[Federal Register Volume 69, Number 193 (Wednesday, October 6, 2004)]
[Notices]
[Pages 59972-59977]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-22441]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50477; File No. SR-NASD-2004-116]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval to Proposed Rule Change and Amendment No. 
1 by National Association of Securities Dealers, Inc. Relating to 
Supervisory Control and Inspection Procedures

September 30, 2004.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'')\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on August 2, 2004, the National Association of Securities Dealers, Inc. 
(``NASD''), filed with the Securities and Exchange Commission (``SEC'' 
or ``Commission'') the proposed rule change as described in Items I, 
II, and III below, which Items have been prepared by NASD. On September 
23, 2004, NASD submitted Amendment No. 1 to the proposed rule 
change.\3\ The Commission is publishing this notice to solicit comments 
on the proposed rule change and Amendment No. 1 from interested 
persons. For the reasons discussed below, the Commission is granting 
accelerated approval to the proposed rule change, as modified by 
Amendment No. 1.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See letter from Patricia Albrecht, Assistant General 
Counsel, NASD, to Katherine A. England, Assistant Director, Division 
of Market Regulation, Commission, dated September 23, 2004 
(``Amendment No. 1'').
---------------------------------------------------------------------------

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

    NASD is proposing to amend NASD Rules 3010 and 3012, with the 
intention of aligning certain supervisory control and inspection 
requirements with the corresponding supervisory control and inspection 
requirements in New York Stock Exchange (``NYSE'') Rule 342.19 and NYSE 
Interpretation Handbook provision 342(a)(b)/03. NASD is also proposing 
several amendments to NASD Rule 22510, relating to discretionary 
accounts, that NASD states are non-substantive and technical. The SEC 
approved these rules in their current form on June 17, 2004.\4\ Below 
is the text of the proposed rule change, as modified by Amendment No. 
1. Proposed new language is in italics; proposed deletions are in 
brackets.
---------------------------------------------------------------------------

    \4\ See Exchange Act Release No. 49883, 69 FR 35092 (June 23, 
2004) (order approving NASD's proposed rule change); Exchange Act 
Release No. 49882 (June 17, 2004), 69 FR 35108 (June 23, 2004) 
(order approving NYSE's proposed rule change).
---------------------------------------------------------------------------

* * * * *
2510. Discretionary Accounts
    (a) through (c) No Change.
    (d) Exceptions
    This Rule shall not apply to:
    (1) discretion as to the price at which or the time when an order 
given by a customer for the purchase or sale of a definite amount of a 
security shall be executed, except that the authority to exercise time 
and price discretion will be considered to be in effect only until the 
end of the business day on which the customer granted such discretion, 
absent a specific, written contrary indication signed and dated by the 
customer. This limitation shall not apply to time and price discretion 
exercised [for orders effected with or for] in an institutional 
account, as defined in Rule 3110(c)(4), pursuant to valid Good-Till-
Cancelled instructions issued on a ``not-held'' basis. Any exercise of 
time and price discretion

[[Page 59973]]

must be reflected on the [customer] order ticket.
    (2) No Change.
* * * * *
3010. Supervision
    (a) through (b) No change.
    (c) Internal Inspections
    (1) through (2) No change.
    (3) An office inspection by a member pursuant to paragraph (c)(1) 
may not be conducted by the branch office manager or any person within 
that office who has supervisory responsibilities or by any individual 
who is directly or indirectly supervised by such person(s). However, if 
a member is so limited in size and resources that it cannot comply with 
this limitation (e.g., a member [with] has only one office or a member 
with a business model where small or single-person offices report 
directly to an office of supervisory jurisdiction manager who is also 
considered the offices' branch office manager), the member may have a 
principal who has the requisite knowledge to conduct an office 
inspection perform the inspections. The member, however, must document 
in the office inspection reports the factors it has relied upon in 
determining that it is so limited in size and resources that it has no 
other alternative than to comply in this manner.
    A member must have in place procedures that are reasonably designed 
to provide heightened office inspections if the person conducting the 
inspection reports to the branch office manager's supervisor or works 
in an office supervised by the branch manager's supervisor and the 
branch office manager generates 20% or more of the revenue of the 
business units supervised by the branch office manager's supervisor. 
For the purposes of this subsection only, the term ``heightened 
inspection'' shall mean those inspection procedures that are designed 
to avoid conflicts of interest that serve to undermine complete and 
effective inspection because of the economic, commercial, or financial 
interests that the branch manager's supervisor holds in the associated 
persons and business being inspected. In addition, for the purpose of 
this section only, when calculating the 20% threshold, all of the 
revenue generated by or credited to the branch office or the branch 
office manager shall be attributed as revenue generated by the business 
units supervised by the branch office manager's supervisor irrespective 
of a member's internal allocation of such revenue. A member must 
calculate the 20% threshold on a rolling, twelve-month basis.
    (d) through (g) No Change.
* * * * *
3012. Supervisory Control System
    (a) General Requirements
    (1) No change.
    (2) The establishment, maintenance, and enforcement of written 
supervisory control policies and procedures pursuant to paragraph (a) 
shall include:
    (A) procedures that are reasonably designed to review and supervise 
the customer account activity conducted by the member's branch office 
managers, sales managers, regional or district sales managers, or any 
person performing a similar supervisory function.
    (i) A person who is either senior to, or otherwise independent of, 
the producing manager must perform such supervisory reviews. 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 (including not being directly 
compensated based in whole or in part on the revenues accruing for 
those activities); and must alternate such review responsibility with 
another qualified person every two years or less. [However, if a member 
(i) does not conduct a public business, (ii) or has a capital 
requirement of $5,000 or less, or (iii) employs 10 or fewer 
representatives and, in the case of (i) through (iii), its business is 
conducted in a manner necessitated by a limitation of resources that 
includes fewer than two layers of supervisory personnel, a person in 
another office of the member who is in the same or similar position to 
the producing manager may conduct the supervisory reviews, provided 
that the person in the same or similar position does not have 
supervisory responsibility over the activity being reviewed, reports to 
his supervisor his supervision and review of the producing manager, and 
has not performed a review of the producing manager in the last two 
years.]
    (ii) If a member 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 (i) above [it 
cannot avail itself of this exception] (e.g., a member [with] has only 
one office or [a member with two offices and] an insufficient number of 
qualified personnel who can conduct reviews on a two-year rotation), [a 
member may have] the reviews may be conducted by a principal who is 
sufficiently knowledgeable of the member's supervisory control 
procedures[ conduct these reviews], provided that the reviews are in 
compliance with (i) to the extent practicable.
    (iii) A member relying on (ii) above must document in its 
supervisory control procedures the factors used to determine that 
complete compliance with all of the provisions of (i) is not possible 
and that the required supervisory systems and procedures in place with 
respect to any producing manager comply with the provisions of (i) 
above to the extent practicable. [The member, however, must document in 
its supervisory control procedures the factors it has relied upon in 
determining that its size and the resources available to it are so 
limited that the member has no other alternative than to comply in this 
manner.]
    (B) procedures that are reasonably designed to review and monitor 
the following activities:
    (i) all transmittals of funds (e.g., wires or checks, etc.) or 
securities from customers [and] to third party accounts (i.e., a 
transmittal that would result in a change of beneficial ownership); 
from customer accounts to outside entities (e.g., banks, investment 
companies, etc.); from customer accounts to locations other than a 
customer's primary residence (e.g., post office box, ``in care of'' 
accounts, alternate address, etc.); and between customers and 
registered representatives, including the hand-delivery of checks;
    (ii) through (iii) No change.
    The policies and procedures established pursuant to paragraph 
(a)(2)(B) must include a means or method of customer confirmation, 
notification, or follow-up that can be documented. If a member does not 
engage in all of the activities enumerated above, the member must 
identify those activities in which it does not engage in its written 
supervisory control policies and document in those policies and 
procedures that additional supervisory policies and procedures for such 
activities must be in place before the member can engage in them; and
    (C) procedures that are reasonably designed to provide heightened 
supervision over the activities of each producing manager who is 
responsible for generating 20% or more of the revenue of the business 
units supervised by the producing manager's supervisor. For the 
purposes of this subsection only, the term ``heightened supervision'' 
shall mean those supervisory procedures that evidence supervisory 
activities that are designed to avoid conflicts of interest that serve 
to undermine complete and effective supervision because of the 
economic, commercial, or financial

[[Page 59974]]

interests that the supervisor holds in the associated persons and 
businesses being supervised. In addition, for the purpose of this 
section only, when calculating the 20% threshold, all of the revenue 
generated by or credited to the producing manager or the producing 
manager's office shall be attributed as revenue generated by the 
business units supervised by the producing manager's supervisor 
irrespective of a member's internal allocation of such revenue. A 
member must calculate the 20% threshold on a rolling, twelve-month 
basis.
    (b) No change.
* * * * *

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

    In its filing with the Commission, NASD included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. NASD has prepared summaries, set forth in sections (A), 
(B), and (C) below, of the most significant aspects of such statements.

(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    On June 17, 2004, the SEC approved proposed changes to NASD and 
NYSE rules generally requiring the establishment, maintenance, and 
testing of supervisory control procedures; enhanced inspection 
procedures; documentation and recordkeeping procedures for account 
name/designation changes; limitations on holding customer mail; and 
one-day limit on time and price discretionary authority for retail 
customer orders.\5\ NASD's and NYSE's new requirements are 
substantially similar. NASD believes that similarity between the rules 
should be enhanced by conforming certain inspection and supervisory 
control requirements in NASD Rules 3010 and 3012 to the corresponding 
requirements in NYSE Rule 342.19 and NYSE Interpretation Handbook 
provision 342(a)(b)/03, as well as certain provisions relating to 
discretionary accounts in NASD Rule 2510(d) to the corresponding 
provisions in NYSE Rule 408(d).
---------------------------------------------------------------------------

    \5\ See Exchange Act Release No. 49883 (June 17, 2004, 69 FR 
35092 (June 23, 2004) (order approving NASD's proposed rule change); 
Exchange Act Release No. 49882 (June 17, 2004); 69 FR 35108 (June 
23, 2004) (order approving NYSE's proposed rule change).
---------------------------------------------------------------------------

(a) NASD Rule 3010(c) (Internal Inspections)
    NASD Rule 3010(c)(3) prohibits a branch office manager, any person 
within that office who has supervisory responsibilities, or any 
individual who is supervised by such person from conducting an office 
inspection. In comparison, according to NASD, NYSE Interpretation 
Handbook provision 342(a)(b)/03 (Annual Branch Office Inspection) 
specifies that any person who directly or indirectly reports to the 
branch office manager is prohibited from conducting an office 
inspection. NASD proposes to revise Rule 3010(c)(3) similarly to 
specify that any individual who directly or indirectly supervised by 
the branch office manager is prohibited from conducting an office 
inspection.

(b) NASD Rule 3012 (Supervisory Control System)

    NASD Rule 3012(a)(2)(A) requires members' supervisory control 
policies and procedures to include procedures that are ``reasonably 
designed to review and supervise the customer account activity 
conducted by the member's branch office managers, sales managers, 
regional or district sales mangers, or any person performing a similar 
supervisory function.'' \6\ Currently, with two limited exceptions 
discussed below, the rule permits only a person who is senior to the 
producing manager to perform supervisory reviews of customer account 
activity conducted by the managers discussed in the rule (i.e., 
``producing manager'').
---------------------------------------------------------------------------

    \6\ NASD Rule 3012(a)(2)(A).
---------------------------------------------------------------------------

    NASD Rule 3012(a)(2)(A) provides a limited exception from the 
``senior to'' requirement if a member has fewer than two layers of 
supervisory personnel and (i) does not conduct a public business, (ii) 
has a capital requirement of $5,000 or less, or (iii) employs 10 or 
fewer representatives. Members meeting these conditions may assign 
supervisory reviews to a person in another office who is in the same or 
similar position to the producing manager being reviewed (the ``first 
exception'').\7\
---------------------------------------------------------------------------

    \7\ Such a person assigned may not have supervisory 
responsibility over the activity being reviewed, must report to his 
supervisor his supervision and review of the producing manager, and 
may not have performed a review of the producing manager in the last 
two years.
---------------------------------------------------------------------------

    NASD Rule 3012(a)(2)(A) further provides that if a member is so 
limited in size and resources that it cannot meet even the conditions 
enumerated in the first exception, the member may assign a principal to 
conduct supervisory reviews (the ``second exception'').\8\ Under NASD 
Rule 3012(a)(2)(A), a member relying on the second exception must 
document the factors it has relied upon in determining that its size 
and resources are so limited that it has no other alternative but to 
comply in this manner.\9\
---------------------------------------------------------------------------

    \8\ Such a principal must be sufficiently knowledgeable of the 
member's supervisory control procedures.
    \9\ In comparison, according to NASD, NYSE Rule 342.19 requires 
that a member relying on the corresponding NYSE exception for 
members of limited size and resources must document the factors used 
to determine that (i) complete compliance with all of the provisions 
of NYSE's general standard for supervisory reviews of customer 
account activity is not possible, and (ii) the member's supervisory 
systems and procedures comply with the standard to the extent 
possible.
---------------------------------------------------------------------------

1. Review of Producing Manager's Customer Account Activity
    NASD is proposing changes to its general standard for supervisory 
reviews to provide that the person reviewing a producing manager's 
customer account activities may be ``either senior to or otherwise 
independent of,'' rather than merely senior to, that producing manager. 
This proposed modification is intended to make NASD Rule 3012(a)(2)(A) 
more similar to NYSE Rule 342.19. For purposes of proposed NASD Rule 
3012, 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 (i.e., may not be directly compensated based in whole or 
in part on the revenues accruing from the activity being reviewed), and 
must alternate such review responsibility with another qualified person 
every two years or less.
    Under NASD Rule 3012(a)(2)(C), members must establish, maintain, 
and enforce heightened supervisory procedures over activities of each 
producing manger who generates 20% or more of the revenue of the 
business units supervised by the producing manager's supervisor (a 
``20% producing manager''). NASD notes that the review of a producing 
manager's activities by an ``otherwise independent'' person would not 
obviate the need for heightened supervisory procedures if such 
procedures otherwise apply under NASD Rule 3012(a)(2)(C).\10\

[[Page 59975]]

Moreover, as discussed above, an ``otherwise independent'' person may 
not be directly compensated based in whole or in part on the revenues 
accruing from the activities being reviewed. Therefore, a supervisor of 
a 20% producing manager would not be considered ``otherwise 
independent'' with respect to that producing manager, for purposes of 
NASD Rule 3012(a)(2)(A).
---------------------------------------------------------------------------

    \10\ Examples of ``heightened supervisory procedures'' are 
discussed in Exchange Act Release No. 49883, 69 FR 35098, and 
include unannounced supervisory reviews and an increased number of 
supervisory reviews by different reviewers within a certain period 
of time.
---------------------------------------------------------------------------

2. Exception for Firms With Limited Resources
    To make NASD Rule 3012 more similar to NYSE Rule 342.19, NASD is 
proposing to eliminate the first exception to the ``senior to'' 
requirement in current NASD Rule 3012(a)(2)(A), in which a member that 
has fewer than two layers of supervisory personnel and (i) does not 
conduct a public business, (ii) has a capital requirement of $5,000 or 
less, or (iii) employs 10 or fewer representatives, may assign a person 
in the same or similar position to the producing manager to conduct 
supervisory reviews, under certain conditions. Instead, proposed NASD 
Rule 3012(a)(2)(A)(ii) provides that a member ``so limited in size and 
resources that there is no qualified person senior to, or otherwise 
independent of, the producing manager'' being reviewed may assign ``a 
principal who is sufficiently knowledgeable of the member's supervisory 
control procedures'' to conduct the supervisory reviews. An example of 
a member that could rely on this proposed exception is one that ``has 
only one office or an insufficient number of qualified personnel who 
can conduct reviews on a two-year rotation.'' \11\ The proposed change 
is intended to provide NASD members with the same flexibility in 
structuring their supervisory review policies and procedures that NYSE 
members have.
---------------------------------------------------------------------------

    \11\ See Amendment No. 1 (proposing to change a one-year 
rotation condition, as proposed in the original filing, to a two-
year rotation condition).
---------------------------------------------------------------------------

    NASD also is proposing to revise the current documentation 
requirements in NASD Rule 3012 for members that rely on the proposed 
exception so that the requirements are more similar to those of NYSE 
Rule 342.19. NASD members would be required to document in its 
supervisory control procedures the factors used to determine that 
complete compliance with the ``either senior to or otherwise 
independent'' standard is not possible, and that the procedures that 
are in place comply with the standard to the extent practicable. NASD 
believes that these documentation requirements will result in members 
providing in greater detail the factors relied upon in determining that 
they must use the exception rather than the general supervisory review 
standard, as well as how closely their policies and practices track the 
general requirements.
    NASD has agreed to file a separate amendment to NASD Rule 3012, 
following the approval of the proposed exception and documentation 
requirements, to require that members inform NASD if they rely or 
intend to rely on the proposed exception.\12\ Members would inform NASD 
through reports filed on a web-based reporting system or other 
automated electronic platform. This manner of reporting will allow NASD 
to collect the necessary information quickly and efficiently and 
provide the information to the Commission promptly, promote timeliness 
of amendments (e.g., members' changes to their use of the proposed 
exception), and allow NASD Member Regulation to integrate the 
information for their purposes without having to process manually paper 
notifications. NASD estimates that it should take no more than one year 
from the date this filing is approved to construct and bring on-line 
this web-based system or other electronic platform. NASD intends to 
require its members to begin reporting their use of the exception when 
the reporting system is brought on-line.
---------------------------------------------------------------------------

    \12\ See letter from Marc Menchel, Executive Vice President and 
General Counsel, to Catherine McGuire, Chief Counsel, Division of 
Market Regulation, Commission, dated September 28, 2004.
---------------------------------------------------------------------------

    Finally, NASD is proposing several changes to NASD Rule 3012 to 
enhance the readability of the rule. The first set of proposed changes 
would be made to an example NASD provides, in proposed NASD Rule 
3012(a)(2)(A)(ii), of a member that may rely on the proposed exception. 
In particular, NASD is proposing to remove from the example members 
with two offices but with insufficient resources to rely on the general 
review procedure. In addition, NASD Rule 3012(a)(2)(B)(i), procedures 
pertaining to transmittals of funds, would be revised as follows: ``all 
transmittals of funds (e.g., wires or checks, etc.) or securities from 
customers [and] to third party accounts * * * from customer accounts to 
locations other than a customer's primary residence (e.g., post office 
box * * *).''
(c) NASD Rule 2510 (Discretionary Accounts)
    NASD also is proposing to make certain changes to NASD Rule 2510 
(Discretionary Accounts). Currently, NASD Rule 2510(d)(1) does not 
require written authorization for the exercise of time and price 
discretion beyond a day for orders effected ``with or for an 
institutional account,'' if such discretion is exercised pursuant to 
valid Good-Til-Cancelled instructions issued on a not-held basis. The 
proposal, intended to be non-substantive and to enhance the rule's 
readability, would change the words ``with or for an institutional 
account'' to ``in an institutional account.'' In addition, NASD is 
proposing to clarify that time and price discretion must be reflected 
on all order tickets.\13\
---------------------------------------------------------------------------

    \13\ This change would accomplished by deleting the word 
``customer'' from the sentence ``Any exercise of time and price 
discretion must be reflected on the customer order ticket,'' and, as 
proposed in Amendment No. 1, by moving the sentence from the end of 
NASD Rule 2510(d)(2), where it currently appears, to the end of NASD 
Rule 2510(d)(1).
---------------------------------------------------------------------------

2. Statutory Basis
    NASD believes that the proposed rule change is consistent with the 
provisions of section 15A(b)(6) of the Act, which requires, among other 
things, that NASD's rules must be designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest. NASD is proposing these requirements to ensure that 
its members have in place standards that are reasonably designed to 
prevent fraudulent and manipulative acts, thereby protecting investors 
and the public interest. In addition, in light of the nature and 
content of these particular rules, NASD believes that NASD's and the 
NYSE's rules in this area should be substantially similar.

(B) Self-Regulatory Organization's Statement on Burden on Competition

    NASD does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act, as amended.

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

    Written comments were neither solicited nor received.

III. Commission's Findings and Order Granting Accelerated Approval of 
Proposed Rule Change

    NASD has requested that the Commission find good cause pursuant

[[Page 59976]]

to section 19(b)(2) of the Act \14\ for approving the proposed rule 
change as amended prior to the 30th day after publication in the 
Federal Register. After careful review, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act and 
the rules and regulations thereunder applicable to NASD, in particular 
section 15A and the rules and regulations thereunder. Specifically, the 
Commission finds that the proposed rule change is consistent with the 
requirements of section 15A(b)(6) \15\ of the Act because it is 
designed to prevent fraudulent and manipulative acts and practices and 
to protect investors and the public interest. The Commission finds that 
NASD's proposal is designed to accomplish these ends by requiring NASD 
members to establish supervisory procedures for the monitoring of 
customer account activities that promote independent review of their 
employees to the extent practicable.
---------------------------------------------------------------------------

    \14\ 15 U.S.C. 78s(b)(2).
    \15\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    (A) NASD Rule 3010(c) (Internal Inspections)
    The Commission believes that the NASD's proposal with respect to 
prohibiting any person who directly or indirectly reports to the branch 
office manager of the branch office being inspected should provide 
clearer guidance on who may perform internal inspections. The 
Commission believes that this clarification should address conflicts of 
interest and further the general purpose of promoting the detection and 
reporting of fraudulent activity in customer accounts, without imposing 
undue burdens on members.
    (B) NASD Rule 3012 (Supervisory Control System)
    NASD has proposed that persons ``either senior to or otherwise 
independent of'' a producing manager would be qualified to review and 
supervise the customer account activity conducted by that producing 
manager. In contrast, NASD Rule 3012 currently permits only persons 
senior to a producing manager to conduct such reviews.
    The Commission believes that this proposed change will provide more 
flexibility for NASD members to conduct supervisory reviews of customer 
account activity consistent with that already provided to NYSE members 
under NYSE Rule 342.19. To the extent the rules of the NASD and NYSE 
are consistent, opportunities for regulatory arbitrage will be 
diminished, which should enhance compliance with more rigorous 
supervisory control procedures. We believe the ``otherwise 
independent'' standard as proposed by NASD contains adequate safeguards 
to limit the conflicts of interest of the person conducting the 
reviews, thereby preserving the integrity of those reviews. In this 
regard, to qualify as an ``otherwise independent'' person, the reviewer 
may not report either directly or indirectly to the producing manager 
under review, must be in an office other than that of the producing 
manager, and must not otherwise have supervisory responsibility over 
the activity being reviewed. Moreover, an ``otherwise independent'' 
person may not be directly compensated based in whole or in part on the 
revenues accruing from the activities being reviewed, and must 
alternate such review responsibility with another qualified person 
every two years or less.
    In addition, NASD has proposed to revise the exceptions, intended 
only for members of limited size and resources, from compliance with 
the general standard for who may conduct supervisory reviews. In 
particular, NASD is proposing to amend NASD Rule 3012(a)(2)(A) to 
permit members ``so limited in size and resources that there is no 
qualified person senior to, or otherwise independent of, the producing 
manager,'' to appoint a principal to conduct supervisory reviews, 
provided that the reviews are in compliance with the general 
supervisory standard to the extend practicable. The principal must be 
sufficiently knowledgeable of the member's supervisory control 
procedures. The Commission believes that the proposal is consistent 
with the Act as an accommodation to the smallest NASD members that lack 
the resources to implement a full scale program to conduct supervisory 
reviews. Nevertheless, the Commission expects NASD to monitor carefully 
the use of this exception to be certain that only members for whom it 
is intended take advantage of it, and that this exception is not 
abused. In this regard, the Commission stresses the importance of the 
NASD's agreement to file an amendment to NASD Rule 3012, following the 
issuance of this Order, to require members to provide reports to NASD 
if they rely on or intend to rely on this proposed exception. At a 
minimum, such reports should provide the number of employees of each 
such member, the member's net capital, as well as its annual revenues, 
and would be made available by the NASD to the Commission or its staff 
upon request. The Commission believes that such a reporting system is 
essential to ensuring that the exception in NASD Rule 3012(a)(2)(A)(ii) 
is used only by those firms for which it is intended (i.e., those with 
very limited resources).
    Finally, NASD has proposed to revise the documentation standards a 
member must satisfy when it relies on NASD Rule 3012(a)(2)(A)(ii), as 
proposed. Under the proposal, a member relying on this exception must 
document the factors used to determine that complete compliance with 
all of the provisions of the ``either senior to or otherwise 
independent of'' standard is not possible, and that the member's 
supervisory systems and procedures comply with this standard to the 
extent practicable. The Commission believes that NASD's proposed 
documentation requirement, in addition to the reports discussed above, 
should help to ensure that this exception is not abused or used by 
members other than those for which it is intended.
    (C) NASD Rule 2510(d) (Discretionary Accounts)
    The Commission believes that the proposed changes to NASD Rule 
2510(d) are consistent with the Act. They generally improve the 
readability of the rule and clarify that any exercise of time and price 
discretion must be reflected on all order tickets.
    (D) Accelerated Approval
    The Commission believes that there is good cause for approving the 
proposed rule change and Amendment No. 1 prior to the 30th day after 
publication in the Federal Register. The proposed rule change is 
amending rules that were approved on June 17, 2004, which currently 
have an effective date of December 17, 2004.\16\ Pursuant to the NASD's 
request, the effective date of January 31, 2005 will apply to the 
proposed rule change, as modified by Amendment No. 1, as well as to the 
amendments made to NASD Rules 2510, 3010, 3012, 3110, and IM 3110 that 
the Commission approved in June 2004.\17\ Accelerated approval of this 
proposed rule change and Amendment No. 1 will enable NASD to announce 
promptly the final rules, as modified, thereby lessening member 
confusion as to the final requirements of NASD Rules 3010 and 3012 and 
permitting members to make the necessary changes to comply with them. 
Based on the above, the Commission finds good cause, consistent with 
section 15A(b)(6) and section 19(b)(2) of the Act, for approving the 
proposed rule change and Amendment No. 1 prior to the 30th day

[[Page 59977]]

after the date of publication of notice of filing thereof in the 
Federal Register.
---------------------------------------------------------------------------

    \16\ See Exchange Act Release No. 49883, 69 FR 35092 (June 23, 
2004) (order approving NASD's proposed rule change).
    \17\ See Amendment No. 1.
---------------------------------------------------------------------------

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change as amended 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-NASD-2004-116 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-NASD-2004-116. This 
rule 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 NASD. 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-NASD-2004-116 and should be 
submitted on or before October 27, 2004.
    It is therefore ordered, pursuant to section 19(b)(2) of the Act, 
that the proposed rule change (SR-NASD-2004-116), as amended, be, and 
hereby is, approved.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\18\
---------------------------------------------------------------------------

    \18\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-22441 Filed 10-6-04; 8:45 am]
BILLING CODE 8010-01-M