
Street Securities, Inc., Jacqueline C. Conley, VP, Compliance (12/
13/02); Main Street Securities, LLC, David L. Meckenstock, VP/CCO 
(12/13/02); Monitor Capital, Inc., Hsiao-wen, President (11/25/02); 
Multi-Financial Securities Corp., Patrick H. McEvoy, President/CEO 
(12/16/02); Mutual Securities, Inc., William L. Sabol, President 
(11/26/02); Mutual Service Corp., Dennis S. Kaminski, EVP/CAO (12/
18/02); MWA Financial Services, Robert M. Roth, President (12/18/
02); National Planning Corporation, M. Shawn Dreffein, President 
(12/2/02); Pacific West Securities, Inc., Philip A. Pizelo, 
President (1/14/03); PrimeVest Financial Services, Inc., Kevin P. 
Maas, VP, Director of Compliance (no date); Princor Financial 
Services Corp., Minoo Spellerberg, Compliance Officer (12/16/02); 
Quest Securities, Inc., Robert J. Schoen, President (11/22/02); 
Rhodes Securities, Inc., Sandra T. Masek, EVP/COO (12/17/02); 
Securities America, Inc., Bryan R. Hill, President (12/16/02); The 
Leaders Group, Inc., Z. Jane Riley, Compliance Officer and/CEO (12/
13/02); Transamerica Financial Advisors, Inc., Sandy Brown, 
President/COO (12/16/02); United Planners' Financial Services of 
America, Thomas H. Oliver, President/CEO (12/13/02); USAllianz 
Securities, Inc., Michael D. Burns, CCO (12/16/02); Vestax 
Securities Corp., R. Jack Conley, President/CEO (12/17/02); 
Washington Square Securities, Inc., Tom K. Rippberger, VP/CCO (no 
date on letter); Waterstone Financial Group, Inc., Thomas A. 
Hopkins, Chairman, (12/16/02); Wharton Equity Corp., Malcom A. 
Morrison, President (1/10/03); World Group Securities, Inc., Leesa 
M. Easley, Chief Legal Officer (12/19/02); World Trade Financial 
Corporation, Rod P. Michel, President (12/31/02).
---------------------------------------------------------------------------

    In response to commenters' concerns, NASD is amending Rule 3010 to 
replace the proposed ``independence'' requirement with a prohibition 
that an office inspection cannot be conducted by a branch office 
manager or any person within that office who has supervisory 
responsibilities or by any individual who is supervised by such 
person(s). In addition, members must establish heightened inspection 
procedures in situations where the person conducting the inspection 
either works in an office supervised by the branch office manager's 
supervisor or reports to the branch office manager's supervisor and the 
branch office manager generates 20% or more of the supervisor's income. 
The proposed rule does not mandate the contents of such heightened 
inspection procedures, in recognition of the fact that such procedures 
will vary depending on the business models and needs of each particular 
member. In establishing such heightened inspection procedures, however, 
members should consider such elements as unannounced office 
inspections, increased frequency of inspections, a broader scope of 
activities inspected, and/or having one or more principals review and 
approve the office's inspections. These examples are meant to 
illustrate the type of procedures a member may want to include in its 
heightened inspection procedures and are not meant to be an exclusive 
or exhaustive list of heightened inspection procedures a member may 
need to put in place. NASD believes that this proposed rule change 
should allow members sufficient flexibility to assign personnel to 
conduct office inspections without creating undue burdens and costs.
    Because NASD has removed the ``independence'' requirement regarding 
inspections conducted pursuant to NASD Rule 3010(c), NASD is removing 
the provision in NASD Rule 3010(c) that would have allowed members to 
seek an exemption from the independence requirement in NASD Rule 
3010(c) subject to specified terms and conditions. NASD is also 
removing NASD Rule 3010(c) from the list of rules in NASD Rule 9610(a) 
from which a member can seek an exemption.
    Many commenters argued that the current supervisory system, which 
allows Office of Supervisory Jurisdiction (``OSJ'') managers to conduct 
office inspections of branch and satellite offices should be retained 
because it was both effective and cost efficient.\22\ Commenters noted 
that OSJ managers are the most familiar with registered representatives 
and activities located at particular offices, and therefore, are the 
most qualified to perform the periodic inspections. In addition, OSJ 
managers' auditing of branch and satellite offices serves to reinforce 
their accountability for the registered representatives' actions.\23\
---------------------------------------------------------------------------

    \22\ Id.
    \23\ Id.
---------------------------------------------------------------------------

    As stated previously, the proposed change to NASD Rule 3010 has 
eliminated the proposed ``independence'' requirement with a prohibition 
that an office inspection cannot be conducted by a branch office 
manager or any person within that office who has supervisory 
responsibilities or by any individual who is supervised by such 
person(s). This structure allows OSJ managers to conduct office 
inspections in any location where the OSJ manager is senior to the 
office's branch manager. In addition, NASD is amending NASD Rule 3010 
to codify previous NASD guidance that non-supervisory branch offices be 
inspected every three years and that all non-branch locations be 
inspected periodically.\24\
---------------------------------------------------------------------------

    \24\ See NASD Notice to Members 98-38 (May 1998); NASD Notice to 
Members 99-45 (June 1999).
---------------------------------------------------------------------------

    iii. Comments on Changes to NASD Rule 2510 (Discretionary Accounts) 
and Proposed Changes. As originally

[[Page 48428]]

proposed, changes to NASD Rule 2510(d)(1) require that time and price 
discretionary authority be limited to the day it is granted, absent 
written authorization to the contrary. Several commenters argued that 
the one-day time and price discretionary authority should be limited 
only to retail accounts and that NASD should craft an exemption for 
institutional accounts.\25\ Commenters argue that large orders for 
institutional accounts are ``worked'' over one or more days on a Good-
Till-Cancelled/Not-Held basis.
---------------------------------------------------------------------------

    \25\ A.G. Edwards & Sons, Inc., Brian C. Underwood, SVP (12/18/
02); Charles Schwab & Co., Inc., Selwyn J. Noteliovitz, SVP (2/25/
03); National Society of Compliance Professionals, Inc., Joan Ht & 
CEO (1/8/03); Securities Industry Association, Self-Regulation and 
Supervisory Practices Group, Christopher R. Franke, Chairman--Self-
Regulation and Supervisory Practices Committee (12/18/02).
---------------------------------------------------------------------------

    NASD believes that a general institutional exemption is 
inappropriate. However, in response to commenters' concerns, NASD is 
amending NASD Rule 2510 to clarify that written authorization need not 
be obtained for the exercise of time and price discretion beyond the 
day a customer grants such discretion for orders effected with or for 
an institutional account, as that term is defined in NASD Rule 
3110(c)(4), that are exercised pursuant to valid Good-Till-Cancelled 
instructions issued on a ``not held'' basis. NASD is also making a 
technical amendment to NASD Rule 3110(c)(4) to include a reference to 
the definition's applicability to NASD Rule 2510.
    Commenters requested that NASD clarify that the requirement to 
obtain written instructions for the exercise of time and price 
discretion beyond the business day it was granted allows customers to 
issue general ``standing'' instructions, rather than issuing written 
instructions on an order-by-order basis.\26\
---------------------------------------------------------------------------

    \26\ National Society of Compliance Professionals, Inc., Joan 
Hinchman, Executive Director, President & CEO (1/8/03); Securities 
Industry Association, Self-Regulation and Supervisory Practices 
Group, Christopher R. Franke, Chairman--Self-Regulation and 
Supervisory Practices Committee (12/18/02).
---------------------------------------------------------------------------

    The current text of NASD Rule 2510(d) clearly limits the exercise 
of time and price discretion to ``the purchase or sale of a definite 
amount of a specified security. * * *'' Any written authorization 
granting time and price discretion must comply with this established, 
trade-specific standard. Customers who wish to grant more extensive 
discretionary authority to their registered representatives may do so 
pursuant to a fully executed trading authorization.
    iv. Comments on NASD Rule 3110 (Books and Records). As originally 
proposed, changes to NASD Rule 3110 require that, before a customer 
order is executed, the account name or designation must be placed upon 
the memorandum for each transaction. In addition, only a designated 
person may approve any changes in account names or designations. The 
designated person also must document the essential facts relied upon in 
approving the changes and maintain the record in a central location. 
The designated person must pass a qualifying principal examination 
appropriate to the business of the firm before he or she can approve 
these changes.
    One commenter stated that its clerical staff is responsible for 
making changes to account names or designations and that requiring a 
principal to authorize the changes and be informed of the surrounding 
facts would place undue burden and cost upon the firm.\27\
---------------------------------------------------------------------------

    \27\ Midland National Life Insurance, P.M. Phalen, Assistant 
Vice President (12/17/02).
---------------------------------------------------------------------------

    NASD understands the concerns that the proposed rule changes may 
place additional costs and burdens upon members. However, NASD believes 
that account names and designations are material information that must 
be protected from possible fraudulent activity. Requiring a principal 
to authorize the change and be aware of the surrounding facts for the 
change is a relatively low-cost method of protecting this information.
    The same commenter stated that the requirement that a name or 
account designation be placed on ``each transaction'' is impractical 
for the administration of a variable life or variable annuity policy 
because dozens of transactions involving expense and insurance charges 
automatically occur each month for the multitude of funds associated 
with each policy.\28\
---------------------------------------------------------------------------

    \28\ Id.
---------------------------------------------------------------------------

    NASD proposed this rule change to promote consistency with the 
SEC's books and records rules. Specifically, SEC Rule 17a-3(a)(6) 
requires that a memorandum of each brokerage order identify, among 
other things, the account for which the order was entered.\29\ NASD 
expects that members, regardless of the type of securities business 
they engage in, will comply with this requirement in the same manner 
that they comply with the SEC's books and records requirements.
---------------------------------------------------------------------------

    \29\ 17 CFR 240.17a-3(a)(6).
---------------------------------------------------------------------------

    At least one commenter requested clarification regarding whether a 
firm may avoid duplicate records by maintaining the ``Account 
Designation Change'' documentation ``in the location whether the 
determination and approval occurs,'' rather than in the central 
location of the ``Home Office.''\30\
---------------------------------------------------------------------------

    \30\ See A.G. Edwards & Sons, Inc., Brian C. Underwood, SVP (12/
18/02).
---------------------------------------------------------------------------

    NASD does not believe that the new account designation change 
recordkeeping requirement should be unduly complicated or burdensome 
for members. Accordingly, NASD has amended the proposed rule change to 
require members to preserve these records in a manner substantially 
similar to the record retention requirements of SEC Rule 17a-4.\31\ 
Specifically, the proposed rule change requires members to preserve 
account designation change documentation for a period of not less than 
three years, with the documentation preserved for the first two years 
in an easily accessible place, as the term ``easily accessible place'' 
is used in SEC Rule 17a-4. This proposed change will not only allow 
members to use existing recordkeeping systems to meet this requirement, 
but it will enable members to make the account designation change 
documentation promptly available if requested by NASD examination 
staff. It also promotes consistency with NASD Rule 3110's existing 
mandate that members' recordkeeping format, medium, and retention 
periods comply with SEC Rule 17a-4 requirements.
---------------------------------------------------------------------------

    \31\ 17 CFR 240.17a-4.
---------------------------------------------------------------------------

    v. Comments on IM-3110 (Customer Account Information). As 
originally proposed, changes to IM-3110 would permit a member, upon a 
customer's written instructions, to hold mail for a customer who will 
not be at his or her usual address for the period of his or her 
absence, but not to exceed (A) two months if the member is advised that 
the customer will be on vacation or traveling or (B) three months if 
the customer is going abroad.
    At least one commenter stated that a member would have to impose 
additional recordkeeping and administrative controls to avoid lost or 
misplaced mail in situations where a customer that travels frequently 
looks to a member to provide custody of his or her mail.\32\ If a 
member provides this service to its customers, NASD understands that 
the member may have to put in place additional procedures to comply 
with the limitations set forth in this rule. However, the rule will 
help to ensure that members that do hold mail for customers who are 
away from their usual addresses, do so only pursuant to the customers' 
written instructions and

[[Page 48429]]

for a specified, relatively short period of time. Thus, there is a 
reduced likelihood of risk that customers would not receive account 
statements or other account documentation at their usual addresses. In 
addition, the rule will help to ensure that customers provide the firms 
with which they do business current address information, insofar as a 
firm will not be permitted to hold mail indefinitely.
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    \32\ John Hancock Financial Services, Inc., Robert H. Watts, 
SVP/CCO (12/17/02) & additional comments (1/16/03).
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    vi. Comments on the Effective Date of the Rule Change. At least one 
commenter has requested that the effective date of any new requirements 
be delayed for 6 to 9 months after the approval date.\33\ In response, 
NASD is proposing to establish an effective date of six months from SEC 
approval of the proposed rule change to allow members sufficient time 
to address any necessary procedural or system changes.
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    \33\ Pacific Select Distributors, Inc., John L. Dixon, President 
(12/18/02).
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    vii. Comments on the Insufficient Comment Process. Many commenters 
criticized NASD for not publishing the proposed rule changes for 
comment prior to filing them with the SEC, stating that the initial 
comment period that followed the filing date was insufficient for 
everyone who wanted to comment to submit their comments in a timely 
manner. Commenters requested additional time to submit further comments 
on the proposed rule changes.\34\
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    \34\ AIG Advisor Group, Inc., Bridget M. Gaughan, EVP (12/30/
02); Commonwealth Financial Network, Peter T. Wheeler, President 
(12/17/02); CUNA Brokerage Services, Inc., Marcia L. Martin, 
President (12/19/02); FFP Securities, Inc., Craig A. Junkins, 
President/CEO (12/18/02); First Allied Securities, Inc., Adam 
Antoniades, President/COO (12/18/02); Invest Financial Corporation, 
Lynn R. Niedermeier, President/CEO (12/17/02); Investment Centers of 
America, Inc., Greg Gunderson, President (12/16/02); Lesko 
Securities, Inc., Charles Lesko, Jr., President (12/18/02); Mutual 
Service Corp., Dennis S. Kaminski, EVP/CAO (12/18/02); Pacific 
Select Distributors, Inc., John L. Dixon, President (12/18/02); 
Princor Financial Services Corp., Minoo Spellerberg, Compliance 
Officer (12/16/02); Rhodes Securities, Inc., Sandra T. Masek, EVP/
COO (12/17/02); Securities America, Inc., Bryan R. Hill, President 
(12/16/02); Transamerica Financial Advisors, Inc., Sandy Brown, 
President/COO (12/16/02); United Planners' Financial Services of 
America, Thomas H. Oliver, President/CEO (12/13/02); USAllianz 
Securities, Inc., Michael D. Burns, CCO (12/16/02); Waterstone 
Financial Group, Inc., Thomas A. Hopkins, Chairman (12/16/02).
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    In response to earlier requests for additional time to submit 
comments on the proposed rule changes, the initial comment period was 
extended an additional 30 days. In addition, it is our understanding 
that the SEC will be publishing the new proposed rule changes for 
comment to allow concerned parties to submit their comments on the 
proposed changes described herein.
2. Statutory Basis
    NASD believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\35\ which requires, among 
other things, that NASD's rules must 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 believes that the proposed rule change is 
designed to accomplish these ends by requiring members to establish 
more extensive supervisory and supervisory control procedures to 
monitor customer account activities of its employees and thereby reduce 
the potential for customer fraud and theft.
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    \35\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    NASD 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, as amended.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    The SEC received 72 written comment letters. NASD's response to 
those comment letters is discussed in Section II above.

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 the self-regulatory organization 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 Amendment Nos. 1 and 2, including whether the 
amendments are 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 NASD. All submissions should refer to File No. SR-
NASD-2002-162 and should be submitted by September 3, 2003.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\36\
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    \36\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-20601 Filed 8-8-03; 8:45 am]
BILLING CODE 8010-01-P