[Federal Register Volume 69, Number 15 (Friday, January 23, 2004)]
[Notices]
[Pages 3410-3412]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-1461]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49081; File No. SR-NASD-2004-05]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the National Association of Securities Dealers, Inc. To Amend 
NASD Rule 2370 Relating to Certain Lending Arrangements Between 
Registered Persons and Customers

January 14, 2004.
    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 January 9, 2004, the National Association of Securities Dealers, 
Inc. (``NASD'' or ``Association''), filed with the Securities and 
Exchange Commission (``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.\3\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ NASD has requested that the Commission find good cause 
pursuant to Section 19(b)(2) of the Act to approve the proposed rule 
change prior to the 30th day after its publication in the Federal 
Register. 15 U.S.C. 78s(b)(2).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    NASD proposes to amend NASD Rule 2370 to exempt certain types of 
permissible lending arrangements from the rule's notice and approval 
requirements and also to indicate that the scope of the rule is limited 
to lending arrangements between registered persons and their customers, 
rather than any customer of the firm. The text of the proposed rule 
change appears below. New text is in italics. Deleted text is in 
brackets.
* * * * *

2370. Borrowing From or Lending to Customers

    (a) No person associated with a member in any registered capacity 
may borrow money from or lend money to any customer of [the member] 
such person unless: (1) The member has written procedures allowing the 
borrowing and lending of money between such registered persons and 
customers of the member; and (2) the lending or borrowing arrangement 
meets one of the following conditions: (A) The customer is a member of 
such person's immediate family; (B) the customer is a financial 
institution regularly engaged in the business of providing credit, 
financing, or loans, or other entity or person that regularly arranges 
or extends credit in the ordinary course of business; (C) the customer 
and the registered person are both registered persons of the same 
member firm; (D) the lending arrangement is based on a personal 
relationship with the customer, such that the loan would not have been 
solicited, offered, or given had the customer and the associated person 
not maintained a relationship outside of the broker/customer 
relationship; or (E) the lending arrangement is based on a business 
relationship outside of the broker-customer relationship[; and (3) the 
m].
    (b) Procedures
    (1) Members [has] must pre-approve[d] in writing the lending or 
borrowing arrangements described in subparagraphs (a)(2)(C), (D), and 
(E) above.
    (2) With respect to the lending or borrowing arrangements described 
in subparagraph (a)(2)(A) above, a member's written procedures may 
indicate that registered persons are not required to notify the member 
or receive member approval either prior to or subsequent to entering 
into such lending or borrowing arrangements.

[[Page 3411]]

    (3) With respect to the lending or borrowing arrangements described 
in subparagraph (a)(2)(B) above, a member's written procedures may 
indicate that registered persons are not required to notify the member 
or receive member approval either prior to or subsequent to entering 
into such lending or borrowing arrangements, provided that, the loan 
has been made on commercial terms that the customer generally makes 
available to members of the general public similarly situated as to 
need, purpose and creditworthiness. For purposes of this subparagraph, 
the member may rely on the registered person's representation that the 
terms of the loan meet the above-described standards.
    [(b)](c) No change in text.
* * * * *

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
    Current NASD Rule 2370 prohibits registered persons from borrowing 
money from or lending money to a customer (collectively referred to 
herein as ``lending arrangements'') unless the member has written 
procedures allowing such lending arrangements consistent with the rule, 
and the loan falls within one of five permissible types of lending 
arrangements. The five types of permissible lending arrangements are: 
the customer is a member of the registered person's immediate family 
(as defined in the rule); the customer is in the business of lending 
money; the customer and the registered person are both registered 
persons of the same firm; the lending arrangement is based on a 
personal relationship outside of the broker-customer relationship; or 
the lending arrangement is based on a business relationship outside of 
the broker-customer relationship. In addition, NASD Rule 2370 requires 
members to pre-approve each loan in writing. This regulatory framework 
gives members greater control over, and more specific supervisory 
responsibilities for, lending arrangements between registered persons 
and their customers. Members that choose to permit their registered 
persons to borrow from or lend to customers consistent with the 
requirements of the rule must evaluate, before granting approval, 
whether the lending arrangement falls within one of the five types of 
permissible arrangements.
    In adopting NASD Rule 2370, NASD considered the potential for 
misconduct when registered persons and customers enter into lending 
arrangements.\4\ NASD has brought disciplinary action against 
registered persons who have violated just and equitable principles of 
trade by taking unfair advantage of their customers by inducing them to 
lend money in disregard of the customers' best interests, or by 
borrowing funds from, but not repaying, customers. The potential for 
misconduct also exists when a registered person lends money to a 
customer.
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    \4\ See Securities Exchange Act Release No. 48242 (August 29, 
2003), 68 FR 52806 (September 5, 2003) (Order approving SR-NASD-
2003-92).
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    Since NASD Rule 2370 became effective on November 10, 2003,\5\ it 
has become apparent to both members and NASD staff that the notice and 
approval requirements with respect to lending arrangements between 
family members and lending arrangements between registered persons and 
a financial institution regularly engaged in the business of providing 
credit, financing, or loans, or other entity or person that regularly 
arranges or extends credit in the ordinary course of business place 
onerous recordkeeping requirements on firms and also may invade the 
legitimate privacy interests of customers and registered persons. NASD, 
therefore, proposes that NASD Rule 2370 be amended to exempt these two 
categories of lending arrangements from the notice and approval 
requirement of NASD Rule 2370, provided that the lending arrangement 
between a registered person and a financial institution loan has been 
made on commercial terms that the customer generally makes available to 
members of the general public similarly situated as to need, purpose 
and creditworthiness.
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    \5\ See NASD Notice to Members 03-62 (October 8, 2003).
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    NASD believes that the potential for misconduct is greatly reduced, 
or eliminated, when loans occur between family members. Therefore, NASD 
proposes to amend NASD Rule 2370 to exempt certain types of permissible 
lending arrangements from the rule's notice and approval requirements. 
With respect to lending arrangements between family members, as 
described in subparagraph (a)(2)(A) to NASD Rule 2370, NASD is of the 
view that it would be sufficient for purposes of compliance with NASD 
Rule 2370 if a member's written procedures indicate that the member 
permits such lending arrangements and that registered persons need not 
notify the member or receive member approval either prior to or 
subsequent to such lending arrangements.
    In addition, NASD believes that the potential for misconduct is 
greatly reduced, or eliminated, when registered persons borrow from 
banks or other financial institutions in the business of lending money, 
provided the terms of the lending arrangement are those that would also 
be available to the general public doing business with those 
institutions who are similarly situated as to need, purpose and 
creditworthiness. Such transactions would include, but not be limited 
to, mortgages, personal loans, home equity lines of credit, and credit 
card accounts, and would also include lending arrangements with an 
affiliate of the customer. Thus, with respect to lending arrangements 
described in subparagraph (a)(2)(B) to NASD Rule 2370, NASD is of the 
view that a member's written procedures may indicate that registered 
persons are permitted to enter into such lending arrangements and are 
not required to notify the member or receive member approval either 
prior to or subsequent to entering into such lending arrangements, 
provided that the loan has been made on commercial terms that the 
customer generally makes available to members of the general public 
similarly situated as to need, purpose and creditworthiness. For 
purposes of this subparagraph, the member may rely on the registered 
person's representation that the terms of the loan meet the above-
described standards. The fact that a registered person can negotiate a 
better rate or terms for a loan that is not the product of the broker-
customer relationship would not vitiate the idea that the loan occurred 
on terms generally offered to the public.
    NASD has also concluded that the potential for misconduct is most 
significant when a registered person enters into a lending arrangement 
with his or her own customer. Moreover, the NASD states that its 
members, especially those members with a significant number of 
institutional customers, have pointed out that

[[Page 3412]]

individual registered persons may not even know nor, for privacy 
reasons, should know, the name of every customer. Thus, in some firms, 
registered persons would be put in the position of reporting, and 
getting approval for, every credit card, every mortgage, and every home 
equity line of credit, in case the banking institution was a firm 
customer. NASD states that this was not the intent of the rule. Thus, 
NASD proposes to amend NASD Rule 2370 to indicate that the scope of the 
rule is limited to lending arrangements between registered persons and 
their customers, rather than any customer of the firm. It is the 
member's responsibility to determine whether a particular individual 
represents or services a customer.
    NASD would also like to make clear that the purpose of NASD Rule 
2370 is to give members the opportunity to evaluate the appropriateness 
of particular lending arrangements between their registered persons and 
customers and the potential for unnecessary and ill-advised conflicts 
of interest between both the registered person and his customer and the 
registered person and the member with which he is associated. NASD Rule 
2370 does not require that members necessarily have oversight of the 
terms of the loan, or its execution or administration. However, the 
absence of such requirements in the rule does not signify the 
conclusion of NASD that, under certain circumstances, such action by 
members may be appropriate and necessary in accordance with the 
member's supervisory obligations. It continues to be the prerogative of 
member firms to exclude any or all lending arrangements between 
registered persons and their customers.
(2) Statutory Basis
    NASD believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\6\ which requires, among 
other things, that NASD 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 (1) continuing to prohibit 
registered persons from borrowing money from or lending money to a 
customer unless the member has written procedures allowing such lending 
arrangements consistent with the rule, and the loan falls within one of 
five permissible types of lending arrangements and (2) maintaining the 
notice and approval requirement except where the lending arrangement is 
between: (a) Registered persons and family members; or (b) between 
registered persons and lending institutions, provided the terms of such 
arrangements are those that the customer would also generally make 
available to members of the general public similarly situated as to 
need, purpose and creditworthiness.
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    \6\ 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.

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

    Written comments were neither solicited nor received.

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 NASD 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-2004-05. This file number should be included on the 
subject line if e-mail is used. To help the Commission process and 
review your 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 filings will also be available 
for inspection and copying at the principal office of the Association. 
All submissions should refer to File No. SR-NASD-2004-05 and should be 
submitted by February 13, 2004.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\7\
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    \7\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-1461 Filed 1-22-04; 8:45 am]
BILLING CODE 8010-01-P