[Federal Register Volume 69, Number 120 (Wednesday, June 23, 2004)]
[Notices]
[Pages 35108-35117]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-14230]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-49882; File No. SR-NYSE-2002-36]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Amendments No. 1, 2, and 3 by New York Stock Exchange, Inc. 
Relating to Internal Controls and Supervisory Control Amendments and 
Notice of Filing and Order Granting Accelerated Approval of Amendment 
No. 4

June 17, 2004.

I. Introduction

    On August 16, 2002, the New York Stock Exchange, Inc. (``NYSE'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change relating to the establishment, 
maintenance, and testing of internal controls and supervision of NYSE 
members. The NYSE submitted Amendment No. 1 to the proposed rule change 
on November 20, 2002.\3\ The proposed rule change, as amended, was 
published for comment in the Federal Register on November 27, 2002.\4\ 
The Commission received five comment letters in response to proposed 
rule change.\5\ In response, on April 28, 2003, the NYSE filed 
Amendment No. 2 to the proposed rule change.\6\ On August 7, 2003, the 
NYSE submitted Amendment No. 3 to the proposed rule change.\7\ On 
August 13, 2003, the Commission published Amendments No. 2 and 3 for 
comment in Federal Register.\8\ The Commission received four comment 
letters in response to these Amendments.\9\ These comment letters and 
the NYSE's response in Amendment No. 4,\10\ submitted on April 16, 
2004, are summarized below. This Order approves the proposed rule, as

[[Page 35109]]

amended, and accelerates approval of Amendment No. 4.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Darla Stuckey, Corporate Secretary, NYSE, to 
Nancy Sanow, Assistant Director, Division of Market Regulation 
(``Division''), Commission, dated November 18, 2002 (``Amendment No. 
1''). In Amendment No. 1, the NYSE added ``customer changes of 
investment objectives'' to the list of enumerated activities with 
regard to which Exchange members must maintain written policies and 
procedures.
    \4\ See Securities Exchange Act Release No. 46858 (November 20, 
2002), 67 FR 70994. On December 18, 2002, the Commission extended 
the 21-day comment period for an additional 30 days. See Securities 
Exchange Act Release No. 47021, 67 FR 78840 (December 26, 2002).
    \5\ See letters from Arthur F. Grant, President, Cadaret, Grant 
& Co., Inc., to Jonathan G. Katz, Secretary, Commission, dated 
December 17, 2002 (``Cadaret Grant Letter''); Christopher R. Franke, 
Chairman, Self-Regulation and Supervisory Practices Committee, 
Securities Industry Association, to Jonathan G. Katz, Secretary, 
Commission, dated December 18, 2002 (``Franke SIA Letter''); 
Kimberly H. Chamberlain, Vice President and Counsel, State 
Government Affairs, Securities Industry Association, to Secretary, 
Commission, dated December 23, 2002 (``Chamberlain SIA Letter''); 
Brian C. Underwood, Senior Vice President and Director of 
Compliance, A.G. Edwards & Sons, Inc., to Jonathan G. Katz, 
Secretary, Commission, dated December 18, 2002 (``A.G. Edwards 
Letter''); and Selwyn J. Notelovitz, Senior Vice President, Global 
Compliance, Charles Schwab & Co., Inc., to Jonathan G. Katz, 
Secretary, Commission, dated February 25, 2003 (``Schwab Letter'').
    \6\ See letter from Darla Stuckey, Corporate Secretary, NYSE, to 
Nancy Sanow, Assistant Director, Division, Commission, dated April 
25, 2003 (``Amendment No. 2''). In Amendment No. 2, the Exchange 
submitted a response to comments that it had received in response to 
the Original Notice. In addition, the Exchange amended portions of 
the proposed rule text to address certain of the commenters' 
concerns.
    \7\ See letter from Darla Stuckey, Corporate Secretary, NYSE, to 
Nancy Sanow, Assistant Director, Division, Commission, dated August 
6, 2003 (``Amendment No. 3''). Amendment No. 3, which replaced and 
superceded Amendment No. 2 in its entirety, responded to certain 
concerns the Commission raised with the NYSE following the 
Exchange's submission of Amendment No. 2.
    \8\ See Securities Exchange Act Release No. 48299 (August 7, 
2003), 68 FR 48431. On September 8, 2003, the Commission extended 
the 21-day comment period for an additional 30 days. See Securities 
Exchange Act Release No. 48460, 68 FR 54034 (September 15, 2003).
    \9\ See letters from Pamela K. Cavness, Director of Compliance, 
Edward Jones, to Jonathan G. Katz, Secretary, Commission, dated 
October 2, 2003 (``Edward Jones Letter''); Barbara Black, Director, 
Pace University Investor Rights Project, to Secretary, Commission, 
dated October 2, 2003 (``Pace Letter''); John Polanin Jr., Chairman, 
Self-Regulation and Supervisory Practices Committee, SIA, dated 
October 3, 2003 (``Polanin SIA Letter''); and Ralph A. Lambiase, 
President, North American Securities Administrators Association, and 
Director, Connecticut Division of Securities, dated October 24, 2003 
(``NASAA Letter'').
    \10\ See letter from Darla Stuckey, Corporate Secretary, NYSE, 
to Nancy Sanow, Assistant Director, Division, Commission, dated 
April 15, 2004 (``Amendment No. 4''). Amendment No. 4, in response 
to comments, altered NYSE Rules 342.42, 408.11 and the 
Interpretation of Rule 342(a)(b)/03.
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II. Description

A. Background

1. Purpose for and General Description of Proposal
    The NYSE's proposed rule change is designed to address concerns 
regarding its members' supervisory systems. Many of these concerns were 
brought to light following an investigation by the Commission into the 
activities of a branch office manager, Frank Gruttadauria.\11\ Over a 
period of 15 years, Mr. Gruttadauria misappropriated over $100 million 
from more than 40 clients. Mr. Gruttadauria was able to cover up his 
fraud by, among other things, providing clients with falsified account 
statements and by causing the actual brokerage statements for some 
clients to be mailed, without the knowledge or authorization of these 
clients, to entities or post office boxes under his control.
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    \11\ See In the Matter of SG Cowen Securities Corporation, 80 
SEC Docket 3154 (September 9, 2003), Securities Exchange Act Release 
No. 48335 (August 14, 2003) Administrative Proceeding File No. 3-
11216. See also In the Matter of Lehman Brothers, Inc., 80 SEC 
Docket 3173 (September 9, 2003), Securities Exchange Act Release No. 
48336 (August 14, 2003) Administrative Proceeding File No. 3-11217.
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    In an effort to ensure that members are more effectively supervised 
going forward, the NYSE has proposed amendments to existing rules to 
strengthen members' supervisory procedures and internal controls. 
Proposed amendments to NYSE Rules 342.19, 342.23, 401 and 410 set forth 
general and specific supervisory control requirements. Amendments to 
NYSE Rule 342(a)(b)/03 of the Exchange Interpretation Handbook set 
forth the subjects that an annual inspection must address when 
evaluating the internal controls present in a particular branch office. 
In addition, the NYSE proposes to amend Exchange Rule 408 to limit the 
duration of a member's authority to exercise time and price discretion 
pursuant to a non-written customer request.
2. General Comments on the Proposed Rule Change
    Many commenters urged greater flexibility in the general 
implementation of the proposed rule changes. For example, two 
commenters suggested that the proposed rule amendments should be 
adopted in the form of ``principles for effective supervision'' or 
``best practices.'' \12\ Most commenters recommended that the NYSE 
adopt more flexible rules to account for the varied member organization 
business models.\13\ Commenters suggested that the proposed amendments 
would not be economically feasible for all types of firms.\14\ One 
commenter suggested that the Gruttadauria case was not so much a 
failure of the current regulatory system, including member firms' 
internal controls and supervisory practices, as it was the result of a 
single individual intent on defrauding his customers.\15\
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    \12\ See Franke SIA Letter and A.G. Edwards Letter.
    \13\ See Franke SIA Letter; A.G. Edwards Letter, Cadaret Letter, 
and Schwab Letter.
    \14\ See Cadaret Letter, Franke SIA Letter, and A.G. Edwards 
Letter.
    \15\ See Franke SIA Letter.
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    The NYSE responded that it believed the authority carried by 
changes to Exchange rules and their interpretations was necessary to 
effectively induce appropriate conduct in this area. The Exchange, 
however, as discussed in greater detail below, agreed that greater 
flexibility would address the varied business organization models that 
its membership represents and provided certain changes to its proposed 
rules to account for such variation.

B. Independent Supervision of Managers' Activity

1. Original Proposal and Comments Received
    NYSE Rule 342.19, as originally proposed, would require that 
members develop written policies and procedures reasonably designed to 
independently review and supervise the customer account activity of 
Sales Managers, Regional/District Sales Managers, Branch Office 
Managers, or any person performing a similar supervisory function 
(collectively, ``Producing Managers''). Some commenters sought 
clarification of the ``independent supervision'' standard.\16\ The same 
commenters suggested that individuals within a firm at equal or higher 
organizational levels, peripherally involved, or who receive an 
indirect benefit from the activity being reviewed may, nevertheless, 
have sufficient independence to supervise Managers.\17\
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    \16\ See Franke SIA Letter; A.G. Edwards; and Schwab Letter.
    \17\ Id.
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    In Amendment No. 2, the NYSE proposed amendments to its Rule 342.19 
to clarify that reviews of Producing Managers' customer account 
activity may be conducted by a ``qualified person,'' provided such 
person is senior to the manager (i.e., not any person with the same job 
function as the manager or any person subordinate to the manager). The 
proposed rule has also been revised to make clear that the ``qualified 
person'' standard, in the context of NYSE Rule 342.19, is defined by 
NYSE Rule 342.13, which, among other things, requires a creditable 
three-year record as a registered representative or equivalent 
experience and passing specified supervisory qualification examinations 
administered by the NASD and acceptable to the NYSE, such as the Series 
9/10 or the Series 24 exams.
    One commenter suggested, in response to Amendments No. 2 and 3, 
that the Rule allow for review by ``sufficiently independent'' persons 
``at equal levels of seniority,'' such as administrative managers who 
are ``outside the * * * manager's reporting line'' and, thus, able to 
act ``without fear of reprisal'' by the Producing Manager.\18\ The NYSE 
responded that customer account activity of Producing Managers is a 
serious and sensitive regulatory area. Nevertheless, while the Exchange 
takes the position that there are advantages when a Producing Manager's 
activity is reviewed by a person senior to that Manager, the Exchange 
recognizes that such arrangements might not be practical for very small 
firms. Further, the Exchange agrees that establishing an alternative 
``independence'' standard for those supervisory persons designated to 
review a Producing Managers' customer activity is a reasonable and 
effective means to provide administrative flexibility.
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    \18\ See Polanin SIA Letter.
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2. Current Proposal
    Thus, in Amendment No. 4 to proposed NYSE Rule 342.19(a), the 
Exchange proposes to permit supervisory reviews to be conducted by a 
qualified person who is either senior to or ``otherwise independent'' 
of the Producing Manager under review. NYSE proposes to define an 
``otherwise independent'' person as one who does not report either 
directly or indirectly to the Producing Manager under review, is not in 
the same office as the Producing Manager, does not otherwise have 
supervisory responsibility over the activity being reviewed, and 
alternates review of the Producing Manager with another qualified 
person at least every two years.
    In addition, the NYSE is proposing to require that ``alternate'' 
independent supervision of a Producing Manager by another qualified 
person be established if the person designated to review a Producing 
Manager receives an override or other income derived from that 
Producing Manager's customer activity

[[Page 35110]]

that represents more than 10% of the designated person's gross income 
derived from the member over the course of a rolling 12-month period.
    Finally, in Amendment No. 4 to Exchange Rule 342.19(b), NYSE 
proposes an exception for members so limited in size and resources that 
there is no qualified person senior to, or otherwise independent of, 
the Producing Manager to conduct the review. In such a situation, the 
NYSE proposes to allow another person who is a ``qualified person,'' 
but not senior to or otherwise independent of the Producing Manager, to 
conduct the review in compliance with the Rule's independence 
provisions to the extent practicable. As provided in proposed Exchange 
Rule 342.19(c), if a member needs to rely on the exception in NYSE Rule 
342.19(b), the member must document all the factors used to determine 
why complete compliance with the Rule is not possible and that the 
procedures in place comply with the Rule to the extent practicable.\19\
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    \19\ For example, the review of a Producing Manager may not be 
conducted by a qualified non-senior person in the Producing 
Manager's office if a qualified senior, or otherwise independent, 
person is available in another office of the member organization.
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C. Internal Controls

1. Original Proposal and Comments Received
    Proposed NYSE Rule 342.23 requires members and member organizations 
to develop and maintain adequate internal controls over each of their 
business activities. The proposed rule further requires that such 
controls provide for the establishment of procedures for independent 
verification and testing of those business activities. Some commenters 
sought clarification as to who would be sufficiently ``independent'' to 
perform these verification and testing functions.\20\ While the 
commenters acknowledged that supervisors lack sufficient independence 
to verify and test procedures they personally implement, they 
nonetheless seek regulatory flexibility to accommodate a variety of 
supervisory structures beyond self-supervision.\21\ Commenters 
contended that senior supervisors in a hierarchal supervisory structure 
should not be excluded simply because they may derive an indirect 
benefit from the activity under review.\22\
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    \20\ See Franke SIA Letter; Schwab Letter; and A.G. Edwards 
Letter.
    \21\ Id.
    \22\ See Franke SIA Letter; and Schwab Letter.
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    In response, the Exchange stated that it recognized the far-ranging 
scope and variety of activities subject to the verification and testing 
requirements. In Amendment No. 2, the Exchange deleted the requirement 
that internal control procedures be ``separate and apart from the day-
to-day supervision of such functions'' from the proposed amendments to 
NYSE Rule 342.23 to allow greater flexibility in establishing such 
internal controls. However, the Exchange stated that firms would be 
expected to make an informed determination that persons responsible for 
verification and testing of business activities are sufficiently 
independent and qualified to do so effectively.
    Commenters also sought clarification and assurance that the 
proposed requirements would not create an obligation for firms to 
annually test and verify ``every aspect'' of their supervisory 
procedures, but rather allow for a ``risk-based approach'' based upon 
ongoing assessments of the firm's business.\23\ In Amendment No. 2, the 
NYSE proposed to revise NYSE Rule 342.23 to allow for an ongoing 
analysis, based upon appropriate criteria, to assess and prioritize 
those business activities requiring independent verification and 
testing.
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    \23\ See Franke SIA Letter; and A.G. Edwards Letter.
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    One commenter recommended that the ``NASD CEO Certification Rule'' 
be applicable to NYSE firms.\24\ The NYSE noted that the NASD did not 
address the issue of CEO certification in the context of its 
corresponding proposed rule change addressing internal and supervisory 
controls.\25\ Accordingly, the NYSE will evaluate the appropriateness 
of a comparable requirement separate and apart from the instant filing.
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    \24\ See NASAA Letter.
    \25\ See Exchange Act Release No. 48298 (August 7, 2003), 68 FR 
48421 (August 13, 2003) (SR-NASD-2002-162) (notice of filing of 
Amendment Nos. 1 and 2 by the NASD relating to supervisory control 
amendments).
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2. Current Proposal
    As amended in response to comments, proposed NYSE Rule 342.23 would 
require that a member or member organization develop and maintain 
adequate controls over each of its business activities, including ones 
that provide for the establishment of procedures for independent 
verification and testing of those business activities. The member may 
employ an ongoing analysis, based upon appropriate criteria, to assess 
and prioritize those business activities that require independent 
verification and testing at a given time. The member must include a 
summary of its efforts, including a summary of the tests conducted and 
significant exceptions identified, in the Annual Report that it submits 
to its chief executive officer or managing partner, pursuant to 
Exchange Rule 342.30. In addition, the proposed rule provides an 
exemption from the independent verification and testing procedures for 
those members that do not conduct a public business, have a capital 
requirement of $5,000 or less, or that employ ten or fewer registered 
representatives. The proposed rule also cross references proposed 
Exchange Rule 401(b), which would establish certain categories of 
activities for which members are required to maintain written policies 
and procedures administered pursuant to proposed NYSE Rule 342.23.

D. Annual Branch Office Inspections

1. Original Proposal and Comments Received
    The NYSE originally proposed to amend Rule 342(a)(b)/03 in the NYSE 
Interpretation Handbook to require that annual branch office 
inspections be conducted by a person who is ``independent'' of the 
direct supervision or control of the branch office, including Branch 
Office Manager, Sales Managers, District/Regional Managers assigned to 
the office, or any other person performing a similar supervisory 
function.
    One commenter suggested that imposing this amendment would be 
economically burdensome to firms, possibly leading firms to hire 
supervisors or outsource the inspection function at significant cost to 
the firm.\26\ In addition, commenters sought clarification as to who 
would be sufficiently independent to conduct the annual 
inspections.\27\ Commenters suggested that supervisors, who are part of 
the direct supervision or control of the branch office and are the most 
familiar with registered representatives and activities located at 
particular offices, are in the best position to review the activities 
of a branch office, identify weaknesses, and take corrective 
action.\28\ One commenter noted that the size and structure of some 
firms may mean that no individual within the firm could be considered 
``independent.'' \29\ Some commenters suggested that scenarios 
involving inspection by supervisory personnel in a hierarchical 
supervisory system may be sufficiently outside the day-to-day chain of 
command to meet the ``independence''

[[Page 35111]]

standard.\30\ Another commenter suggested that firms should have the 
flexibility to design internal control systems that conform to the 
nature of the business conducted by the member.\31\ In addition, a 
commenter asserted that business line supervisors' auditing of branch 
and satellite offices serves to reinforce their accountability for the 
registered representatives' actions.\32\
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    \26\ See Pace Letter.
    \27\ See Franke SIA Letter; Schwab Letter; and A.G. Edwards 
Letter.
    \28\ See Schwab Letter, and Franke SIA Letter.
    \29\ See Franke SIA Letter.
    \30\ See Franke SIA Letter; and A.G. Edwards Letter.
    \31\ See Schwab Letter.
    \32\ Id.
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    In response to the commenters' concerns, the NYSE stated its belief 
that in order for a branch inspection program to be effective, it needs 
to include reasonable guidelines to minimize conflicts of interest. The 
Exchange also suggested that such guidelines should not exclude all 
participants at every level of a branch office's hierarchal supervisory 
structure, but that it was reasonable to exclude the branch manager and 
any person to whom the branch manager directly reports.
    Accordingly, in Amendment Nos. 2 and 3, the NYSE amended Rule 
342(a)(b)/03 in the NYSE Interpretation Handbook to delete the 
characterization of Sales Managers, District/Regional Managers assigned 
to an office, or any other person performing similar supervisory 
function as individuals not independent of the direct supervision or 
control of the branch office, but retained the characterization of 
Branch Office Managers as not being independent. The Exchange also 
added persons who report to a Branch Office Manager, and any person to 
whom such manager directly reports, to the list of people who are 
deemed not ``independent'' for the purposes of NYSE Rule 342(a)(b)/03 
in the Exchange Interpretation Handbook.
    Commenters raised the concern that the proposed amendments, in 
conjunction with a pending NYSE rule proposal \33\ to amend the 
definition of ``branch office,'' would increase the burden with respect 
to annual inspections for firms with far-reaching branch networks.\34\ 
The Exchange currently requires, absent a specific waiver, annual 
inspections of each branch office location.\35\ The Exchange responded 
that pending NYSE Rule amendments relating to the definition of a 
``branch office'' would significantly reduce the types of locations 
required to be registered as branch offices. Accordingly, the NYSE 
believes that the number of branch office inspections required of each 
member organization would be reduced. NASAA also requested 
clarification that a person conducting a branch office inspection 
cannot be a person who directly or indirectly reports to the sales 
manager of the office.\36\ The NYSE agreed and is adding this 
clarification to the Interpretation of the Rule in Amendment No. 4. The 
NYSE represents that the wording ``any person who reports to such 
Manager'' is intended to be broadly construed to encompass all persons 
who report, directly or indirectly, to a Manager.
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    \33\ The NYSE submitted a proposed rule change amending the 
definition of ``branch office' to include, with certain limited 
exceptions, any location, other than a main office, where one or 
more associated persons of a member organization regularly conduct 
the business of effecting any transactions in or inducing or 
attempting to induce the purchase or sale of any security, or is 
held out as such. See Securities Exchange Act Release No. 46888 
(November 22, 2002), 67 FR 72257 (December 4, 2002) (SR-NYSE-2002-
34).
    \34\ See A.G. Edwards Letter, Franke SIA Letter and Chamberlain 
SIA Letter.
    \35\ See Rule 342(a)(b)/03 in the NYSE Interpretation Handbook.
    \36\ See NASAA Letter.
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    Finally, NASAA suggests requiring all branch office inspection 
reports be sent to the member organization's compliance department 
directly and then delivered to the branch office.\37\ The Exchange does 
not intend to amend the proposed rule in this regard as it believes 
that each member organization should address to whom within the firm an 
inspection report must be sent in its policy and procedures manual.
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    \37\ Id.
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2. Current Proposal
    Thus, the NYSE proposes to amend Rule 342(a)(b)/03 in the NYSE 
Interpretation Handbook to require that the branch office inspections 
that are to be conducted at least annually be conducted by a person who 
is ``independent'' of the direct supervision or control of the branch 
office, including the Branch Office Manager, any person who reports 
directly or indirectly to such Manager, or any person to whom such 
Manager directly reports. Accordingly, the Exchange is amending Rule 
342(a)(b)/03 in the NYSE Interpretation Handbook to clarify that the 
person conducting the inspection may not be someone that directly or 
indirectly reports to a Manager. The NYSE proposes that members conduct 
inspections at least annually, absent a demonstration to the 
satisfaction of the Exchange that because of proximity, special 
reporting or supervisory practice, other arrangements may satisfy the 
supervisory requirements provided for in the NYSE Rule 342. The 
proposed rule change, as amended, also provides that a written 
authorization by the Exchange of an alternative arrangement to the 
annual inspections would suffice for recordkeeping purposes.
    In addition, the NYSE proposes to require that office inspections 
include, without limitation, the testing and independent verification 
of the member's internal controls 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.

E. Written Policies and Procedures for Certain Customer Activities

1. Original Proposal and Comments Received
    Proposed NYSE Rule 401(b) requires each member and member 
organization to maintain written policies and procedures, administered 
pursuant to the internal control requirements prescribed under proposed 
NYSE Rule 343.23, that specifically address transmittals of customer 
funds or securities between accounts, changes in investment objectives, 
and changes of address. These designated policies and procedures must 
include a method of customer confirmation, notification, or follow-up 
that can be documented.
    One commenter requested that these requirements apply only to 
retail accounts.\38\ An ``institutional carve-out'' was sought on the 
grounds that much institutional business is done ``delivery versus 
payment,'' ``receipt versus payment,'' or through prime brokerage 
accounts. Another commenter suggested that, since institutional trading 
processes, systems, and controls are so distinct from retail account 
servicing, the proposed Rule 401 requirements should apply to retail 
activity but have ``limited, if any, application to institutional 
business.'' \39\
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    \38\ See Franke SIA Letter.
    \39\ See Polanin SIA Letter.
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    The Exchange believes that an exemption for institutional accounts 
is inappropriate, notwithstanding the concerns raised in the comment 
letters. The NYSE states that in order for an internal controls policy 
to be effective, it must be comprehensive. Accordingly, the Exchange 
believes that it is reasonable and appropriate that regulatory 
oversight in the sensitive areas designated in proposed NYSE Rule 
401(b) should extend to institutional account activity.

[[Page 35112]]

2. Current Proposal
    Thus, the proposed amendments to NYSE Rule 401 would require 
members and member organizations to maintain written policies and 
procedures, administered pursuant to the internal control requirements 
prescribed under NYSE Rule 342.23, specifically with respect to 
transmittals of customer funds or securities, customer changes of 
address, and customer changes of investment objective. The policies and 
procedures must include a means/method of customer confirmation, 
notification, or follow-up that can be documented.

F. Discretionary Accounts

1. Original Proposal and Comments Received
    As originally proposed, changes to existing NYSE Rule 408(d) 
provided that a member retains time and price discretion on behalf of 
its customer until the end of the day on which the order was given to 
the member, absent written authorization to the contrary. Several 
commenters suggested that the one-day time and price discretionary 
authority should be limited only to retail accounts and that NYSE 
should craft an exemption for institutional accounts.\40\ Commenters 
argued that large orders for institutional accounts are ``worked'' over 
more than a day on a good-till-cancelled/not-held basis.
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    \40\ See A.G. Edwards Letter, Schwab Letter, and Franke SIA 
Letter.
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    NYSE responded that it believes that a general institutional 
exemption is inappropriate. However, the Exchange responded to the 
comments by revising its Rule to provide 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 handled by 
floor brokers pursuant to valid good-till-cancelled instructions issued 
on a ``not held'' basis.
    One commenter requested that NYSE 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.\41\ The NYSE responded that 
Exchange Rule 408(d) clearly limits the exercise of time and price 
discretion to a single transaction and that customers may grant more 
extensive discretionary authority by executing a trading authorization 
with their registered representative. Another commenter noted that by 
limiting the institutional exemption to ``floor broker'' orders, the 
NYSE may inappropriately be its own market, and creating a regulatory 
disincentive for firms to access other marketplaces.\42\ In response, 
the Exchange stated in Amendment No. 4 that it agreed the institutional 
exemption need not apply solely to NYSE floor brokers.
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    \41\ See Franke SIA Letter.
    \42\ See Polanin SIA Letter.
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2. Current Proposal
    Accordingly, the NYSE proposes to amend NYSE Rule 408(d) so that 
the limitation would not apply to time and price discretion exercised 
in an ``institutional account'' pursuant to valid good-till-cancelled 
instructions issued on a not-held basis and to remove the limitation of 
the exemption to situations where ``floor brokers'' exercise such price 
and time discretion. The Exchange also proposes to require that any 
exercise of time and price discretion be reflected on the order ticket. 
This would provide an exception to the general rule that restricts a 
broker's authority to exercise time and price discretion 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.
    In Amendment No. 4, the Exchange proposes to define an 
``institutional account'' to mean ``the account of (i) a bank (as 
defined in Section 3(a)(6) of the Securities Exchange Act of 1934), 
(ii) a savings association (as defined in Section 3(b) of the Federal 
Deposit Insurance Act), the deposits of which are insured by the 
Federal Deposit Insurance Corporation, (iii) an insurance company (as 
defined in Section 2(a)(17) of the Investment Company Act of 1940), 
(iv) an investment company registered with the Securities Exchange 
Commission under the Investment Company Act of 1940, (v) a state or a 
political subdivision thereof, (vi) a pension or profit sharing plan, 
subject to ERISA, with more than $25,000,000 total assets under 
management, or of an agency of the United States or of a political 
subdivision thereof, (vii) any person that has a net worth of at least 
forty-five million dollars and financial assets of at least forty 
million dollars, or (viii) an investment adviser registered under 
Section 203 of the Investment Advisers Act of 1940.''
    One commenter suggests a means of communicating this time and price 
discretion restriction to clients to create ``an additional safeguard 
against potential abuse,'' since client awareness of the restriction 
would allow them to ``check the behavior of member associates.'' \43\ 
The NYSE responded that, as a practical matter, brokers will need to 
inform clients who grant time and price discretionary authority that a 
``same-day'' restriction is in effect with respect to that authority. 
The Exchange believes that the Information Memorandum to be issued in 
conjunction with an approval of the proposals will remind registered 
representatives and firms of their obligations in this regard.
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    \43\ See Pace Letter.
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G. Maintenance of ``Account Designation Change'' Documentation

1. Original Proposal and Comments Received
    The proposed amendments to NYSE Rule 410 would enhance the 
recordkeeping requirements for orders that members receive. Currently, 
Exchange Rule 410 requires members and member organizations to preserve 
a record of certain information about every order transmitted or 
carried to the floor of the Exchange and prescribes procedures for 
administering changes in account name or designation.
    In addition to certain technical changes, the original proposed 
amendments to NYSE Rule 410 would expand the application of the Rule to 
orders sent to all marketplaces, not just the floor of the Exchange. 
The original proposal also would require that any person who approves 
account name or designation changes be qualified by passing an 
examination acceptable to the Exchange, such as the NASD Series 9/10 or 
the Series 14. In addition, the original proposed rule change would 
clarify that the Rule applies to all account name and designation 
changes, including related accounts and error accounts. Furthermore, 
the proposal would require written documentation of the essential facts 
relied upon when approving an account name or designation change and 
that such documentation is to be maintained in a ``central location.'' 
One commenter sought clarification that such documentation be 
maintained ``in a location where the determination and approval occurs, 
not in the Home Office'' so as to avoid a ``duplicate record.'' \44\
---------------------------------------------------------------------------

    \44\ See A.G. Edwards Letter.
---------------------------------------------------------------------------

    The Exchange responded that it believes that the determination of 
where such documentation should be retained would depend on the 
supervisory structure of the firm. Typically, the ``central location'' 
would be where the account name or designation change

[[Page 35113]]

was approved. However, the NYSE believes that the proposed rule 
amendments should not be construed to be determinative of precisely 
where such records should be maintained, nor discourage maintenance of 
records in more than one location if regulatory purposes are well 
served by doing so.
2. Current Proposal
    In response to the comment, the Exchange has proposed to delete the 
requirement that relevant documentation be maintained in ``a central 
location'' and to replace the phrase with the requirement that such 
documentation be maintained for three years, the first two in an 
``easily accessible place,'' consistent with the meaning of that term 
in Rule 17a-4 under the Act.\45\ The remainder of the current proposal 
to amend NYSE Rule 410 remains the same as the original proposal.
---------------------------------------------------------------------------

    \45\ See 17 CFR 240.17a-4.
---------------------------------------------------------------------------

H. Effective Date

    Commenters expressed concern that the effective date of any new 
requirements allow adequate time to enable firms to make necessary 
systems changes in an efficient and cost-effective manner.\46\ 
Accordingly, the Exchange intends to establish an effective date six 
months from Commission approval of the proposed rule change, as 
amended, to allow members and member organizations sufficient time to 
address any necessary procedural or systems changes.
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    \46\ See Franke SIA Letter and A.G. Edwards Letter.
---------------------------------------------------------------------------

III. Discussion

    After careful review, the Commission finds that the proposed rule 
change, as amended, is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to a national 
securities exchange.\47\ In particular, the Commission finds that the 
proposal, as amended, is consistent with the provisions of section 
6(b)(5) of the Act,\48\ which requires, among other things, that a 
national securities exchange's rules be designed, to prevent fraud and 
manipulative acts and practices, to promote just and equitable 
principles of trade, to remove impediments to and to perfect the 
mechanism of a free and open market and a national market system and, 
in general, to protect investors and the public interest. The 
Commission finds that the NYSE proposal, as amended, is designed to 
accomplish these ends by requiring members to monitor certain conduct 
of employees that handle customer accounts, to establish more extensive 
supervisory and internal control procedures for customer accounts, and 
to enhance the annual inspection requirements that members undertake. 
The Commission also believes that the proposed rule change, as amended, 
may reduce the potential for customer fraud and theft of customers' 
identities and funds.
---------------------------------------------------------------------------

    \47\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).
    \48\ 15 U.S.C. 78f(b)(5).
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A. Independent Supervision of Producing Managers' Activity

    Proposed Exchange Rule 342.19 is designed to provide for the 
independent supervision of the customer account activity that is 
effected by Producing Managers. In response to commenters' requests for 
clarity as to who would be considered ``independent'' of a Producing 
Manager for purposes of performing the supervisory reviews, the NYSE 
specified in Amendment No. 3 that someone ``qualified'' as a supervisor 
pursuant to NYSE Rule 342.13 \49\ that is senior to the Producing 
Manager under review would be sufficiently independent of the Producing 
Manager. In response to comments to proposed NYSE Rule 342.19 that 
advocated non-senior, but independent peer managers to be able to 
conduct supervisory reviews, the NYSE adopted a more flexible approach 
where a person who is senior or ``otherwise independent'' of the 
Producing Manager could conduct the review of the Manager. The Exchange 
also provided that if the senior or otherwise independent person 
received more than 10% of his or her gross income from the Producing 
Manager under review through overrides or other income derived from the 
Producing Manager's customer activity, the member must provide that an 
alternate independent qualified person supervise the Producing Manager. 
In addition, the Exchange established an exception for firms that, by 
reason of limitations in size and/or resources, could not provide a 
supervisor who is ``senior to or otherwise independent of'' the 
Producing Manager or a supervisor that receives 10% or less of his or 
her income as commission overrides from the Producing Manager (e.g., if 
the firm has only one office, or an insufficient number of qualified 
personnel who can conduct reviews on a two-year rotation).\50\ If a 
firm relies on this exception, it must document the factors used to 
determine that complete compliance is not possible, and in any event it 
must comply with the senior or otherwise independent standard to the 
extent practicable.\51\ The Commission expects the NYSE to carefully 
monitor member compliance with the requirements for invoking this 
exception.
---------------------------------------------------------------------------

    \49\ NYSE Rule 342.13 provides, inter alia, that a person may 
qualify as a supervisor if he or she passes the NASD Sales 
Supervisor Qualification Examination (Series 9/10) or another 
examination or the NASD General Securities Principal Examination 
(Series 24).
    \50\ SeeStaff Legal Bulletin No. 17: Remote Office Supervision, 
Division, Commission, fn 39 (March 19, 2004).
    \51\ For example, the supervisory review of a Producing Manager 
may not be conducted by a qualified non-senior person in the 
Producing Manager's office if a qualified senior, or otherwise 
independent, person is available in another office of the member 
organization.
---------------------------------------------------------------------------

    The Commission believes that the supervision of managers is an 
important component to an effective internal control system that seeks 
to monitor the business activity of a member. Because managers often 
conduct the day-to-day supervision of their branch, division, or 
region, the Commission believes that it is important that they are 
themselves monitored for their dealings with customer accounts. The 
Commission believes that a ``qualified'' supervisor under NYSE Rule 
342.13--such as a person registered as a Sales Supervisor (NASD Series 
9/10) or Principal (NASD Series 24)--possesses a sufficiently high 
level of expertise to understand the issues that arise during the 
reviews. Moreover, the Commission believes that Exchange's requirement 
that the supervisor be ``senior to or otherwise independent of'' the 
Producing Manager, and the standards proposed to define ``otherwise 
independent,'' should diminish the likelihood that the supervisory 
review would be conducted less than vigorously because of the self-
interest of the reviewer. In addition, the Commission believes that the 
NYSE's proposed documentation requirement, for members desiring to rely 
on the ``small firm'' exception, should encourage members to attempt 
earnestly to comply with the requirement that the supervisor be senior 
to or otherwise independent of the Producing Manager under review.

B. Supervisory Controls and Independent Testing and Verification and 
Written Polices and Procedures for Certain Customer Activities

    The NYSE proposes to require that its members develop and maintain 
adequate controls over each of their business activities. Under 
proposed Exchange Rule 342.23, these controls must provide for 
procedures for the independent verification and testing of

[[Page 35114]]

their business activities. The portion of the original proposal that 
required that the internal control procedures be ``separate and apart 
from the day-to-day supervision of such functions'' has been removed 
from the proposal. In response to commenters' concerns, the Exchange 
added a provision to enable members to perform an analysis on an 
ongoing, risk-based basis, to assess and prioritize those business 
activities requiring independent verification and testing, apart from 
the ongoing supervision that results from such procedures. The proposed 
rule also provides an exemption from the independent verification and 
testing procedures for those members who do not conduct a public 
business, have a capital requirement of $5,000 or less, or that employ 
ten or fewer registered representatives. Each member must include a 
summary of its efforts in the Annual Report that it files with its 
chief executive officer or managing partner, pursuant to Exchange Rule 
342.30.
    Further, proposed NYSE Rule 401(b) would require that members 
maintain written polices and procedures, administered pursuant to the 
internal control requirements of NYSE Rule 342.23, that address 
specified types of business conduct (transmittals of funds or 
securities from customer accounts or between customers and registered 
representatives, customer changes of address, and customer changes of 
investment objectives). The policies and procedures for these specified 
activities must include a method of customer confirmation, 
notification, or follow-up that can be documented. The Exchange, in 
response to comments, affirmed that the proposed rule would apply to 
business conduct affecting both institutional and retail accounts.
    The Commission believes that proposed Exchange Rule 342.23, 
requiring NYSE members to develop adequate controls of their business 
activities, will enhance the quality of members' supervision and that 
such enhancement is appropriate. Because members are specifically 
required to maintain adequate controls over each of their business 
activities, members should be compelled to develop a supervisory system 
that, among other things, monitors the areas of business conduct that 
present a particular risk for the misappropriation of a customer's 
funds, securities, or account information. In this regard, the 
Commission notes that members would be required to maintain written 
policies and procedures for the activities that proposed NYSE Rule 
401(b) identifies. The Commission believes that the proposed rules 
should help to make customers less vulnerable to members' 
misappropriating their funds, securities or account information. The 
Commission further believes that applying the requirements of NYSE Rule 
401(b) to institutional account activity is appropriate because the 
Commission believes a broker's representation of an institutional 
customer's account also presents a risk of the broker's mishandling of 
the account. The Commission also believes that the proposed rules 
provide sufficient flexibility to tailor different control procedures 
for different types of business activity, should circumstances warrant.
    The Commission believes that enabling members to employ an ongoing 
analysis to assess and prioritize those business activities requiring 
independent verification and testing provides member firms with 
sufficient flexibility to make risk-based judgments. Further, the 
Commission believes that the Exchange's removal of the requirement in 
the original proposal that the internal control procedures be 
``separate and apart from the day-to-day supervision of [business 
activities]'' should provide adequate flexibility for firms to 
establish internal controls. The Commission notes that the NYSE and the 
Commission expect members to make an affirmative, informed 
determination that persons responsible for verification and testing of 
all business activities are sufficiently independent and qualified to 
effectively conduct such verification and testing note. The Commission 
acknowledges that some firms lack the size and/or resources to 
establish procedures without undue hardship. Accordingly, the 
Commission believes that excepting members and member associations that 
do not conduct a public business or that employ ten or fewer registered 
representatives, is appropriate.

C. Annual Branch Office Inspections

    The Commission believes that the NYSE's proposal to enhance the 
requirements for annual internal branch office inspections in Rule 
342(a)(b)/03 of the NYSE Interpretation Handbook should increase the 
likelihood that fraudulent activity with respect to handling customer 
accounts will be detected in a timely manner. To this end, the NYSE 
proposed to require that the person conducting the annual branch office 
inspections to be ``independent'' of the direct supervision or control 
of the branch office, including the Branch Office Managers, Sales 
Managers, District/Regional Mangers assigned to the office, or any 
other person performing a similar supervisory function. In response to 
comment letters expressing concern about the breadth of the proposed 
``independence'' standard, the Exchange amended the proposal to narrow 
those excluded from being independent inspectors to the Branch Office 
Manager, any person who directly or indirectly reports to such manager, 
or any person to whom such manager directly reports.
    The Commission believes that prohibiting persons who are under the 
direct supervision or control of the branch office from conducting 
annual inspections of those same offices should reduce conflicts of 
interest and lead to more objective and vigorous inspections because 
persons who have a significant financial interest in the success of a 
branch office would be precluded from inspecting it. The Commission 
further believes that the NYSE's proposed changes in response to 
commenters' concerns about the independence standard clarify which 
persons are eligible to conduct an annual inspection.
    As part of the annual branch office inspection, the NYSE proposes 
that its members must independently verify and test the internal 
controls in several key areas including: safeguarding customer funds 
and securities, maintaining books and records, supervision of accounts 
serviced by branch office managers, transmittal of funds between 
customers and registered representatives or other third parties, 
validation of customer address changes, and validation of changes in 
customer account information.
    The Commission believes that the areas identified in particular by 
the NYSE as subject to testing and verification effectively reduce the 
possibility of fraudulent activity in important aspects of customer 
account handling, but are not so broad that members will be overly 
burdened by inspections. In forming this belief, the Commission notes 
that the areas specified for internal controls testing include two 
types of events (transmittal of funds between a customer and a 
registered representative or a third party, and customer change of 
address) that the NYSE has proposed to require in the annual branch 
office inspection in proposed Exchange Rule 401(b). The Commission also 
believes that testing of internal controls in the remaining categories 
should further protect customers' funds and securities, particularly 
from fraudulent transfer. Finally, the Commission believes that 
Exchange members can adequately address to whom within a firm an 
inspection report must be sent in its policy and procedures manual, as 
the

[[Page 35115]]

NYSE suggests in response to NASAA's comments.

D. Discretionary Accounts

    Currently, NYSE Rule 408(d) permits Exchange members to exercise 
discretion as to the time and price at which a customer order is 
executed beyond the day on which the customer grants the broker time 
and price discretion, without specific written authorization from the 
customer. The Commission believes that the NYSE's proposal to limit the 
time for such discretion to the end of the business day on which it was 
granted, absent a signed authorization from the customer to extend the 
authority beyond the business day, is appropriate. Such a requirement 
should limit the opportunity for misapplication of discretionary 
authority, thus furthering investor protection. The Commission also 
believes that this change will clarify for members and customers the 
length of time for which discretionary authority is granted in the 
ordinary course. Further, the Commission agrees with the NYSE that 
Exchange members must inform their customers that their authority to 
exercise time and price discretion terminates at the end of the day on 
which such discretion is granted, absent a signed authorization. The 
NYSE's Information Memorandum issued conjunction with this approval 
order is designed to remind members of this obligation.
    Commenters argued that the limited duration for the exercise of 
time and price discretion should be applied only retail accounts, not 
institutional accounts. NYSE chose not to include a general 
institutional exemption, but instead amended NYSE Rule 408 to provide a 
limited exception from the requirement to obtain written authorization 
for good-till-cancelled orders for institutional accounts where 
discretion is exercised on a ``not held'' basis. The Commission 
believes that this exception from the general rule will provide members 
handling institutional accounts the flexibility they require while 
still providing adequate protection over client accounts. The 
Commission further believes that modifying the amendment to extend the 
institutional exception to include marketplaces other than the NYSE is 
consistent with principles of fair competition.

E. Maintenance of ``Account Designation Change'' Documentation

    The Commission believes that the proposed amendments to Exchange 
Rule 410 will enhance the quality of the records that members maintain 
relating to customer orders and changes in customer account names or 
designation. The Commission believes that requiring members to preserve 
records of all orders for at least three years will provide an examiner 
with a more complete record of the orders that a member receives, not 
limited to just those orders transmitted to or carried by the member to 
the Floor of the Exchange.
    The Commission also believes that enhancing the recordkeeping 
standards and qualification standards for the review of customer 
account name and designation changes is consistent with the protection 
of investors and the public interest. The Commission believes that 
requiring the qualified person to memorialize the reasons why he or she 
approved such a change should enhance the scrutiny that the qualified 
person exercises when reviewing the underlying facts giving rise to an 
account designation change. The Commission further believes that 
requiring the record of such approval to be maintained for two years in 
an ``easily accessible place,'' as that term is used in Rule 17a-4 
under the Act, clarifies the appropriate repository for such records. 
Finally, the Commission believes that specifying that only persons 
passing an examination acceptable to the Exchange is appropriate and 
clarifies what types of persons can approve such a change.

F. Effective Date of Proposed Rule Change

    The Commission notes that NYSE has proposed an effective date for 
the proposed rule change of six months from the date of Commission 
approval. The Commission recognizes that the proposed rule change may 
require members to make procedural or systems changes, and therefore 
believes that it is appropriate to delay the effective date of this 
proposed rule change for six months. Accordingly, the effective date of 
the proposed rule change shall be December 17, 2004.

IV. Amendment No. 4

    The Commission finds good cause for approving Amendment No. 4 prior 
to the thirtieth day after the date of publication of notice thereof in 
the Federal Register. In Amendment No. 4, the NYSE proposed further 
amendments to NYSE Rules 342.19, 408(d), 408.11, and Rule 342(a)(b)/.03 
in the NYSE Interpretation Handbook in response to concerns raised by 
commenters.\52\ In Amendment No. 4, NYSE made certain technical 
changes, in response to commenters, to the requirements related to the 
supervision of managers under proposed Exchange Rule 342.19 to allow 
flexibility for ``independent'' but ``non-senior'' persons to conduct 
supervisory reviews of Producing Managers.\53\ In the Amendment, the 
NYSE provided that both senior and ``otherwise independent'' persons 
may conduct supervisory reviews of Producing Managers, defined the term 
``otherwise independent,'' and precluded supervisory reviews by persons 
earning more than 10% of their gross income from the production of the 
Producing Manager under review. Further, in response to commenters, the 
NYSE created a small firm exception to these standards for cases where 
the member is demonstrably so limited in size and resources, that there 
is no qualified person senior to, or otherwise independent of, the 
manager to conduct the supervisory reviews. The Commission, however, 
expects the NYSE to closely monitor the use of this exception to be 
certain that only members for whom the exception is intended take 
advantage of it and this exception is not abused. The Commission 
believes that the proposed changes in Amendment No. 4 provide for an 
appropriate level of enhanced flexibility for those firms that, because 
of size or structure, cannot appropriately designate a senior person to 
conduct supervisory reviews of a Producing Manager. The Commission 
further believes that precluding supervisory reviews from being 
conducted by a person who receives a greater than 10% of his or her 
income as an ``override'' from the activity of the Producing Manager 
under review appropriately balances the interest of customer protection 
and the efficiency of the supervision process.
---------------------------------------------------------------------------

    \52\ See Section II, supra.
    \53\ See Polanin SIA Letter.
---------------------------------------------------------------------------

    In addition, in response to commenters, the Exchange, in Amendment 
No. 4, broadened the applicability of the exception to the proposed 
limitations on time and price discretion pursuant to the Exchange Rule 
408(d) amendments to apply to any member that receives valid good-till-
cancelled instructions issued on a ``not-held'' basis for an 
institutional account. The Commission believes that extending the 
exemption to marketplaces other than the NYSE is consistent with 
principles of fair competition.
    Finally, in response to comments, the NYSE amended its annual 
branch office inspection rule to clarify that any person who directly 
or indirectly reports to a Branch Office Manager cannot conduct an 
annual inspection of

[[Page 35116]]

that member. The Commission believes that this amendment to Rule 
342(a)(b)/03 in the NYSE Interpretation Handbook appropriately 
clarifies that branch office inspections may not be conducted by 
persons who indirectly report to the Branch Office Manager of the 
branch office under review. Therefore, for all of the foregoing reasons 
and the overall importance of the proposed rules, the Commission finds 
good cause for granting accelerated approval to Amendment No. 4 and 
believes that it is consistent with section 19(b)(2) of the Act.\54\
---------------------------------------------------------------------------

    \54\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------

V. Text of Amendment No. 4

    In Amendment No. 4, the NYSE proposed further amendments to NYSE 
Rules 342.19, 408(d) and 408.11, and Rule 342(a)(b)/03 in the NYSE 
Interpretation Handbook. The base text is that proposed in Amendment 
Nos. 1, 2, and 3 (i.e., how the rule would appear if only Amendment 
Nos. 1, 2 and 3 were approved by the Commission). Changes made by 
Amendment No. 4 are in italics; deletions are in brackets.
* * * * *
Offices--Approval, Supervision and Control
    Rule 342. (a) through (e) unchanged.
Supplementary Material.
    .10 through .18 (No Change.)
    .19 Supervision of Producing Managers.--Members and member 
organizations must develop and implement written policies and 
procedures reasonably designed to independently review and supervise 
customer account activity conducted by each Branch Office Manager, 
Sales Manager, Regional/District Sales Manager, or by any person 
performing a similar supervisory function. Such supervisory reviews 
must be performed by a qualified person pursuant to Rule 342.13 who: 
[is senior to the Manager under review.]
    (a) is either senior to, or otherwise independent of, the Producing 
Manager under review. For purposes of this Rule, an ``otherwise 
independent'' person: may not report either directly or indirectly to 
the Producing Manager under review; must be situated in an office other 
than the office of the Producing Manager; must not otherwise have 
supervisory responsibility over the activity being reviewed; and must 
alternate such review responsibility with another qualified person 
every two years or less. Further, if a person designated to review a 
Producing Manager receives an override or other income derived from 
that Producing Manager's customer activity that represents more than 
10% of the designated person's gross income derived from the member or 
member organization over the course of a rolling twelve-month period, 
the member or member organization must establish alternate senior or 
otherwise independent supervision of that Producing Manager to be 
conducted by a qualified person, pursuant to Rule 342.13, other than 
the designated person receiving the income.
    (b) If a member or member organization is so limited in size and 
resources that there is no qualified person senior to, or otherwise 
independent of, the Producing Manager to conduct the reviews pursuant 
to (a) above (for instance, the member or member organization has only 
one office, or an insufficient number of qualified personnel who can 
conduct reviews on a two-year rotation), the reviews may be conducted 
by a person, qualified pursuant to Rule 342.13, in compliance with (a) 
to the extent practicable.
    (c) A member or member organization relying on (b) above must 
document the factors used to determine that complete compliance with 
all of the provisions of (a) is not possible, and that the required 
supervisory systems and procedures in place with respect to any 
Producing Manager comply with the provisions of (a) to the extent 
practicable.
Discretionary Power in Customers' Accounts
Rule 408
    (a) through (c) unchanged.
    (d) The provisions of this rule shall not apply to 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 specified security shall 
be executed. 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 [by Floor 
brokers] in an institutional account pursuant to valid Good-Till-
Cancelled instructions issued on a ``not-held'' basis. Any exercise of 
time and price discretion must be reflected on the order ticket.
Supplementary Material.
    .10 No Change.
    .11 For purposes of this rule, an ``institutional account'' shall 
mean the account of (i) a bank (as defined in Section 3(a)(6) of the 
Securities Exchange Act of 1934), (ii) a savings association (as 
defined in Section 3(b) of the Federal Deposit Insurance Act), the 
deposits of which are insured by the Federal Deposit Insurance 
Corporation, (iii) an insurance company (as defined in Section 2(a)(17) 
of the Investment Company Act of 1940), (iv) an investment company 
registered with the Securities Exchange Commission under the Investment 
Company Act of 1940, (v) a state or a political subdivision thereof, 
(vi) a pension or profit sharing plan, subject to ERISA, with more than 
$25,000,000 total assets under management, or of an agency of the 
United States or of a political subdivision thereof, (vii) any person 
that has a net worth of at least forty-five million dollars and 
financial assets of at least forty million dollars, or (viii) an 
investment adviser registered under Section 203 of the Investment 
Advisers Act of 1940.
Interpretation
Rule 342 Offices--Approval, Supervision and Control
    (a)(b)
    /03 Annual Branch Office Inspection Branch office inspections by 
members and member organizations are expected to be conducted at least 
annually pursuant to this Rule, unless it has been demonstrated to the 
satisfaction of the Exchange that because of proximity, special 
reporting or supervisory practice, other arrangements may satisfy the 
Rule's requirements. All required inspections must be conducted by a 
person who is independent of the direct supervision or control of the 
branch office (i.e., not the Branch Office Manager, or any person who 
directly or indirectly reports to such Manager, or any person to whom 
such Manager directly reports). Written reports of these inspections, 
or the written authorization of an alternative arrangement, are to be 
kept on file by the organization for a minimum period of three years.
    An annual branch office inspection program must include, but is not 
limited to, testing and independent verification of internal controls 
related to the following areas:
    (1) Safeguarding of customer funds and securities,
    (2) Maintaining books and records,
    (3) Supervision of customer accounts serviced by Branch Office 
Managers,
    (4) Transmittal of funds between customers and registered 
representatives and between customers and third parties,
    (5) Validation of customer address changes, and

[[Page 35117]]

    (6) Validation of changes in customer account information.
    For purposes of this interpretation, ``annually'' means once in a 
calendar year.
* * * * *

VI. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether Amendment No. 4 
is consistent with the Act. Comments may be submitted by any of the 
following methods:

Electronic Comments.

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number SR-NYSE-2002-36 on the subject line.

Paper Comments.

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609.
    All submissions should refer to File Number SR-NYSE-2002-36. 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, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml). 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 Section, 450 Fifth 
Street, NW., Washington, DC 20549. Copies of such filing also will be 
available for inspection and copying at the principal office of the 
NYSE. All comments received will be posted without change; the 
Commission does not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly. All submissions should refer to File Number SR-
NYSE-2002-36 and should be submitted on or before July 14, 2004.

VII. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\55\ that the proposed rule change (SR-NYSE-2002-36), as amended, 
be, and it hereby is, approved, and Amendment No. 4 is approved on an 
accelerated basis.
---------------------------------------------------------------------------

    \55\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\56\
---------------------------------------------------------------------------

    \56\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-14230 Filed 6-22-04; 8:45 am]
BILLING CODE 8010-01-P