[Federal Register Volume 69, Number 180 (Friday, September 17, 2004)]
[Notices]
[Pages 56107-56110]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E4-2227]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50347; File No. SR-NASD-2003-176]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Amendments Nos. 1 and 2 Thereto by the National Association 
of Securities Dealers, Inc. Relating to Chief Executive Officer 
Certification and Designation of Chief Compliance Officer

September 10, 2004.

I. Introduction

A. Background

    On November 28, 2003, the National Association of Securities 
Dealers, Inc. (``NASD'') 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 Chief Executive 
Officer Certification and Designation of Chief Compliance Officer. The 
proposed rule change was published for comment in the Federal Register 
on December 31, 2003.\3\ The Commission received six comment letters in 
response to the proposed rule change.\4\
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Exchange Act Release No. 48961 (Dec. 23, 2003), 68 FR 75704 
(December 31, 2003). Subsequently, the Commission designated a 
longer period for Commission action and extended the comment period. 
Exchange Act Release No. 49129 (January 27, 2004), 69 FR 5228 
(February 3, 2004).
    \4\ See letters to Jonathan G. Katz, Secretary, Commission from: 
Laura Singer, Vice President and General Counsel, E*Trade Brokerage 
Holdings, Inc. dated February 11, 2004 (E*Trade Letter); George R. 
Kramer, Vice President and Acting General Counsel, Securities 
Industry Association, Paul A. Merolla, Executive Vice President, SIA 
Compliance and Legal Division, and Paul Saltzman, Executive Vice 
President and General Counsel, The Bond Market Association dated 
February 6, 2004 (``SIA/TBMA Letter''); Joan Hinchman, Executive 
Director, President, and CEO, National Society of Compliance 
Professionals, Inc. dated February 5, 2004 (``NSCP Letter''); and 
Christiane G. Hyland, Senior Vice President and General Counsel, 
Empire Corporate FCU dated January 21, 2004 (``Empire Letter''); 
Stephen A. Batman, CEO, 1st Global Capital Corp. dated January 21, 
2004 (``1st Global Letter''); and Herbert A. Pontzer, SVP/Chief 
Compliance Officer, NFP Securities, Inc. dated February 4, 2004 
(``NFP Letter''). The comments are available online at http://www.sec.gov/rules/sro/nasd/nasd2003176.shtml.
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    On March 8, 2004, NASD filed Amendment No. 1 to the proposed rule 
change.\5\ On July 15, 2004, NASD filed Amendment No. 2 to the proposed 
rule change.\6\
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    \5\ See letter from Philip A. Shaikun, Assistant General 
Counsel, NASD, to Catherine McGuire, Chief Counsel, Division of 
Market Regulation, Commission, dated March 8, 2004 (``Amendment No. 
1''). In Amendment No. 1, NASD proposed to add a requirement that 
the mandated meetings between the CEO and CCO include discussion of 
compliance system deficiencies, risks and resources.
    \6\ See letter from Philip A. Shaikun, Assistant General 
Counsel, NASD, to Catherine McGuire, Chief Counsel, Division of 
Market Regulation, Commission, dated July 15, 2004 (``Amendment No. 
2''). In Amendment No. 2, NASD eliminated the CCO certification 
requirement and added to the accompanying interpretive material a 
description of the CCO's role in the member's compliance scheme and 
the CEO certification required under this proposed rule.
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    On August 3, 2004, Amendments No. 1 and 2 were published for 
comment in the Federal Register.\7\ The Commission received eight 
comment letters in response to these amendments.\8\ For the reasons 
discussed below, the Commission is approving the proposal as amended.
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    \7\ Exchange Act Release No. 50105 (July 28, 2004), 69 FR 46603 
(August 3, 2004).
    \8\ See Letters to Jonathan G. Katz, Secretary, Commission from: 
Pamela Fritz, CCO, MWA Financial Services, Inc. dated August 6, 2004 
(``MWA Letter''); Stephen A. Batman, CEO, 1st Global, Inc. dated 
August 23, 2004 (``1st Global-2 Letter''); R. Bredt Norwood, General 
Counsel, NFP Securities, Inc. dated August 23, 2004 (``NFP-2 
Letter''); Barry S. Augenbraun, Senior Vice President and Corporate 
Secretary, Raymond James Financial, Inc. dated August 24, 2004 
(``Raymond James Letter''); S. Kendrick Dunn, Assistant Vice 
President, Pacific Select Distributors dated August 24, 2004 
(``Pacific Select Letter''); John Polanin, Jr., Chairman, SIA Self-
Regulation and Supervisory Practices Committee, and Paul A. Merolla, 
Executive Vice President, SIA Compliance and Legal Division dated 
August 24, 2004 (``SIA Letter''); Dale E. Brown, CAE Executive 
Director, CEO Financial Services Institute dated August 24, 2004 
(``FSI Letter''); Gregory E. Smith, President, Sunset Financial 
Services, Inc. dated August 24, 2004 (``SFS Letter''). The comments 
are available online at http://www.sec.gov/rules/sro/nasd/nasd2003176.shtml.
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B. NASD Notice to Members 03-29

    In June 2003, NASD issued Notice to Members 03-29, seeking comment 
on a proposal to require members to designate a Chief Compliance 
Officer (``CCO'') and have their CCOs and Chief Executive Officers 
(``CEOs'') annually certify that the member ``has in place adequate 
compliance and supervisory policies and procedures reasonably designed 
to comport with applicable NASD rules, MSRB rules and federal 
securities laws and rules.'' \9\ The proposal would have required, 
among other things, that the CCO and CEO

[[Page 56108]]

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. 
Interpretive material included in the rule proposal 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.
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    \9\ NASD Notice to Members 03-29. Notice to Members 03-29 is 
available online at http://www.nasdr.com/pdf-text/0329ntm.txt.
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    NASD received 166 comments on the proposal, most of which 
disfavored the proposal.\10\ According to NASD, commenters contended, 
among other things, that the proposal was duplicative of existing 
requirements. They also complained that the proposal could impose 
liability on the signatories in an unfair manner. Finally, they 
criticized the potential breadth of the certification.
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    \10\ Exchange Act Release No. 48961 (December 23, 2003), 68 FR 
75704, 75706 (December 31, 2003).
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    Although NASD disputed most of the criticism with the proposal, it 
acknowledged the difficulty in certifying to absolute compliance at any 
given moment in the face of dynamic regulatory and business 
environments. As a result, in its initial filing of this rule proposal 
with the Commission, in response to comments it received on Notice to 
Members 03-29, NASD changed the focus of the proposed certification 
from whether the member had ``adequate'' compliance and supervisory 
policies to whether the member had 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.\11\
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    \11\ Exchange Act Release No. 48961 (December 23, 2003), 68 FR 
75704 (December 31, 2003).
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II. Description

A. Description of the Proposal

    NASD's proposal seeks to provide a mechanism to compel substantial 
and purposeful interaction between senior management and compliance 
personnel to enhance the quality of members' supervisory and compliance 
systems. Specifically, NASD proposes to adopt new Rule 3013 requiring 
(1) That each member designate a principal to serve as CCO and (2) each 
member's CEO 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 and regulations.
    With respect to the certification, the proposed rule change also 
would require the CEO \12\ to certify annually that senior executive 
management has in place processes to (1) Establish, maintain and review 
policies and procedures reasonably designed to achieve compliance with 
applicable NASD rules, MSRB rules and federal securities laws and 
regulations; (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 federal securities laws and 
regulations. The proposed rule change further would require the CEO to 
certify that those processes are evidenced in a report that has been 
reviewed by the CEO and submitted to the member's board of directors 
and audit committee.\13\ The processes, at a minimum, must include one 
or more meetings annually between the CEO and CCO to (1) Discuss and 
review the matters that are the subject of the certification; (2) 
discuss and review the member's compliance efforts as of the date of 
such meetings; and (3) identify and address significant compliance 
problems and plans for emerging business areas.
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    \12\ The rule proposal originally filed by NASD with the 
Commission called for both the CEO and CCO to sign the certification 
but in response to comments, the CCO certification requirement was 
removed by Amendment No. 2. See Exchange Act Release No. 50105 (July 
28, 2004), 69 FR 46603 (August 3, 2004) at footnote 3.
    \13\ 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 CEO certification and gives further guidance 
as to the requirements and limitations of the proposed rule. The 
proposed interpretive material recognizes that responsibility for 
discharging compliance policies and written supervisory procedures 
rests with business line supervisors. The proposed interpretive 
material clarifies that consultation on the certification does not, by 
itself, establish a signatory as having such line supervisory 
responsibility.
    The proposed interpretive material also discusses what information 
must be included in 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 be 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. 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 proposed NASD Rule 3013, and that 
the entire report is provided in response to any regulatory request for 
all or part of the combined report.

B. Comment Summary

    The proposal was published for comment in the Federal Register on 
December 31, 2003.\14\ The SEC received six comment letters in response 
to the proposed rule change.\15\
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    \14\ Exchange Act Release No. 48961 (December 23, 2003), 68 FR 
75704 (December 31, 2004).
    \15\ See note 4 supra.
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    Three commenters generally supported requiring members to identify 
CCOs, prepare annual compliance reports, hold CEO/CCO meetings on the 
compliance function, and present the annual compliance report to their 
boards of directors and audit committees.\16\
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    \16\ See SIA/TBMA Letter; NSCP Letter; and E*Trade Letter.
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    Three commenters opposed the proposed rule change in its 
entirety.\17\ They argued it was duplicative of existing rules 
requiring members to establish and maintain supervisory systems.
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    \17\ See Empire Letter; NFP Letter; and 1st Global Letter.
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    Two commenters opposed the proposed CEO/CCO certification 
requirement included in the proposed rule change.\18\ They argued this 
certification was unnecessary in light of existing rules. These 
commenters also contended that CEO/CCO certification would weaken 
compliance by diverting compliance personnel from their day-to-day 
functions, and would increase CEO and CCO exposure to arbitration 
claims and legal actions.
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    \18\ See SIA/TBMA Letter; and E*Trade Letter.
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    One commenter opposed requiring the CCO to sign the certification 
alongside the CEO and called for further study on whether to have a CEO 
certification requirement.\19\ This commenter argued requiring CCO

[[Page 56109]]

certifications could compromise the ability of compliance officers to 
endorse novel approaches to new business or regulatory challenges.
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    \19\ See NSCP Letter.
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    In response to these comments and following additional discussions 
with SEC staff, NASD submitted Amendments No. 1 and 2, which, among 
other things, propose to eliminate the CCO certification requirement 
and incorporate into the accompanying interpretive material language 
that describes the obligations of the CCO with respect to a member's 
compliance scheme and the role the CCO must play to enable the CEO to 
make the certification that a member has in place compliance processes. 
The proposal, as amended by Amendment Nos. 1 and 2, was published for 
comment in the Federal Register on August 3, 2004. The SEC received 
eight comment letters in response to the proposed rule change.\20\
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    \20\ See note 8 supra.
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    The comments generally reiterated arguments made by earlier 
commenters. Four commenters supported the proposed rule change's 
requirement for designation of a CCO but opposed the proposed rule's 
requirement for CEO certification.\21\ Three commenters opposed the 
proposed rule change by reiterating arguments that the proposal was 
duplicative of existing rules and would place member CEOs and CCOs at 
undue liability risk.\22\ In a telephone conversation with staff, NASD 
staff stated its belief that as a general matter, the commenters' 
concerns discussed above had been raised previously and had already 
been addressed in Amendment Nos. 1 and 2.\23\
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    \21\ See FSI Letter; Raymond James Letter; SFS Letter; and NFP-2 
Letter.
    \22\ See 1st Global-2 Letter; Pacific Select Letter; and MWA 
Letter.
    \23\ Telephone call dated August 26, 2004 between Brian 
Baysinger, Special Counsel, Division and Philip Shaikun, Associate 
General Counsel, NASD.
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    One commenter supported the proposed rule change but expressed 
concern that some language in the Interpretive Material describing 
areas of expertise attributable to the CCO may create confusion if that 
language is compared with other language in the IM, and in other SRO 
rules, that recognize the possibility of allocation of some aspects of 
compliance functions to other firm personnel.\24\
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    \24\ See SIA Letter.
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    NASD staff stated that they believed other language in the 
Interpretive Material, including the statement that the CCO should have 
an expertise in ``evidencing the supervision by the line managers who 
are responsible for the execution of compliance policies'' rendered the 
language questioned by the commenter unambiguous. NASD staff also 
indicated they would monitor the implementation of the rule, and if 
aspects of the rule were confusing to members, NASD staff would 
consider developing Questions and Answers to clarify any aspects of the 
rule confusing to members.\25\
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    \25\ Telephone call dated August 26, 2004 between Brian 
Baysinger, Special Counsel, Division and Philip Shaikun, Associate 
General Counsel, NASD.
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C. Discussion

    The Commission finds the proposed rule change is consistent with 
the Act and in particular with Section 15A(b)(6) of the Act, which 
requires, among other things, that NASD's rules 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.\26\ The Commission believes 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.
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    \26\ 15 U.S.C. 78o-3(b)(6).
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    The proposal's requirements for designation of CCOs, annual CEO 
certifications, mandatory meetings of the CCOs and CEOS, annual 
compliance reports, and provision of the compliance reports to member 
boards of directors and audit committees should increase members' 
senior management's focus on the effectiveness of member compliance 
efforts with applicable NASD rules, MSRB rules, and federal securities 
laws. The requirement that the person designated as CCO be a principal 
helps ensure a person with appropriate stature within the member 
organization will in fact hold this responsibility at each member.
    The proposed requirement that the CEO certify the member has 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 and 
regulations will help to ensure that members have in place a compliance 
framework that will allow the member to adapt its compliance efforts to 
the ever-changing business and regulatory environment. Especially 
helpful in this regard is the requirement that the processes, at a 
minimum, must include one or more meetings annually between the CEO and 
CCO to (1) Discuss and review the matters that are the subject of the 
certification; (2) discuss and review the member's compliance efforts 
as of the date of such meetings; and (3) identify and address 
significant compliance problems and plans for emerging business areas. 
The Commission believes it is appropriate that the proposed 
interpretive material recognizes that responsibility for discharging 
compliance policies and written supervisory procedures rests with 
business line supervisors. The Commission also believes it is 
appropriate that the proposed interpretive material clarifies that 
consultation on the certification does not in itself establish a 
signatory as having such line supervisory responsibility. In this 
respect, the proposal should encourage full cooperation throughout the 
member organization in meeting the requirements of proposed NASD Rule 
3013 without assigning regulatory obligations on member employees that 
is not commensurate with their responsibilities in the organization.
    The requirement for annual CEO certifications and preparation of a 
related report will help motivate firms to keep their compliance 
programs current with business and regulatory developments. 
Notwithstanding comments to the contrary \27\ the Commission believes 
the proposal supplements rather than duplicates current member 
compliance obligations. In particular, 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 designed to achieve compliance with applicable rules and 
regulations.\28\
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    \27\ See note 21 supra.
    \28\ The Commission recently approved a proposed rule change 
requiring members, among other things, 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 members' supervisory procedures are reasonably designed to 
achieve compliance with applicable securities laws and NASD rules. 
Exchange Act Release No. 49883 (June 17, 2004), 69 FR 35092 (June 
23, 2004) (approving SR-NASD-2002-162).
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    The Commission also believes that Amendments Nos. 1 and 2, as well 
as NASD's oral assurances to provide necessary clarification if 
requested adequately and appropriately addresses commenters' concerns 
regarding the originally proposed CCO certification (which NASD has 
omitted) and the potential inconsistencies in the interpretive 
materials regarding CCO

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obligations.\29\ The requirement that the annual report be provided to 
members' boards of directors and audit committees will further enhance 
member focus on the need for strong and effective compliance programs.
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    \29\ See SIA Letter and summary of NASD staffs' oral response in 
text accompanying footnote 23 above.
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    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the Act 
\30\ that the proposed rule change (File No. SR-NASD-2003-176) as 
amended by Amendment Nos. 1 and 2 be, and hereby is, approved.\31\
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    \30\ 15 U.S.C. 78s(b)(2).
    \31\ In approving this proposed rule change, the Commission 
notes that it has considered the proposed rule's impact on 
efficiency, competition, and capital formation. 15 U.S.C. 78c(f).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\32\
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    \32\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. E4-2227 Filed 9-16-04; 8:45 am]
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