[Federal Register Volume 68, Number 250 (Wednesday, December 31, 2003)]
[Notices]
[Pages 75704-75707]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-32131]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48961; File No. SR-NASD-2003-176]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc. Relating 
to Chief Executive Officer and Chief Compliance Officer Certification

December 23, 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 28, 2003, the National Association of Securities Dealers, 
Inc. (``NASD'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as 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 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.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    NASD is proposing to establish NASD Rule 3013 and accompanying 
Interpretive Material (``IM'') 3013 to require each member to designate 
a chief compliance officer (``CCO'') and further require the member's 
chief executive officer (``CEO'') and CCO to certify annually to having 
in place a process to establish, maintain, review, modify, and test 
policies and procedures reasonably designed to achieve compliance with 
applicable NASD rules, MSRB rules and the federal securities laws. 
Below is the text of the proposed rule change. Proposed new language is 
in italics.
* * * * *

3013. Annual Certification of Compliance and Supervisory Processes

(a) Designation of Chief Compliance Officer

    Each member shall designate and specifically identify to NASD on 
Schedule A of Form BD a principal to serve as chief compliance officer.

(b) Annual Certification

    Each member shall have its chief executive officer (or equivalent 
officer) and chief compliance officer jointly certify annually, as set 
forth in IM-3013, that the member has in place processes to establish, 
maintain, review, test and modify written compliance policies and 
written supervisory procedures reasonably designed to achieve 
compliance with applicable NASD rules, MSRB rules and federal 
securities laws and regulations.

IM-3013. Annual Compliance and Supervision Certification

    The NASD Board of Governors is issuing this interpretation to the 
requirement under Rule 3013(b), which requires that the member's chief 
executive officer (or equivalent officer) and chief compliance officer 
execute annually \1\ a certification that the member has in place 
processes to establish, maintain, review, test and modify written 
compliance policies and written supervisory procedures reasonably 
designed to achieve compliance with applicable NASD

[[Page 75705]]

rules, MSRB rules and federal securities laws. The certification shall 
state the following:
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    \1\ Members must ensure that each ensuing annual certification 
is effected no later than on the anniversary date of the previous 
year's certification.
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Annual Compliance and Supervision Certification

    The undersigned are respectively the chief executive officer (or 
equivalent officer) and chief compliance officer of [name of member 
corporation/partnership/sole proprietorship] (the ``Member''). As 
required by NASD Rule 3013(b), the undersigned make the following 
certification:
    1. The Member has in place processes to:
    (a) establish and maintain policies and procedures reasonably 
designed to achieve compliance with applicable NASD rules, MSRB rules 
and federal securities laws;
    (b) modify such policies and procedures as business, regulatory and 
legislative changes and events dictate; and
    (c) test the effectiveness of such policies and procedures on a 
periodic basis, the timing and extent of which is reasonably designed 
to ensure continuing compliance with NASD rules, MSRB rules and federal 
securities laws;
    2. The Member's processes, with respect to item 1 above, are 
evidenced in a report reviewed by the chief executive officer (or 
equivalent officer), chief compliance officer and such other officers 
as the Member may deem necessary to make this certification. These 
processes at a minimum must include: (a) one or more meetings between 
the chief executive officer (or equivalent officer) and the chief 
compliance officer to discuss and review the matters that are the 
subject of this certification and (b) review of the report by the 
Member's board of directors and audit committee; and
    3. The undersigned chief executive officer (or equivalent officer), 
chief compliance officer and other officers as applicable (referenced 
in item 2 above) have consulted with or otherwise relied on those 
employees, officers, outside consultants, lawyers and accountants, to 
the extent they deem appropriate, in order to attest to the statements 
made in this certification.
    It is critical that each NASD member understand the importance of 
employing comprehensive and effective compliance policies and written 
supervisory procedures. Compliance with applicable NASD rules, MSRB 
rules and federal securities laws and rules is the foundation of 
ensuring investor protection and market integrity and is essential to 
the efficacy of self-regulation. Consequently, the certification 
requirement is intended to require processes by each member to 
establish, maintain, review, test and modify its compliance policies 
and written supervisory procedures in light of the nature of its 
businesses and the laws and rules that are applicable thereto, and to 
evidence such processes in a report reviewed by those executing the 
certification.
    The execution of the certification by the chief compliance officer 
(and other designated officers with primary compliance responsibility) 
is intended to ensure that the person(s) charged with managing the 
member's compliance program has regular and significant interaction 
with senior management concerning the subject matter of the 
certification. The rule permits co-certifications by other compliance 
officers that report to the chief compliance officer. However, the NASD 
Board of Governors expects that any such co-certifications will be 
executed only by senior compliance officers that have primary 
compliance responsibility over a segment of a member's business 
operations.
    The NASD Board of Governors recognizes that supervisors with 
business line responsibility are accountable for the discharge of a 
member's compliance policies and written supervisory procedures. The 
signatories to the certification are certifying only as to having 
processes in place to establish, maintain, review, test and modify the 
member's written compliance and supervisory policies and procedures and 
the execution of this certification does not by itself establish 
business line responsibility.
    The requirement to designate a chief compliance officer does not 
preclude such person from holding any other position within the member, 
including the position of chief executive officer, provided that such 
person can discharge the duties of a chief compliance officer in light 
of his or her other additional responsibilities. The requirement that a 
member's processes include a review of the report (required by item 2 
of the certification) by the board of directors and audit committee 
does not apply to members that do not utilize these types of governing 
bodies and committees in the conduct of their business.\2\
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    \2\ Members, as a part of their process, must have the report 
reviewed by their governing bodies and committees that serve similar 
functions in lieu of a board of directors and audit committee.
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    The report required in item 2 of the certification must document 
the member's processes for establishing, maintaining, reviewing, 
testing and modifying compliance policies. The report must be produced 
prior to execution of the certification and be reviewed by the chief 
executive officer (or equivalent officer), chief compliance officer and 
any other officers the member deems necessary to make the 
certification. The report should include the manner and frequency in 
which the processes are administered, as well as the identification of 
officers and supervisors that have responsibility for such 
administration. The report need not contain any conclusions produced as 
a result of following the processes set forth therein. The report may 
be combined with any other compliance report or other similar report 
required by any other self-regulatory organization provided that (1) 
such report is clearly titled in a manner indicating that it is 
responsive to the requirements of the certification and this 
Interpretive Material; (2) a member that submits a report for review in 
response to an NASD request must submit the report in its entirety; and 
(3) the member makes such report in a timely manner, i.e., annually.
* * * * *

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 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
    Comprehensive compliance and supervisory systems constitute the 
bedrock of effective securities industry self-regulation and the 
primary strata of investor protection. As such, NASD believes that a 
member's senior management should focus the same attention to a 
member's compliance and supervisory policies and procedures as is 
accorded to a member's revenue-producing businesses and such 
fundamental operational prerequisites as, for example, net capital 
requirements.
    To that end, NASD is proposing a rule change that would bolster 
investor

[[Page 75706]]

protection by promoting regular and meaningful interaction between 
senior management and compliance personnel to ensure that compliance is 
given the highest priority by a member's senior executive officers. 
Specifically, the proposed rule change would require (1) that each 
member designate a principal to serve as CCO and (2) the CEO and CCO to 
certify annually to having in place processes to establish, maintain, 
review, modify, and test policies and procedures reasonably designed to 
achieve compliance with applicable NASD rules, MSRB rules and federal 
securities laws.
    As to the former, NASD Rule 1022 currently requires a person 
designated as a CCO on Schedule A of Form BD to be registered as a 
General Securities Principal unless certain exceptions apply.\3\ 
However, the current rules do not require that a member so designate 
such a person. The proposed rule change would mandate that a member 
designate a CCO and identify that person on Schedule A of Form BD.
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    \3\ See Notice to Members 01-51 (August 2001).
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    With respect to the certification, the proposed rule change also 
would require the CEO and CCO to certify annually that senior executive 
management has in place processes to (1) establish and maintain 
policies and procedures reasonably designed to achieve compliance with 
applicable NASD rules, MSRB rules and federal securities laws; (2) 
modify such policies and procedures as business, regulatory and 
legislative changes and events dictate; and (3) test the effectiveness 
of such policies and procedures on a periodic basis, the timing of 
which is reasonably designed to ensure continuing compliance with NASD 
rules, MSRB rules and the federal securities laws. The proposed rule 
change further would require the CEO and CCO to certify that those 
processes are evidenced in a report that has been reviewed by those 
executing the certification, as well as the member's board of directors 
and audit committee.\4\ Notably, the processes, at a minimum, must 
include one or more meetings between the CEO and CCO to discuss and 
review the matters that are subject of the certification.
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    \4\ Members that do not employ a board of directors or audit 
committee or other similar bodies in their governance and management 
would not be subject to this requirement.
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    The proposed rule change also would create IM-3013, which sets 
forth the language of the certification and gives further guidance as 
to the requirements and limitations of the rule. For example, the 
interpretive material clarifies that the person designated as CCO also 
may hold other positions within the member, including CEO, provided 
that individual can effectively discharge the CCO responsibilities 
while maintaining another position. Thus, resource-constrained members 
are not required to hire or designate a dedicated CCO. The proposed 
interpretive material also explains that the rule permits co-
certifications by other compliance officers that report to the CCO, 
provided those individuals are senior compliance officers who have 
primary responsibility over a segment of the member's business 
operations.
    The proposed interpretive material further recognizes that 
responsibility for discharging compliance policies and written 
supervisory procedures rests with business line supervisors. The 
proposed interpretive material clarifies that execution of the 
certification does not by itself establish a signatory as having such 
line supervisory responsibility.
    The proposed interpretive material also sets forth the particulars 
regarding the report that must evidence a member's compliance 
processes. It states that the report must be produced prior to 
execution of the certification and reviewed by the CEO, CCO and such 
other officers as the member deems necessary. The report also must 
include the manner and frequency in which the processes are 
administered and identify those officers and supervisors with 
responsibility for such administration. The proposed interpretive 
material further explains that the report need not contain conclusions 
that result from following the specified processes, such as compliance 
deficiencies. Additionally, the proposed interpretive material states 
that the report may be combined with other reports required by a self-
regulatory organization, provided the report is made annually, clearly 
indicates in the title that it contains the information required by 
Rule 3013, and that the entire report is provided in response to any 
regulatory request for all or part of the combined report.
    Finally, with respect to review of the report, the proposed 
interpretive material clarifies that review by a member's board of 
directors and audit committee only applies to those members whose 
corporate governance structure have such or similar governing bodies 
and committees--it does not impose a requirement that members create 
them if they do not currently exist.
    The proposal would complement and underscore the closely related 
obligations that currently exist under NASD rules that require each 
member to designate principals who must review the member's supervisory 
systems and procedures and recommend to senior management appropriate 
action to ensure the systems are reasonably designed to achieve 
compliance with applicable rules and regulations.\5\ NASD believes the 
proposal provides an effective mechanism to compel substantial and 
purposeful interaction between senior management and compliance 
personnel, thereby enhancing the quality of members' supervisory and 
compliance systems. NASD further believes the rule change imposes the 
minimal additional burden on members that is necessary to achieve the 
proposal's purpose.
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    \5\ See 3010(a)(8). NASD has filed with the Commission a 
proposed rule change that would incorporate the requirements of Rule 
3010(a)(8) into new Rule 3012 and eliminate Rule 3010(a)(8) 
altogether. If the proposed rule change is approved, Rule 3012 would 
require members to designate one or more principals who will 
establish, maintain, and enforce a system of supervisory control 
policies and procedures that test and verify that the member's 
supervisory procedures are reasonably designed to achieve compliance 
with applicable securities laws and NASD rules and amend supervisory 
procedures where the need is identified. See SR-NASD-2002-162.
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2. Statutory Basis
    NASD believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act, 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 that the proposed rule change is 
consistent with the provisions of the Act noted above in that it will 
enhance focus on members' compliance and supervision systems, thereby 
decreasing the likelihood of fraud and manipulative acts and increasing 
investor protection.

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.

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

    In June 2003, NASD issued Notice to Members 03-29, seeking comment 
on a different proposal with similar objectives. That proposal would 
have required each member to designate a CCO and further required that 
the CCO and CEO certify annually to the

[[Page 75707]]

adequacy of the member's compliance and supervisory systems. A proposed 
interpretive material clarified that the signatories to the 
certification would incur no additional liability as a consequence of 
the certification, provided there was a reasonable basis to certify at 
the time of execution. The previous proposal differed from the current 
proposal in that it would have required, among other things, that the 
CCO and CEO have a reasonable basis to certify that a member was in 
compliance with all applicable laws, rules and regulations at a fixed 
moment in time. By contrast, the current proposal requires 
certification to having processes in place to establish, maintain, 
review, modify and test policies and procedures reasonably designed to 
achieve compliance with those laws, rules and regulations.
    NASD received 166 comments to the proposal, including submissions 
on behalf of members from 65 CCOs and 34 CEOs, as well as nine comments 
from various trade organizations. The overwhelming majority of 
commenters disfavored the proposal. Only six commenters favored the 
proposal.
    Broadly, commenters questioned the value of the proposal, whether 
it was duplicative of existing requirements, the scope of the 
certification, and the potential liability of the signatories. CCOs 
expressed concern that the proposal could lead to retaliation by CEOs 
if a CCO refused to certify. Additionally, questions arose as to 
whether the goal of better compliance could be achieved only at the 
expense of increased potential liability on the part of members. 
Commenters also noted that the dynamic nature of compliance and the 
need to allocate finite compliance resources on a risk assessment basis 
did not lend itself to a certification of compliance certainty at any 
fixed moment. Commenters further expressed concern that the proposal 
would spawn baseless litigation by opportunistic plaintiffs' attorneys. 
Small firms also commented that the cost of compliance would outweigh 
the benefits for their firms and would divert resources from more 
substantive compliance matters.
    NASD disagrees with a number of the comments, including that the 
previous proposal duplicated existing requirements and added no value 
to the quality of compliance. On the contrary, both the previous and 
present proposals would place focus on the obligations of the 
compliance function in an unprecedented manner by giving an elevated 
voice to compliance personnel and forcing regular and productive 
interaction with the CCO by the CEO. NASD also disagrees that the 
proposal would have created new liability on CEOs and CCOs who 
otherwise have no supervisory responsibility--a fact expressly stated 
in the previously proposed interpretive material. Moreover, NASD does 
not believe the possibility of meritless litigation should dictate its 
regulatory actions--abusive litigation should be dealt with by 
sanctions, not abandoned policy.
    Nonetheless, NASD agrees with many of the commenters' other 
concerns. In particular, NASD recognizes the difficulty in certifying 
to absolute compliance at any given moment in the face of dynamic 
regulatory and business environments. At the same time, NASD is 
committed to the initial proposal's intent: to promote investor 
protection through improved compliance and supervisory systems and the 
promotion of regular and meaningful interaction between senior 
management and compliance personnel. Thus, NASD now is submitting to 
the Commission a modified proposal that takes a different approach to 
the issue, one that NASD believes more efficiently and pragmatically 
achieves the same goal of enhanced compliance. In addition, NASD 
believes the new proposal effectively focuses senior management 
attention on compliance matters in a way that allays CCO concerns about 
incurring additional personal liability and fear of retaliation.

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 the foregoing, including whether the proposed rule 
change 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. 
Comments may also be submitted electronically at the following e-mail 
address: [email protected]. All comment letters should refer to 
File No. SR-NASD-2003-176. This file number should be included on the 
subject line if e-mail is used. To help the Commission process and 
review comments more efficiently, comments should be sent in hardcopy 
or by e-mail but not by both methods. Copies of the submission, all 
subsequent amendments, all written statements with respect to the 
proposed rule change that are filed with the Commission, and all 
written communications relating to the proposed rule change between the 
Commission and any person, other than those that may be withheld from 
the public in accordance with the provisions of 5 U.S.C. 552, will be 
available for inspection and copying in the Commission's Public 
Reference Room. Copies of such filing will also be available for 
inspection and copying at the principal office of the NASD. All 
submissions should refer to File No. SR-NASD-2003-176 and should be 
submitted by January 21, 2004.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\6\
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    \6\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 03-32131 Filed 12-30-03; 8:45 am]
BILLING CODE 8010-01-P