[Federal Register Volume 62, Number 230 (Monday, December 1, 1997)]
[Notices]
[Pages 63589-63592]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-31393]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39349; File No. SR-NASD-97-96]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change and Amendment No. 1 by the National Association of Securities
Dealers, Inc. To Amend Its Rule 3230 Relating to Clearing Agreements
November 21, 1997.
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 October 14, 1997, the NASD Regulation, Inc. (``NASD Regulation'')
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 Regulation. On
November 20, 1997, the NASD Regulation filed Amendment No. 1 to the
proposed rule change.\3\ The Commission is publishing this notice to
solicit comments on the proposed rule change, as amended, from
interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Letter from John M. Ramsay, Deputy General Counsel, NASD
Regulation, to Katherine A. England, Assistant Director, Division of
Market Regulation, Commission, dated November 19, 1997 (``Amendment
No. 1''). In Amendment No. 1, the NASD Regulation amended the
proposal to: (1) Add a sentence to the rule relating to the
responsibility of introducing members to notify clearing members of
the specific reports needed by the introducing members to supervise
its business; (2) clarify that failure to provide such notification
would violate not only the proposed rule but also, the Association's
supervisory rules; and (3) delete a series of questions directed to
readers of the proposal. Commission staff has incorporated the
changes set forth in Amendment No. 1 into the notice.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
NASD Regulation proposes to amend the National Association of
Securities Dealers, Inc.'s (``NASD'' or ``Association'') Rule 3230 to:
(1) establish standards for the disposition of written customer
complaints received by clearing firms about introducing member firms
relating to their functions and responsibilities under the clearing
agreement; (2) govern how exception reports are made available to
introducing firms and retained by clearing firms; and (3) permit
introducing firms to write checks on their clearing firm's account.
Below is the text of the proposed rule change. Proposed new language is
in italics; proposed deletions are in brackets.
3230. Clearing Agreements
(a) All clearing or carrying agreements entered into by a member,
except where any party to the agreement is also subject to a comparable
rule of a national securities exchange, shall specify the respective
functions and responsibilities of each party to the agreement and
shall, at a minimum, specify the responsibility of each party with
respect to each of the following matters:
(1) Opening, approving and monitoring customer accounts;
(2) Extension of credit;
(3) Maintenance of books and records;
(4) Receipt and delivery of funds and securities;
(5) Safeguarding of funds and securities;
(6) Confirmations and statements;
(7) Acceptance of orders and execution of transactions;
(8) Whether, for purposes of the Commissioner's financial
responsibility rules adopted under the Act, and the Securities Investor
Protection Act, as amended, and regulations adopted thereunder,
customers are customers of the clearing number; and
(9) the requirement to provide customer notification under
paragraph [(d)](g) of this Rule.
(b)(1) In order for the introducing member to carry out its
functions and responsibilities under the agreement, each clearing
member must forward promptly any written customer complaint received by
the clearing member regarding the introducing member or its associated
persons relating to functions and responsibilities allocated to the
introducing member under the agreement directly to: (A) the introducing
member; and (B) the introducing member's examining authority designated
under Section 17 of the Act (``DEA'') (or, if none, to its appropriate
regulatory agency or authority). The clearing or carrying agreement
must specifically direct and authorize the clearing member to do so.
(2) The clearing member must also notify the customer, in writing,
that it has received the complaint, and that the complaint has been
forwarded to the introducing member and to the introducing member's DEA
(or, if none, to its appropriate regulatory agency or authority). This
written notice to the customer must also contain a statement that reads
substantially as follows: ``Please be aware that you retain the right,
at your discretion, to transfer your account to another broker/dealer
of your choice.''
(c)(1) A clearing member, when it enters into a clearing agreement,
must immediately, and annually thereafter, provide the introducing
member a list or description of all reports (exception and other types
of reports) which it offers to the introducing member to assist the
introducing member in supervising its activities, monitoring its
customer accounts, and carrying out its functions and responsibilities
under the clearing agreement. The introducing member must notify
promptly the clearing member, in writing, of those specific reports by
the clearing member that the introducing member requires to supervise
and monitor its customer accounts.
(2) The clearing member must retain as part of its books and
records required to be maintained under the Act and the Association's
rules, copies of the reports requested by or provided to the
introducing member. For purposes of this Rule, the clearing member will
be in compliance with the requirements of this paragraph it if retains
the data from which the original report was produced, provided, the
clearing member can, at the request of the DEA, either (A) recreate the
report; or (B) provide the data and the data formatting that was used
to prepare the report.
(3) Each year, no later than July 31, the clearing member must
notify in writing the introducing member's chief executive and
compliance officers of the reports offered to the introducing member
and the reports requested by or supplied to the introducing member
during the previous year ending June 30. The clearing member must also
provide a copy of the notice to the introducing member's DEA.
(4) The clearing member must provide, at the request of the
introducing member's DEA, any reports (or, if the reports are not
available, information or data from which the
[[Page 63590]]
reports could have been prepared) that were offered to the introducing
member but which the introducing member did not request.
(d) The clearing or carrying agreement may permit the introducing
member to issue negotiable instruments directly to the introducing
member's customers using instruments for which the clearing member is
the maker or drawer. The clearing member may not grant the introducing
member the authority to issue negotiable instruments until the
introducing member has notified the clearing member in writing that it
has established, and will maintain and enforce, supervisory procedures
with respect to the issuance of such instruments.
[(b)](e) Whenever a clearing member designated to the Association
for oversight pursuant to Section 17 of the Act, or a rule of the
Commission adopted thereunder, amends any of its clearing or carrying
agreements with respect to any item enumerated in subparagraphs (a)(1)
through (a)(9) or enters into a new clearing or carrying agreement with
an introducing member, the clearing member shall submit the agreement
to the Association for review and approval.
[(c)](f) Whenever an introducing member designated to the
Association for oversight pursuant to Section 17 of the Act, or a rule
of the Commission adopted thereunder, amends its clearing or carrying
agreement with a clearing member designated to another self-regulatory
organization for oversight with respect to any item enumerated in
subparagraphs (a)(1) through (a)(9) enters into a new clearing
agreement with another clearing member, the introducing member shall
submit the agreement to its local Association district office for
review.
[(d)](g) Each customer whose account is introduced on a fully
disclosed basis shall be notified in writing upon the opening of his
account of the existence of the clearing or carrying agreement.
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 Regulation 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 Regulation 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
Recent concerns about questionable sales practices and potentially
fraudulent activity by certain introducing firms, and the handling of
customer complaints about those firms by their clearing firms, caused
the staffs of NASD Regulation and the New York Stock Exchange, Inc.
(``NYSE'') to examine the relationship between clearing firms and their
client introducing firms. The examination resulted in proposals to
amend the NASD's and NYSE's Rules relating to the content and approval
of clearing agreements to specify requirements for handling customer
complaints, for providing, requesting and retaining exception reports,
and for issuing checks. The NYSE's proposal to amend their Rule 382 has
been filed with the Commission.\4\ The NASD believes its proposal to
amend Rule 3230 discussed below is consistent with the current NYSE
proposal to amend NYSE Rule 382.
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\4\ See Securities Exchange Act Release No. 39200 (October 3,
1997) 62 FR 53369 (October 10, 1997) (noticing File No. SR-NYSE-97-
25).
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While the Board of Directors of NASD Regulation (``Board'')
approved the proposed rule in recognition of the importance of
maintaining consistency with the NYSE's proposal, the Board expressed
strong concerns regarding the proposal, including those relating to two
particular issues. First, the Board expressed concern that the proposed
rules not change or be interpreted as changing the fundamental nature
of the relationship between introducing and clearing firms, or
otherwise affect rights, responsibilities or liabilities of the
introducing or clearing firm under law or contract. Other than to
establish limited requirements to enable the introducing member to
carry out its responsibilities under its clearing or carrying agreement
with the clearing member, the proposals are not intended to change the
fundamental nature of the relationship between introducing and clearing
firms, or otherwise affect any existing rights, responsibilities or
liabilities under law or contract.
Second, the Board expressed concern that the requirement that the
customer be notified by the clearing firm that he or she has the right
to transfer his or her account to another firm may unfairly single out
a particular category of complaints, create an unfair implication that
each such complaint would warrant the customer's transferring his
account, or otherwise operate inappropriately to distinguish this class
of complaints from others. In recognition of the importance of
maintaining consistency with the NYSE's proposal, the NASD requests
that the SEC defer approval of the NYSE's proposal until the NASD and
the SEC have had an opportunity to consider comments in response to the
publication for comment of the NASD proposal in the Federal Register.
Description of Proposed Rule Change
Customer Complaints. It is generally the practice of clearing firms
to forward to introducing firms customer complaints they receive
relating to matters that are the responsibility of the introducing
firm. Under NASD Rule 3070, a member is required to report to the
Association any written customer complaint against it involving
allegations of theft or misappropriation of funds or securities or of
forgery. Recently, however, there have been instances where introducing
firms may not have complied in a timely manner with the requirements of
Rule 3070 when their clearing firms forwarded customer complaints to
them. Thus, the Association does not get the reports in a timely manner
and NASD Regulation staff is not aware of the customer complaints until
long after the fact. Since there is no mechanism other than Rule 3070
designed to provide this information to NASD Regulation, such late
reporting undermines the purpose of Rule 3070, which is to provide NASD
Regulation with early warning indicators to generate a regulatory
response to problems. In addition, receipt by clearing firms of large
numbers of complaints regarding introducing firms may be indicative of
sales practice problems requiring prompt regulatory attention.
To address this concern, proposed new paragraph (b) states that
when a clearing firm receives a customer complaint about an introducing
firm relating to the functions and responsibilities of the introducing
firm, the clearing firm must forward the complaint to the introducing
firm and send a copy of the complaint to the introducing firm's DEA.
The requirement may provide an early warning to the DEA of potential
problems at introducing firms. The proposed amendment also provides
that the clearing agreement must expressly direct and authorize the
clearing firm to forward the complaint to the introducing firm and send
a copy of the complaint to the introducing firm's DEA.
[[Page 63591]]
In addition, the proposed rule provides that the clearing firm must
notify the customer in writing that the complaint was received, and was
forwarded to the introducing firm and to the introducing firm's DEA.
This requirement will serve to alert the customer that the complaint
has been received and forwarded to the appropriate entity (the
introducing firm) for a response, and that the introducing firm's
regulator has also been made aware of the customer's complaint. This
written notice to the customer must also contain a statement that reads
substantially as follows: ``Please be aware that you retain the right,
at your discretion, to transfer your account to another broker/dealer
of your choice.''
The requirement that the complaints be forwarded to the appropriate
DEA is intended to provide notice to the DEAs of the types of
complaints that are being received and to provide information that may
be useful for examining or investigating particular conduct. It is not
intended, however, to result in an investigation of each, or any
proportion, of complaints that are received by the DEA.
Exception Reports. All NASD member firms are required under NASD
and federal regulations to establish, maintain and enforce supervisory
systems and procedures that are designed to address all areas of a
member's business. A key aspect of these supervisory procedures is
exception and other compliance reports that a member creates to help
meet these supervisory responsibilities. In a fully disclosed clearing
arrangement, the clearing member generally provides exception reports
that are available to assist the introducing member in carrying out its
supervisory obligations. In addition, officers and managers of
introducing members should be on notice of the reports and information
that were available to them in meeting their supervisory and monitoring
obligations. Paragraph (c) of the proposed amendment addresses these
issues.
Proposed new paragraph (c)(1) requires the clearing firm to provide
its introducing firm, both at the commencement of the introducing/
clearing arrangement and annually thereafter, a list or description of
all exception or other reports which it offers to introducing firms to
assist the introducing firm in supervising its activities, monitoring
its accounts and carrying out its functions and responsibilities under
the clearing agreement. Proposed new paragraph (c)(1) also requires the
introducing member to notify promptly the clearing member, in writing,
of those specific reports offered by the clearing member that the
introducing member requires to supervise and monitor its customer
accounts. Failure to provide notification would not only be a violation
of this rule, but also of Rule 3010, which requires that members
establish and maintain proper supervisory systems.
Even though the language of the proposed amendment requires the
clearing firm to provide the introducing firm with a list or
description of reports that it will provide, the staff recognizes that
some clearing firms do not create such reports, but rather provide data
and data formatting software to their introducing clients that allow
the introducing firms to prepare their own reports. The proposal would
permit compliance with the provision where clearing firms communicate
with their introducing firms about the data and data formatting which
they make available so that the introducing firms can determine which
reports they will create in order to meet their supervisory and
monitoring needs.
Paragraph (c)(2) requires the clearing firm to retain as part of
its books and records, copies of any reports requested or provided to
the introducing firm. The provision permits a clearing firm to meet the
requirement if it retains the data that was used to prepare the report
but only if the clearing member, at the request of the DEA, can
recreate the report or provide the data and data formatting that was
used to prepare the report. Similarly, if the clearing firm provided
data and report formatting to the introducing firm, the clearing firm
could provide the data and data formatting that was provided to the
introducing firm to the DEA to fulfill this requirement.
Paragraph (c)(3) requires the clearing member, immediately after
entering into the clearing agreement, to notify the introducing
member's chief executive and compliance officers of the reports that it
offers to the introducing member, and the reports requested by or
supplied to the introducing firm. The clearing member must provide this
notice each year thereafter as of June 30, to be provided no later than
the following July 31.
Finally, paragraph (c)(4) requires the clearing member, at the
request of the introducing member's DEA, to provide to the DEA reports
that were offered to the introducing member but which the introducing
member did not request. As with the record retention provision in
paragraph (c)(2), this requirement may be met if the clearing member
retains the data from which the original report was produced and then
either recreates the report or provides the data and data formatting
that was used to prepare the report.
Check Writing. Under proposed new Paragraph (d), the clearing
agreement may permit the introducing firm to issue checks to the
introducing firm's customers that are drawn on the clearing member's
account upon written representation from the introducing firm that it
has established, and will maintain and enforce, supervisory procedures
with respect to the issuance of negotiable instruments. This rule is
intended to protect customers by clearly establishing that the clearing
member will be the maker or drawer of such instruments and, therefore,
liable for any mistakes or fraud by the introducing firm in the making
or drawing of the check. This provision is intended to establish that
clearing firms are liable to the introducing firm's customer if the
introducing firm misuses the authority and, thereby, to protect the
customer with the clearing member's funds.
2. Statutory Basis
NASD Regulation believes that the proposed rule change is
consistent with the provisions of Section 15A(b)(6) of the Act,\5\
which require that the Association adopt and amend its rules to promote
just and equitable principles of fair trade, and generally provide for
the protection of investors and the public interest in that the
proposed rule change is designed to establish standards for the
disposition of written customer complaints about introducing member
firms, govern how exception reports are made available to introducing
firms and retained by clearing firms, and permit introducing firms to
write checks on their clearing firm's account.
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\5\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition
NASD Regulation does not believe the proposed rule change will
result in any burden on competition that is not necessary or
appropriate in furtherance of the purposes of the Act.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants or Others
Comments were neither solicited or received.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 35 days of the publication of this notice in the Federal
Register or
[[Page 63592]]
within such longer period (i) as the Commission may designate up to 90
days of such date if it finds such longer period to be appropriate and
publishes its reasons for so finding or (ii) as to which the self-
regulatory organization consents, the Commission will:
A. By order approve such proposed rule change, or
B. Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing. In addition to any other issues
that the public may wish to address, the Commission specifically
requests comments on the following questions:
General
Will the respective obligations imposed on clearing and introducing
firms by the proposal help introducing firms and regulators better
address sales practice problems?
To what extent would the proposal discourage either introducing or
clearing firms from agreeing to enter into new clearing relationships,
or to renew existing ones, or affect the degree of care employed when
entering into such a relationship?
Customer Complaints
How quickly are customer complaints that are directed to clearing
firms and that concern introducing firms or their associated persons
currently forwarded to introducing firms? What proportion of these
complaints concerns matters identified in NASD Rule 3070(a)(2), i.e.,
allegations of theft or misappropriation of funds or securities, or of
forgery? What other types of complaints typically are received?
Why in general are complaint letters addressed to clearing firms
rather than introducing firms, when they concern conduct of the
introducing firms? Please address the extent to which this occurs
because of confusion by customers over the relative responsibilities of
the firms based on the contacts with the customer, such as
confirmations, or for other reasons, e.g., the failure to receive a
response from the introducing firm?
Should the requirements of the proposed rule regarding customer
complaints apply equally to complaints against a clearing firm sent by
a customer to an introducing firm with whom the clearing firm has a
clearing agreement?
Presently, copies of customer complaints that are received by
securities firms are not required to be forwarded to the SEC or any
self-regulatory organization (``SRO''). Rather, the firms are required
to submit summaries of complaints to their SRO. To the extent that this
requirement is imposed, should clearing firms be required to send
summaries or actual complaint letters to the SROs?
Will the requirement that, upon the clearing firm's receipt of a
customer complaint, the customer be notified by the clearing firm that
he or she has the right to transfer his or her account to another firm
serve a useful purpose, in informing customers that they are not tied
to the introducing broker in the case of sales problems? Does it create
an unfair implication that each such complaint would warrant the
customer's transferring his account, or otherwise unfairly tarnish the
introducing firm? To the extent that this type of information is useful
to investors, does it make sense to provide this notice only in the
circumstances identified?
Exception Reports
What compliance or cost burdens would result from the requirement
that clearing firms retain copies of exception reports or data that is
provided to introducing firms? To what extent is this data now stored,
and for how long?
What are the relative costs and benefits of the requirements for
annual reports to the executive and compliance officers of introducing
firms as to the exception reports that were offered and supplied? Is it
feasible for the clearing firm to provide reports to the DEAs that the
introducing firm did not request?
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 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 at the Commission's Public
Reference Section, 450 Fifth Street, N.W., Washington, D.C. 20549.
Copies of such filing will also be available for inspection and copying
at the principal office of the above-mentioned self-regulatory
organization. All submissions should refer to File No. SR-NASD-97-76
and should be submitted by December 22, 1997.
For the Commission, by the Division of Market Regulations,
pursuant to delegated authority.\6\
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\6\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-31393 Filed 11-28-97; 8:45 am]
BILLING CODE 8010-01-M
