[Federal Register Volume 62, Number 225 (Friday, November 21, 1997)]
[Notices]
[Pages 62385-62391]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-30622]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39326; File Nos. SR-NASD-97-71, SR-NASD-96-20, and SR-
NASD-96-29]
Self-Regulatory Organizations; National Association of Securities
Dealers, Inc.; Order Approving Proposed Rule Change and Amendment No. 1
to the Proposed Rule Change, Notice of Filing and Order Granting
Accelerated Approval of Amendment No. 2 to the Proposed Rule Change,
and Order Extending Temporary Approval of SR-NASD-96-20 and SR-NASD-96-
29, Regarding Proposed Changes in the By-Laws and Restated Certificates
of Incorporation of the NASD, NASD Regulation, Inc., The Nasdaq Stock
Market, Inc., and the Plan of Allocation and Delegation of Functions by
the NASD to Subsidiaries
November 14, 1997.
On September 19, 1997, the National Association of Securities
Dealers, Inc. (``NASD'') filed with the Securities and Exchange
Commission (``Commission'') a proposed rule change pursuant to Section
19(b)(1) of the Securities Exchange Act of 1934 (``Act''),\1\ and Rule
19b-4 thereunder.\2\ In this filing, the NASD proposed amendments to
the corporate documents of the NASD, its regulatory subsidiary, NASD
Regulation, Inc. (``NASD Regulation''), and its stock market operating
subsidiary, The Nasdaq Stock Market, Inc. (``Nasdaq''),\3\ as well as
to the Plan of Allocation and Delegation of Functions by NASD to
Subsidiaries (``Delegation Plan''), in order to finalize the corporate
restructuring of the Association.\4\ Notice of this proposed rule
filing was published in the Federal Register on October 10, 1997
(``Notice'').\5\ The Commission did not receive any comment letters on
the filing.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ In this Order, NASD Regulation and Nasdaq are referred to as
the ``Subsidiaries.'' The three entities, NASD, NASD Regulation, and
Nasdaq are referred to collectively as the ``Association.''
\4\ The corporate documents proposed for amendment are: (1) The
By-Laws of the NASD; (2) the By-Laws of NASD Regulation; (3) the By-
Laws of Nasdaq; (4) the Restated Certificate of Incorporation of the
NASD; (5) the Restated Certificate of Incorporation of NASD
Regulation; and (6) the Restated Certificate of Incorporation of
Nasdaq. The by-laws and restated certificates of incorporation of
the NASD and its Subsidiaries are collectively referred to in this
Order as the ``corporate governance documents.''
\5\ Securities Exchange Act Release No. 39175 (September 30,
1997), 62 FR 53062 (October 10, 1997). On September 29, 1997, the
NASD filed a technical amendment to the proposed rule change, the
substance of which was included in the Notice. See letter from T.
Grant Callery, General Counsel, NASD, to Katherine A. England,
Assistant Director, Division of Market Regulation, Commission, dated
September 29, 1997. On September 30, 1997, the filing was further
amended by the NASD to correct non-substantive typographical errors,
all of which were incorporated in the original filing as well.
Conversation between Mary Dunbar, Office of General Counsel, NASD
Regulation, and Mandy S. Cohen, Division of Market Regulation,
Commission. Subsequent to notice of the rule filing, the NASD filed
Amendment No. 2, which adjusted the period during which a member may
add an agenda item to the annual meeting, to allow the NASD
sufficient time to prepare for the new agenda item. See letter from
T. Grant Callery, General Counsel, NASD, to Katherine A. England,
Assistant Director, Division of Market Regulation, Commission, dated
October 7, 1997. Collectively, the original filing and its
subsequent amendments are referred to herein as the ``NASD''
Proposal.''
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Portions of the NASD Proposal were previously submitted and noticed
in the Federal Register in SR-NASD-96-02, SR-NASD-96-16, SR-NASD-96-20,
SR-NASD-96-29, and SR-NASD-97-28.\6\ The versions of the by-laws and
[[Page 62386]]
Delegation Plan contained in SR-NASD-96-02 and 96-16 were superseded by
the later filings. The Commission's temporary approval of the versions
of the by-laws and Delegation Plan proposed in SR-NASD-96-20 and 96-29
(as amended), which is scheduled to lapse on November 15, 1997, will be
temporarily extended again, until the effective dates of the provisions
approved in this Order.\7\ The revisions to the corporate governance
documents and the Delegation Plan proposed in SR-NASD-97-28 were
withdrawn by Amendment No. 3 thereto.\8\
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\6\ Securities Exchange Act Release No. 37106 (April 11, 1996),
61 FR 16944 (April 18, 1996) (File No. SR-NASD-96-02); Securities
Exchange Act Release No. 37107 (April 11, 1996), 61 FR 16948 (April
18, 1996) (File No. SR-NASD-96-16); Securities Exchange Act Release
No. 37282 (June 6, 1996), 61 FR 29777 (June 12, 1996), (File No. SR-
NASD-96-20), as amended; Securities Exchange Act Release No. 37425
(July 11, 1996), 61 FR 37518 (July 18, 1996) (File No. SR-NASD-96-
29), as amended; and Securities Exchange Act Release No. 38545
(April 24, 1997) 62 FR 25226 (May 8, 1997) (File No. SR-NASD-97-28),
as amended, respectively.
\7\ See Securities Exchange Act Release No. 38909 (August 7,
1997), 62 FR 43571 (August 14, 1997) (SR-NASD-97-29) and Securities
Exchange Act Release No. 38644 (May 15, 1997), 62 FR 43571 (May 22,
1997) (SR-NASD-96-20). The effective dates of the provisions
approved by this Order are set forth infra notes 51 and 52 and the
accompanying text.
\8\ See letter from Alden S. Adkins, General Counsel, NASD
Regulation, to Katherine A. England, Assistant Director, Division of
Market Regulation, Commission, dated July 11, 1997 (Amendment No. 3
to SR-NASD-97-28).
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I. Introduction and Background
In November 1994, the NASD Board of Governors appointed the Select
Committee on Structure and Governance (``Select Committee'') to review
the NASD's corporate governance structure and to recommend changes to
enable the NASD to better meet its regulatory and business obligations,
including its oversight of the Nasdaq market. The Select Committee
published its findings and recommendations in the Report of the NASD
Select Committee on Structure and Governance to the NASD Board of
Governors (``Select Committee Report''), which was presented to the
NASD Board of Governors at its September 1995 board meeting.
Following the recommendations of the Select Committee, the NASD
proposed reorganizing its corporate structure. Nasdaq was given sole
responsibility to operate and oversee the Nasdaq market and other over-
the-counter (``OTC'') markets, while NASD Regulation was given
responsibility for regulation and member and constituent services. The
NASD retained ultimate policymaking, oversight, and corporate authority
as the parent holding company and statutory self-regulatory
organization (``SRO''), while granting substantial deference to the
operating Subsidiaries in the areas of their respective jurisdictions.
These revisions to the corporate structure, outlined in the Delegation
Plan \9\ and implemented through amendment of the governing corporate
documents, were proposed and adopted in mid-1996.\10\
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\9\ The initial version of the Delegation Plan (with the
implementing provisions contained in Rule 0130) was filed with the
Commission in SR-NASD-96-16. For the purposes of this Order,
reference to a ``Rule'' refers to the NASD Rules of the Association.
It was published for comment and approved by the Commission on a
temporary basis for a period of 90 days. See Release No. 34-37107,
supra note 6. The Commission thereafter published notice of proposed
rule changes containing revisions to the initial Delegation Plan and
granted temporary accelerated approval thereto in Release No. 34-
37425, supra note 6 (additional 120 day approval, as revised),
Securities Exchange Act Release No. 37957 (November 15, 1996), 61 FR
59267 (November 21, 1997) (additional six month temporary approval
through November 15, 1997, as revised), Securities Exchange Act
Release No. 38645 (May 15, 1997), 62 FR 28086 (May 22, 1997)
(additional six month temporary approval, as revised), and Release
No. 34-38909, supra note 7 (continuing temporary approval through
November 15, 1997).
\10\ The Commission first granted temporary approval of the by-
law revisions implementing the restructuring on April 11, 1996. See
Release No. 34-37106, supra note 6. The Commission thereafter
published notice of proposed rule changes containing revisions to
the by-laws and/or granted temporary accelerated approval of such
revisions in Securities Exchange Act Release No. 37424 (July 11,
1996), 61 FR 37515 (July 18, 1996) (notice); Release No. 34-37282,
supra, note 6 (temporary approval for 120 days, as revised);
Securities Exchange Act Release No. 37956 (November 15, 1996), 61 FR
59265 (November 21, 1996) (temporary approval for 6 months, as
revised); Release No. 34-38644, supra note 7 (temporary approval for
6 months, as revised).
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On August 8, 1996, the Commission issued an order pursuant to
Section 19(h)(1) of the Act (``SEC Order''), including fourteen
undertakings (``Undertakings''),\11\ and a related report pursuant to
Section 21(a) of the Act (``21(a) Report'').\12\ The SEC Order made
certain findings about the NASD and imposed remedial sanctions,
including ordering the NASD to comply with the Undertakings. The
Commission determined that the NASD had not complied with its own rules
and had failed to satisfy its obligations under the Act to enforce such
rules and the federal securities laws.
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\11\ Securities Exchange Act Release No. 37538 (Aug. 8, 1996)
(SEC Order Instituting Public Proceedings Pursuant to Section
19(h)(1) of the Securities Exchange Act of 1934, Making Findings and
Imposing Remedial Sanctions, In the Matter of National Association
of Securities Dealers, Inc., Administrative Proceeding File No. 3-
9056). The first six Undertakings included in the SEC Order are
reproduced infra, in note 14.
\12\ Report and Appendix to Report Pursuant to Section 21(a) of
the Securities Exchange Act of 1934 Regarding the NASD and The
Nasdaq Stock Market (Aug. 8, 1996).
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The 21(a) Report findings indicated, among other things, that
market making firms were afforded a disproportionate representation on
the boards and committees that formerly governed the NASD, administered
its disciplinary process, and operated the Nasdaq market. The
Commission found that the ``undue influence of market makers and a lack
of vigor and balance in the NASD's enforcement activities with respect
to market maker firms'' was inconsistent with the NASD's statutory
obligation to oversee the Nasdaq market, and to enforce its rules and
regulations fairly as to all member firms.\13\
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\13\ See 21(a) Report, supra note 11, at 39.
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Based on the Commission's specific findings, the NASD agreed to the
Undertakings, including, among other things, undertakings to improve
public representation on its Boards and committees, to confer sole
discretion in the regulatory staff of the NASD as to prosecutorial and
regulatory matters, and to promulgate and apply uniform standards for
regulatory and other access issues.\14\ In response to the
[[Page 62387]]
Commission's findings in the 21(a) Report and to comply with the terms
of certain undertakings, the NASD subsequently proposed the amendments
to the Delegation Plan and the Association's corporate governance
documents; these amendments were temporarily approved by the
Commission. As discussed below, the NASD is now proposing further
changes to the Association's corporate governance documents.
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\14\ Undertakings one through six of the SEC Order require the
NASD:
(1) To implement and maintain at least fifty percent independent
public and non-industry membership in its Board of Governors, the
Board(s) of Governors or Directors of all of its subsidiaries and
affiliates that exercise or have delegated self-regulatory
functions, and the following committees: The National Nominating
Committee, the Trading/Quality of Markets Committee, the Arbitration
Committee, the Market Surveillance Committee (now the Market
Regulation Committee), the National Business Conduct Committee, the
Management Compensation Committee, and all successors thereto.
(2) To provide that NASDR and any successor thereto has,
consistent with the NASD's By-Laws and Plan of Delegation, as
amended from time to time and as approved by the Commission, primary
day-to-day responsibility for the regulation, surveillance,
examination, and disciplining of NASD member firms and registered
persons, with respect to market activities as well as other self-
regulatory matters, with full access to the records of the Nasdaq
market.
(3) To institute the participation of professional Hearing
Officers (who shall be attorneys with appropriate experience and
training) to preside over disciplinary proceedings.
(4) To provide for the autonomy and independence of the
regulatory staff of the NASD and its subsidiaries such that the
staff, subject only to the supervision of the Board of Governors of
the NASD and the Boards of Directors of NASDR and Nasdaq, and any
successor thereto, (a) has sole discretion as to what matters to
investigate and prosecute, (b) has sole discretion to handle
regulatory matters such as approval of applications for membership
and the conditions and limitations that may be placed thereon, (c)
prepares rule proposals, rule interpretations and other policy
matters with any consultations with interested NASD constituencies
made in fair and evenhanded manner, and (d) is generally insulated
from the commercial interests of its members and the Nasdaq market.
Among other things, the District Business Conduct Committees and the
Market Surveillance Committee shall not have any involvement in
deciding whether or not to institute disciplinary proceedings, nor
shall the District Committees, or any subcommittee thereof, have any
involvement in the review or approval of applications for membership
in the NASD. Subject to the foregoing, the regulatory staff of the
NASDR engaged in the disciplinary process may, solely on their own
initiative, inform themselves on matters of market or other
securities industry expertise by consulting with representatives of
member firms or committees of the NASD or its subsidiaries.
(5) To promulgate and apply on a consistent basis uniform
standards for regulatory and other access issues, such as admission
to the NASD as a member firm, and conditions to becoming a market
maker; and institute safeguards to ensure fair and evenhanded access
to all services and facilities of the NASD.
(6) To ensure the existence of a substantial, independent
internal audit staff which reviews all aspects of the NASD
(including the regulatory function, the disciplinary process and the
Nasdaq stock market and its systems) and reports directly to an
audit committee of the NASD Board of Governors which includes a
majority of public and non-industry Governors and is chaired by a
public Governor.
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II. Description of the Proposal \15\
The revisions to the Association's corporate governance documents
and the Delegation Plan respond to the changes required by the SEC
Order, and the 21(a) Report. They also implement the most recent
corporate restructuring, by reducing the number of members of the NASD,
NASD Regulation and Nasdaq governing boards. In addition, they clarify
various provisions in the corporate governance documents to more
clearly delineate Association practices and procedures. The purpose of
the amendments is to streamline the Association's decision making
process to be more responsive, while simultaneously promoting public
and member access to, and scrutiny of, the day-to-day activities of the
Association.
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\15\ Only substantive changes to the corporate governance
documents and the Delegation Plan are highlighted. Unless
specifically noted otherwise, the term ``committee'' include the NAC
and the Listing Council. For a more detailed description of the
NASD's proposed rule change, see Notice, supra page 2.
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A. The Corporate Governance Documents
The NASD proposes to retain the current three corporation
structure, but reduce the overall number of board members for the three
corporations and revise the structure of the three governing boards.
Currently, the NASD Board has eleven Governors, the NASD Regulation
Board has twenty-four Directors, and the Nasdaq Board has fourteen
Directors.\16\ As amended, the NASD Board will consist of twenty-one to
twenty-seven Governors, and include a nucleus of Governors who will not
serve as directors on either Subsidiary board.\17\ The Subsidiary
boards will have five to eight Directors each, all of whom will serve
simultaneously as an NASD Governor.\18\ The number of directors on each
Subsidiary board will be equal, thereby enabling the nucleus of
individuals serving only as NASD Governors to perform a tie-breaking
function on the parent board. Each board will be balanced between
Public, Non-Industry and Industry participants.\19\ Specific terms of
office for board and committee members have also been imposed.\20\
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\16\ The NASD Proposal will allow the Association to reduce the
overall number of Association board members from forty-nine to
twenty-seven, reduce the number of board meetings from seventeen to
seven, reduce the number of board committees from nine to five, and
replace two Subsidiary board executive committees with one parent
board executive committee.
\17\ As reconstituted, the NASD Board will include the Chief
Executive Officer and the Chief Operating Officer of the NASD, the
Presidents of NASD Regulation and Nasdaq, the Chair of the NAC, and
between 16 and 22 elected Governors. The elected Governors will
include an investment company, an insurance company, and a Nasdaq
issuer.
\18\ The NASD Regulation and Nasdaq Boards of Directors will
have five to eight Directors, and will be equal in size at all
times. Only Governors of the NASD Board are eligible for election to
these boards. The boards will include their respective Presidents.
The Chief Executive Officer of the NASD will be an ex-officio non-
voting member of each, but will not be recognized for compositional
purposes. The NASD Regulation Board will also include the chair of
NAC, as well as an investment company and an issuance company
representative. The Nasdaq Board will include at least one issuer
representative. See new NASD Regulation By-Laws, Article IV,
Sections 4.2, 4.3; see also new Nasdaq By-Laws, Article IV,
Sections. 4.2, 4.3.
\19\ A majority of the Governors on the NASD Board will be Non-
Industry, including five or six Public Governors, depending on the
size of the board. Non-Industry Directors on the NASD Regulation and
Nasdaq Boards must equal or exceed the number of Industry Directors
plus their respective President, and will also include at least one
Public Director each (or two each for eight-member boards). For a
discussion of the terms ``Public,'' ``Non-Industry,'' and
``Industry,'' see infra notes 26, 27, and 29.
\20\ The term of office for the Board of Governors of the NASD
varies between elected and appointed positions. The Chief Executive
Officer and the Chief Operating Officer of the NASD and the
Presidents of NASD Regulation and Nasdaq serve until a successor is
elected, or until death, resignation, or removal. The Chair of the
NAC serves as a Governor for a one year term, or until a successor
is elected and qualified, or until death, resignation,
disqualification, or removal. The Governors elected by the members
of the NASD serve three year terms. See new NASD By-Laws, Article
VII, Sections 5(a-c). Members of the Boards of Directors for both
NASD Regulation and Nasdaq are elected annually. See new NASD
Regulation By-Laws, Article IV, Section 4.4; new Nasdaq By-Laws,
Article IV, Section 4.4.; new Nasdaq By-Laws, Article IV, Section
4.4. Members of the NASD's Management Compensation Committee serve a
term of one year. See new Delegation Plan, Article I(C).
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The NASD Board, while remaining ultimately responsible for the
actions of its Subsidiaries, will retain its current authority to
review and ratify or reject certain actions of the Subsidiaries. The
process of exercising this authority, however, will be expedited by
transferring certain functions to new entities under each Subsidiary
board. The most significant of these transfers involves adjudication
and listing decisions. Given the increased responsibilities of
individual Governors created by the new interlocking boards structure,
the Association wishes to ensure that a sufficient number of qualified
individuals are available to review adjudication and listing decisions.
The functions of the National Business Conduct Committee, a committee
of the NASD Regulation Board composed entirely of board members,
therefore will be transferred to a new entity, the National
Adjudicatory Council (``NAC''),\21\ and the functions of the Nasdaq
Listing and Hearing Review Committee will transfer to the new Nasdaq
Listing and Hearing Review Council (``Listing Council'').\22\ The NAC
will be appointed by the NASD Regulation Board, after nomination by the
National Nominating Committee. Similarly, the Listing Council members
will be appointed by the Nasdaq Board. Except for the Chair of the NAC,
members of the councils will not serve on any of the Association's
boards. These new councils will meet at least 15 days before the
Subsidiary boards and generally will provide written reports of their
decisions to their respective boards not later than 15 days before the
Subsidiary board meetings, which will be scheduled to occur one day
before the meetings of the NASD Board.
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\21\ See new NASD Regulation By-Laws Article V.
\22\ See new Nasdaq By-Laws Article V.
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In addition to changes in the structure and composition of the
Association's boards and committees, the NASD proposes to include
strict quorum requirements. These requirements provide that decisions
made by less than the entire board or balanced committee are also
reached through balanced consideration.\23\ For example,
[[Page 62388]]
representation of Non-Industry and Public committee members on the new
NASD Executive Committee must be at least as great as the
representation of Non-Industry and Public Governors on the NASD Board,
and the quorum for the transaction of business at Executive Committee
meetings must consist of a majority of its members, including at least
50 percent of the Non-Industry committee members. Similarly, a quorum
for the transaction of business at Audit Committee meetings will
require a majority of the Audit Committee, including at least 50
percent of the Non-Industry committee members.\24\
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\23\ See new NASD By-Laws Article IX, Section 4(d); new NASD By-
Laws Article IX, Section 5(e); see also new NASD By-Laws Article
VII, Section 8 (establishing quorum for transaction of business at
Board meetings as a ``majority of the Board, including not less than
50 percent of the Non-Industry Governors''); new NASD Regulation By-
Laws Article V, Section 5.9 (establishing quorum requirements for
the NAC as ``a majority of the members, including not less than 50
percent of the Non-Industry members''); new Nasdaq By-Laws Article
IV, Section 4.9 (establishing quorum for the Board of Directors to
transact business as ``a majority of the Board, including not less
than 50 percent of the Non-industry Directors''.
\24\ Similar quorum requirements will be imposed on the
Executive Committees of the Subsidiaries, the NASD Finance
Committee, the National Nominating Committee, the Management
Compensation Committee, and the NAC.
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Finally, the definitions of Industry, Non-Industry and Public have
been revised.\25\ A Public participant on a board or committee is
someone who has no material business relationship with the Association,
or with any broker or dealer.\26\ The Non-Industry category is slightly
broader, permitting participation by those connected with companies
listed on Nasdaq.\27\ The Industry category is,\28\ and includes all
brokers and dealers, their officers, directors, and holding companies,
large shareholders of brokers and dealers, as well as many of the
people (including professionals) that work for them.\29\
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\25\ In addition, disqualification and removal procedures have
been imposed, supporting adherence to a balanced compositional
structure. Disqualification in this instance refers to a change in
status from Public and/or Non-Industry to Industry. See new NASD
Article VII, Section 6. Both Governors and members of the NAC and
the National Nominating Committee may be removed by the Board if
they refuse, fail, neglect, or are not able to discharge their
duties. See NASD By-Laws, Article VII, Section 1(b) (NASD); NASD By-
Laws, Article VII, Section 9(d) (NAC); See NASD Regulation By-Laws,
Article V, Section 5.6 (National Nominating Committee).
\26\ The new NASD By-Laws define a ``Public'' participant as one
``who has no material business relationship with a broker or dealer
or the NASD, NASD Regulation, or Nasdaq.'' See NASD By-Laws Article
I, Section (ff) and (gg); new NASD Regulation By-Laws Article I,
Section (z); new Nasdaq By-Laws Article I, Section (s).
\27\ The new NASD By-Laws define a ``Non-Industry'' participant
as one ``who is: (1) a Public Governor or committee member; (2) an
officer or employee of an issuer of securities listed on Nasdaq or
traded in the over-the-counter market; or (3) any other individual
who would not be an Industry Governor or committee member.'' See new
NASD By-Laws Article I, Section (cc) and (dd); NASD Regulation By-
Laws Article I, Section (x); new Nasdaq By-Laws Article I, Section
(q).
\28\ Although not specifically defined as ``Industry''
participants, officers of the NASD, NASD Regulation or Nasdaq
serving as members (other than ex-officio members) of a board or
committee appointed under the newly revised by-laws of any of the
three corporations, will be counted with the Industry participants
for compositional and quorum requirements.
\29\ The new NASD By-Laws define an ``Industry'' participant as
one ``who: (1) Is or has served in the prior three years as an
officer, director, or employee of a broker or dealer, excluding an
outside director or a director not engaged in the day-to-day
management of a broker or dealer; (2) is an officer, director,
(excluding an outside director) or employee of an entity that owns
more than ten percent of the equity of a broker or dealer, and the
broker or dealer accounts for more than five percent of the gross
revenues received by the consolidated entity; (3) owns more than
five percent of the equity securities of any broker or dealer, whose
investments in brokers or dealers exceed ten percent of his or her
net worth, or whose ownership interest otherwise permits him or her
to be engaged in the day-to-day management of a broker or dealer;
(4) provides professional services to brokers or dealers, and such
services constitute 20 percent or more of the professional revenues
received by the governor or committee member or 20 percent or more
of the gross revenues received by the Governor's or committee
member's firm or partnership; (5) provides professional services to
a director, officer, or employee of a broker, dealer, or corporation
that owns 50 percent or more of the voting stock of a broker or
dealer, and such services relate to the director's, officer's, or
employee's professional capacity and constitute 20 percent or more
of the professional revenue received by the Governor or committee
member or 20 percent or more of the gross revenues received by the
Governor's or committee member's firm or partnership; or (6) has a
consulting or employment relationship with or provides professional
services to the NASD, NASD Regulation, or Nasdaq or has had any such
relationship or provided any such services at any time within the
prior three years.'' See new NASD By-Laws Article I, Section (n) and
(o); new NASD Regulation By-Laws, Article I, Section (q); new Nasdaq
By-Laws Article I, Section (j).
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In addition to revising the structure of the boards and defining
the categories of participants, the NASD proposes to change the
nomination process for Governors, Directors and members of the NAC and
the Listing Council.\30\ Compositional requirements will be introduced
for the National Nominating Committee, the number of Governors and
Directors serving will be limited, and specific removal provisions for
National Nominating Committee members will be added.\31\ In addition,
the provisions through which dissident candidates can stand for
election will be refined.\32\ Members will be given additional time in
which to propose dissident candidates, and, in their official
capacities, Governors will not be allowed to express a preference for
any candidate during elections involving dissident candidates.\33\
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\30\ See new NASD By-Laws Article VII, Sections 9 and 10.
\31\ See, e.g., new NASD By-Laws Article VII, Section 4(a)
(Board size and composition); new NASD By-Laws Article VII, Section
1(b) (removal of Governors for cause); new NASD Regulation By-Laws
Article V, Section 5.2(a) (NAC size and composition); new NASD
Regulation By-Laws Article V, Section 5.6 (NAC member removal
provisions); new Nasdaq By-Laws Article Vi, Section 5.2(a) (Listing
Council size and composition); new Nasdaq By-Laws Article V, Section
5.6 (Listing Council member removal provisions).
\32\ See new Article VII, Section 10. Related to these changes,
enhanced procedures for participation in annual meetings have been
added. See new NASD By-Laws Article XXI, ``Meetings of Members.''
\33\See new NASD By-Laws Article VII, Section 11; new NASD
Regulation By-Laws Article IV, Section 4.14; new Nasdaq By-Laws
Article IV, Section 4.15.
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The NASD also proposes to amend the conflicts of interest
provisions.\34\ As revised, Governors and committee members will be
prohibited from directly or indirectly participating in any
adjudication of the interests of a party if they have a conflict of
interest or bias, or if circumstances otherwise exist where their
fairness might reasonably be questioned. Governors or committee members
must recuse themselves or be disqualified in accordance with the Rules
of the Association.\35\ In addition, similar provisions address
contracts and transactions between the NASD and any entity in which a
Governor or officer is involved.\36\
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\34\ See, e.g., new NASD By-Laws, Article 4, Section 4.14(a).
\35\ See, e.g., Rule 9160.
\36\ New Article XV, Section 4(b) of the NASD By-Laws provides
that a contract or transaction between the NASD and a Governor or
officer, or between the NASD and any entity in which a Governor or
officer is a director or officer, or has a financial interest, is
not void or voidable solely for this reason, or solely because the
Governor or officer is present at the meeting of the Board or
committee that authorizes the contract or transaction, or solely
because the Governor's or officer's vote is counted for such
purposes if: (1) The material facts pertaining to such relationship
or interest are disclosed or are known to the Board or the
committee, and the Board or committee in good faith authorizes the
contract or transaction by the affirmative vote of a majority of the
disinterested Governors; or (2) the contract or transaction is fair
to the NASD as of the time it is authorized, approved, or ratified
by the Board or committee. New Section 4(b) further provides that
only disinterested Governors may be counted in determining the
presence of a quorum at a meeting of the Board or of a committee
which authorizes the contract or transaction. Contracts and
Transactions between the NASD and its Subsidiaries are not subject
to proposed Section 4(b). See also new NASD Regulation By-Laws,
Article IV, Section 4.14(b); new Nasdaq By-Laws, Article IV, Section
4.14(b).
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1. Changes to the NASD By-Laws
In addition to the structural and related changes, the NASD is
proposing several clarifying amendments to its by-laws. For example,
the term ``person associated with a member'' is revised to clarify that
this term includes any natural person registered under the Rules of the
Association, without regard to employment responsibilities.\37\ This
[[Page 62389]]
counters the suggestion in certain case law that any person whose job
title or position is not specifically identified in the Association's
definition of associated person (regardless of whether the individual
is registered with an NASD member firm) may not be considered an
associated person if he or she is not directly ``engaged'' in the
securities business.\38\
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\37\ See new NASD By-Laws Article I(ee); new NASD Regulation By-
Laws I(y); and new Nasdaq By-Laws Article I(r).
\38\ See Slade versus Metropolitan Life Ins. Co. Index No.
117688/94, Decision and Order of April 9, 1996 (Sup. Ct., N.Y. Co.),
aff'd, 231 A.D.2d 467 (N.Y. 1996), appeal denied, 676 N.E.2d 500
(N.Y. 1996).
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Similarly, the revisions clarify the proceedings for obtaining
relief from the Association's eligibility requirements. The current
language could be read to suggest that a broker or dealer seeking
admission to the Association could use such proceedings to obtain
relief from the eligibility requirements as a means of gaining
admission to the Association. The Association did not intend to apply
this provision to applicants for membership, and the amendment removes
this potential ambiguity.\39\
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\39\ See Article III, Section 3(d). The changes include deletion
of Section 3(d)(2), the status of members or persons engaged in
eligibility proceedings, which is not set forth in the 9520 series
of the Rules of the Association. This is not a substantive change in
the Association's practice. The by-law revisions also remove the
requirement that members, registered representative and other
associated persons release the Association from liability except for
willful malfeasance. See Former Article III, ``Membership,''
renumbered as new Article IV, and former Article IV, ``Registered
Representatives and Associated Persons,'' renumbered as new Article
V. The Association proposes to delete Sections 1(a)(3) of Membership
and 2(a)(2) of Registered Representatives and Associated Persons,
which previously included the willful malfeasance release. This is
not substantive revision, however. The governing state law in
Delaware contains a similar release from liability under the
``business judgment'' rule, see, Smith v. Van Gorkom, 488 A.2d 858,
873 (De. 1985) (recognizing the gross negligence standard of care in
the context of analyzing a corporate director's duty of care),
although ``there is no protection for directors who have made `an
unintelligent or unadvised judgment.''' Id., at 872 (citing Mitchell
v. Highland-Western Glass, 167 A.2d 831, 833 (De. 1933)).
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2. Changes to the NASD Regulation By-Laws
The current NASD Regulation By-Laws were adopted on July 19, 1996,
in connection with the initial restructuring of the NASD following
presentation of the Select Committee Report to the NASD Board. In
addition to amending the NASD Regulation By-Laws to conform them to the
changes described above, the by-laws now include recognition of the
NASD as sole stockholder of NASD Regulation capital stock. Furthermore,
the language describing the composition and powers of the new NAC,
including procedures for district elections, are included in the NASD
Regulation By-Laws. Finally, indemnification provisions protecting NASD
Regulation personnel (including Directors), identical to those of the
NASD and proposed for Nasdaq, have been added.\40\
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\40\ See new NASD Revised Certificate of Incorporation Article
Fifth (Indemnification; Governor Liability); new Nasdaq By-Laws
Article VIII (Indemnification of Directors, Officers, Employees,
Agents, Nasdaq Listing and Hearing Review Council and Committee
Members).
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3. Changes to the Nasdaq By-Laws
Nasdaq adopted its current By-Laws on October 27, 1993. The
proposed amendments conform the by-laws to the changes described above.
The provisions creating and defining the Listing Council are contained
herein. In addition, indemnification provisions mirroring the NASD and
NASD Regulation have been included.\41\
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\41\ See e.g., new NASD Revised Certificate of Incorporation
Article Fifth (Indemnification; Governor Liability); new NASD
Regulation By-Laws Article X (Indemnification of Directors,
Officers, Employees, Agents, NAC and Committee Members).
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4. Changes to the Restated Certificates of Incorporation
The changes to the NASD Restated Certificate of Incorporation
conform it to the NASD Board structural changes previously
described.\42\ Similar conforming changes will be made to the NASD
Regulation and Nasdaq Certificates of Incorporation.\43\
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\42\See new Article Eighth.
\43\ Full text versions of these changes are contained in the
Notice, see supra text accompanying note 5.
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B. The Delegation Plan
The amendments to the Delegation Plan reflect the new interlocking
board structure of the NASD and its Subsidiaries, discussed above. For
example, the Delegation Plan is amended to authorize the NASD Board to
take action on its own initiative, either by the full board or through
the NASD Executive Committee. The purpose of this amendment is to allow
the Association to act quickly and decisively when necessary. Separate
consideration by the Subsidiary board can be avoided without any loss
of Subsidiary board input because the Subsidiary board members
constitute a subset of the NASD Board. This option is not available
under the current corporate structure, which requires that matters
within a Subsidiary's sphere of delegated authority be considered by
that Subsidiary's board before consideration by the NASD Board.
In addition, time-sensitive matters arising between regularly
scheduled board meetings can be resolved by the NASD Executive
Committee. Currently, the Subsidiaries' executive committees may take
initial action on such matters, but the action cannot be implemented
without the unanimous written consent of the NASD Board. Obtaining such
consent can impede the Association's ability to respond to urgent
matters. As revised, the NASD Executive Committee will be able to
convene telephonically on an as-needed basis to address time-sensitive
matters.
The revisions to the Delegation Plan also include provisions
addressing petitions for reconsideration of NAC and Listing Council
recommendations on proposed rule changes, when their recommendations
are inconsistent with later action taken by their respective governing
Subsidiary boards. If either the NAC or Listing Council disagrees with
its respective Subsidiary board, they may now petition the NASD Board
for reconsideration of the matter.\44\
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\44\ See new sections II.B.2. and III.B.3.
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In addition to the changes related to reconstitution of the
governing boards, the revised Delegation Plan includes changes to
several important committees. Specifically, the compositional and
quorum requirements of the NASD's Management Compensation Committee,
NASD Regulation's Market Regulation, National Arbitration and
Mediation, and Operations Committees, as well as Nasdaq's Quality of
Markets and Market Operations Review Committees, are included in the
revised Delegation Plan, providing for diversity of member, non-
industry and public participation.
Furthermore, the revised Delegation Plan includes an amendment
requiring establishment of procedures to consider requests by members,
associated persons, and members of the public to initiate formal
disciplinary action.\45\ This will allow the Association to be more
responsive to public inquiry and/or complaints about brokers, dealers
and their employees.
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\45\ See new section II.A.1.f. Additional discussion of these
procedures is included in the order approving SR-NASD-97-28,
discussed supra note 6, in connection with deletion of former Rule
8120 of the Rules of the Association. See Securities Exchange Act
Release No. 38908 (August 7, 1997), 62 FR 43385 (August 13, 1997).
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Finally, the oversight and management responsibilities of
Stockwatch, which handles the trading halt functions for the Nasdaq
market and exchange-listed securities traded in the over-the-counter
market, are more clearly defined. As amended, the Delegation Plan
provides that review of all questionable market activity, possible rule
infractions, or any other matters that require any type of
[[Page 62390]]
investigative or regulatory follow-up will be referred to and conducted
by NASD Regulation, which will assume sole responsibility for the
matter until resolution. This responsibility will include examinations,
investigations, document requests, and any enforcement action that NASD
Regulation deems necessary. In addition, the revisions provide that
NASD Regulation staff at all times will have access to all records and
files of the Stockwatch function.
III. Comments
The Commission did not receive comments on the NASD Proposal.
IV. Discussion
A. The Proposed Amendments
As discussed below, the Commission has determined at this time to
approve the NASD Proposal. The standard by which the Commission must
evaluate a proposed rule change is set forth in Section 19(b) of the
Act. The Commission must approve a proposed NASD rule change if it
finds that the proposal is consistent with the requirements of the Act
and the rules and regulations thereunder that govern the NASD.\46\ In
evaluating a given proposal, the Commission examines the record before
it and all relevant factors and necessary information. In addition,
Section 15A of the Act establishes specific standards for NASD rules
against which the Commission must measure the NASD Proposal.\47\
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\46\ 15 U.S.C. 78s(b).
\47\ 15 U.S.C. 78o-3.
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The Commission has evaluated the NASD's proposed rule change in
light of the standards and objectives set forth in the Act
(particularly Sections 15A \48\ and 3(f) \49\), as well as the SEC
Order and the 21(a) Report. The Commission believes that the changes to
the Association's corporate structure are consistent with those
provisions, as well as the objectives of the Undertakings and the 21(a)
Report. The proposed rule change maintains a balanced governance
structure by providing that the number of Public and Non-Industry
members of the NASD Board exceed the number of Industry members. By
providing for substantial and meaningful public and non-industry
involvement, in addition to diverse representation of various sectors
of the securities industry, on the governing boards, the NASD Proposal
should encourage dispassionate performance of the NASD's
responsibilities as an SRO.
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\48\ For example, Section 15A(b)(8) requires that the rules of
an association provide a fair procedure for the disciplining of
members and persons associated with members, the denial of
membership, the barring of any person becoming associated with a
member thereof, and for the prohibition or limitation by the
association of any person with respect to access to services offered
by the association. Section 15A(h)(2) requires a registered
securities association when determining whether a person shall be
denied membership, barred from becoming associated with a member, or
prohibited or limited with respect to access to services offered by
the association or member thereof, to notify such person of and give
him an opportunity to be heard upon, the specific grounds for
denial, bar, or prohibition or limitation under consideration and
keep a record. Section 15A(h)(3) governs when a registered
securities association may summarily suspend a member or a person
associated with a member.
\49\ In approving this proposal, the Commission notes that it
has considered the proposed rule change's impact on efficiency,
competition, and capital formation. 15 U.S.C. 78c(f).
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As reconstituted under the proposed rule change, each corporation
will continue to retain a clear and distinct role, with separate
officers and staff. Specifically, the NASD will continue to resolve
conflicts between the Subsidiaries and retain ultimate responsibility
for its statutory obligations as an SRO; NASD Regulation will continue
to perform the day-to-day regulation of brokers and dealers, have
primary responsibility for adjudication and enforcement, and to
supervise surveillance of Nasdaq and other OTC markets; and Nasdaq will
continue to own and operate the Nasdaq market and develop and implement
rules governing that market.\50\
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\50\ Specifically, the proposed rule changes comport with the
requirements (i) by balancing the Association's boards and
committees (see new NASD By-Laws Article VII, Section 4 and Article
IX; new NASD Regulation By-Laws Article IV; new Nasdaq By-Laws
Article IV; Delegation Plan I.C., II.C); (ii) by placing primary
day-to-day responsibility for regulatory matters with NASD
Regulation (see new Delegation Plan section II.A.1); (iii) by
providing for the autonomy and independence of the regulatory staff
of the NASD and its Subsidiaries (see id.); and (iv) by providing
for the existence of a substantial, independent internal audit staff
that reports directly to an audit committee of the NASD Board (see
new NASD By-Laws Article IX, Section 5).
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The substitution of the NAC and the Listing Council for their
predecessor board committees, should provide that the adjudication and
listing review process is conducted by qualified individuals
representing both the public and the industry. Creation of the new
councils is consistent with the requirements of the Act, and with the
NASD's obligations under the SEC Order and the 21(a) Report.
Finally, the various changes to the quorum provisions, the
nominating procedures, and the conflicts of interest provisions
contribute to and enhance the Association's ability to perform its SRO
responsibilities in an objective, balanced and responsive manner.
B. Effectiveness of the Amendments
The NASD has requested varying effective dates for the amendments
contained in this Order.\51\ In general, those portions addressing
nomination and election procedures will become effective upon issuance
of this Order. Immediate effectiveness of these changes will facilitate
the nomination and election of members of the NASD, NASD Regulation,
and Nasdaq Boards, the NAC, and the Listing Council whose terms of
office will begin in 1998.
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\51\ See Letter from T. Grant Callery, Vice President and Generl
Counsel, NADS to Katherine A. England, Assistant Director,
Commission, dated November 12, 1997.
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The remaining changes will become effective at the January 1998
meeting of the NASD Board, which will itself conform to the new
balanced compositional requirements contained in this Order. Allowing a
period of time between approval of this Order and the effective date
will give the Association adequate time to achieve the comprehensive
changes to its structure.
Finally, the Commission's temporary approval of SR-NASD-96-20 and
SR-NASD-96-29, which is currently scheduled to lapse on November 15,
1997 (to the extent these rule filings are not superseded by the
immediately-effective nomination and election procedure amendments), is
extended until the first meeting of the NASD Board of Governors in
January, 1998.\52\
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\52\ Specifically, the following sections of the corporate
governance documents will become effective immediately upon issuance
of this Order:
NASD By-Laws Article VII, Section 9(a), 9(e), and 10
through 14;
NASD By-Laws Article XX and XXI;
NASD Regulation By-Laws Article IV, section 4.16
Nasdq By-Laws Article IV, Section 4.15.
These provisions will supersede the following provisions of the
temporarily approved Plan of Allocation and Delegation of Functions
by NADS to Subsidiaries: I.C.2.a; I.C.2.b.3; IC.3., II.B.2. a
through II.B.2.c; and III.B.2.a.
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V. Amendment No. 2
The Commission finds good cause for approving Amendment No. 2 prior
to the thirtieth day after the date of publication of notice thereof in
the Federal Register. Specifically, Amendment No. 2 amends the time
during which a member may submit agenda items for the annual meeting of
NASD members. The Commission believes that this change, combined with
those in the initial filing of SR-NASD-97-71 are consistent with the
Act, and should enhance both the fair and efficient operation of the
NASD and the dispassionate application of the rules and fairness in the
NASD's adjudicatory and listing processes, as
[[Page 62391]]
well as other regulatory activities. Finally, the acceleration of the
effectiveness of Amendment No. 2 will enable the Commission to approve
its changes at the same time as the other major modifications to the
NASD corporate governance procedures proposed in the Notice. Therefore,
the Commission believes that granting accelerated approval to Amendment
No. 2 is appropriate and consistent with Section 19(b)(2) of the
Act.\53\
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\53\ 15 U.S.C. 78s(b)(2).
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VI. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment No. 2 to the proposed rule change.
Persons making written submissions should file six copies thereof with
the Secretary, Securities and Exchange Commission, 450 Fifth Street,
N.W., Washington, D.C. 20549. Copies of the submission, all subsequent
amendments, all written statements with respect to Amendment No. 2 that
are filed with the Commission, and all written communications relating
to Amendment No. 2 between the Commission and any persons, other than
those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for inspection and
copying in the Commission's Public Reference Room. Copies of such
filing will also be available for inspection and copying at the
principal office of the NASD. All submissions should refer to File No.
SR-NASD-97-71 and should be submitted by December 12, 1997.
VII. Conclusion
For all of the aforementioned reasons, the Commission finds that
the proposed rule changes are consistent with the requirements of the
Act and the rules and regulations thereunder applicable to a national
securities association.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\54\ that (a) the proposed rule change (SR-NASD-97-71) is approved,
including approval of Amendment No. 2 on an accelerated basis (with the
effective date of the nomination and election procedures to be
immediate and the effective date of the remaining provisions to occur
at the time of the January 1998 meeting of the NASD Board), and (b)
temporary approval of the proposed rule changes (SR-NASD-96-20 and SR-
NASD-96-29), to the extent not superseded by the immediately effective
amendments to SR-NASD-97-71, is extended until the January 1998 meeting
of the NASD Board.
\54\ 15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\55\
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\55\ 17 CFR 200.300-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-30622 Filed 11-20-97; 8:45 am]
BILLING CODE 8010-01-U
