[Federal Register Volume 63, Number 243 (Friday, December 18, 1998)]
[Notices]
[Pages 70173-70177]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-33558]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-40784; File No. SR-NASD-98-44]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the National Association of Securities Dealers, Inc.,
Relating to Enhanced Supervision of Unregistered Persons Performing
Limited Marketing Activities
December 11, 1998.
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 July 6, 1998, the National Association of Securities Dealers, Inc.
(``NASD'' or ``Association'') through its wholly-owned subsidiary, the
NASD Regulation, Inc. (``NASDR'') 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 the NASDR. On December 2, 1998, the NASDR submitted
Amendment No. 1 to the proposed rule change.\3\ The Commission is
publishing this notice to solicit comments on the proposed rule change
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 Gary L. Goldsholle, Assistant General
Counsel, NASDR, to Katherine A. England, Assistant Director,
Division of Market Regulation, Commission, dated November 30, 1998
(``Amendment No. 1''). In Amendment No. 1, the NASDR proposes to
amend its filing by deleting its reference to the use by member
firms of third-party telemarketing firms for limited marketing
activities.
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I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
The NASDR is proposing to amend Rule 1060 and create a new
Interpretative Material, IM-3010, to codify existing practice by
exempting from registration persons whose securities business is
limited to certain limited marketing activities and specify supervisory
requirements for members concerning such unregistered persons. Below is
the text of the proposed rule change. Proposed new language is in
italics.
1060. Persons Exempt From Registration
(a) The following persons associated with a member are not required
to be registered with the Association:
(1) persons associated with a member whose functions are solely and
exclusively clerical or ministerial;
(2) persons associated with a member who are not actively engaged
in the investment banking or securities business;
(3) persons associated with a member whose functions are related
solely and exclusively to the member's needs for nominal corporate
officers or for capital participation; and
(4) persons associated with a member whose functions are related
solely and exclusively to:
(A) effecting transactions on the floor of a national securities
exchange and who are registered as floor members with such exchange;
(B) transactions in municipal securities, except as provided in
Rule 1110 hereof, or
(C) transactions in commodities; and
(5) persons associated with a member whose investment banking or
securities business is limited to marketing activities through the
telephone or other electronic communications media for the following:
(A) extending invitations to firm-sponsored events at which any
substantive presentations and account or order solicitation will be
conducted by appropriately registered personnel;
(B) inquiring whether the prospective or existing customer wishes
to discuss investments with a registered person; and
(C) inquiring whether the prospective or existing customer wishes
to receive investment literature from the firm.
In connection with subparagraphs (A), (B) and (C), unregistered persons
shall be permitted to mention the products and services generally
available from
[[Page 70174]]
the member, provided, however, that such unregistered persons shall not
discuss the attributes or merits of any particular investment products
or services or class of products or services, pre-qualify prospective
customers as to financial status and investment history and objectives,
or solicit new accounts or orders. Nothing in this subparagraph shall
affect the ability of administrative personnel to contact customers
regarding clerical or ministerial matters affecting a customer's
account(s).
IM-3010. Supervision of Solicitation and Marketing Activities by
Unregistered Persons
Each member employing or using unregistered associated persons in
accordance with Rule 1060(a)(5) (hereinafter referred to as
``unregistered marketers'') shall ensure that the member's supervisory
system includes the following:
(a) Background Investigation. Prior to employing or using an
unregistered marketer, the member shall conduct a reasonable
investigation into the background of such person to determine that he
or she is not subject to a disqualification as defined in the
Association's By-Laws.
(b) Instruction and Training. The member, or a person designated by
the member, shall instruct all unregistered marketers acting on behalf
of the member concerning the scope of their permissible activities,
including: the matters that they may discuss pursuant to Rule
1060(a)(5), the telemarketing time-of-day and disclosure obligations
required under Rule 2211, and the requirement to make and maintain a
centralized do-not-call list pursuant to IM-3110 and to refrain from
soliciting customers whose names are included on the list.
(c) Designated Principals. The member shall designate one or more
principals who shall be responsible for implementing and overseeing the
member's supervisory system concerning the employment or use of
unregistered marketers;
(d) Signed Acknowledgment. The member shall not permit unregistered
marketers to contact customers on behalf of the member until the
unregistered marketer acknowledges, in writing or by electronic means,
that he or she:
(i) is an associated person of the member;
(ii) as an associated person:
a. is not subject to a disqualification as defined in the
Association's By-Laws; and
b. submits to the authority of the jurisdiction of the Association
and
(iii) has been instructed by the member, or a person designated by
the member, concerning the permissible activities of unregistered
marketers, as specified in subparagraph (b).
(e) Compensation. Unregistered marketers shall be compensated on an
hourly or salary basis only, and shall not receive any bonus or
additional compensation or other incentives tied to transactions.
(f) Monitoring. Registered persons shall periodically monitor calls
made by unregistered marketers to ensure that they comply with the
limitations described in Rule 1060(a)(5).
(g) Recordkeeping. The member shall prepare written records
demonstrating compliance with the provisions of this interpretation,
which shall include reports documenting the frequency of periodic
monitoring and the results of such monitoring. The member also shall
keep copies of all scripts used by unregistered marketers calling on
their behalf. The member shall preserve each record for a period of not
less than three years from the date the record was created, the first
two years in a readily accessible place. In addition, the member shall
retain the acknowledgment required in subparagraph (d) for a period of
not less than three years from the date an individual ceased marketing
on behalf of the member, the first two years in a readily accessible
place.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, the NASDR 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. The NASDR 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
Background
The Association's current policy, contained in Notice to Members
(``NTM'') 88-50, permits unregistered individuals to extend invitations
to firm-sponsored events and to inquire whether a prospective customer
wishes to discuss investments with a registered person or receive
investment literature. The proposed rule change adds certain specific
supervisory requirements concerning the activities of these
unregistered persons, while codifying in the NASD's rules the extent to
which such persons may act on behalf of a member without registration.
Specifically, under the proposed rule change, members using
unregistered persons for the permitted activities will be required to
supervise and periodically monitor such persons to ensure that their
marketing activities do not exceed the narrowly prescribed limits. In
addition, members will be required to conduct a background
investigation on unregistered persons, provide instruction and training
on the scope of their limited permissible activities, designate one or
more principals to be responsible for the marketing activities of
unregistered persons, and compensate such unregistered persons on an
hourly or salary basis only. Any unregistered person who proposes
marketing to customers on behalf of a member also must acknowledge in
writing certain matters, including that he or she submits to the
authority of the Association.
The Proposal in Notice to Members 97-58
In August 1997, in NTM 97-58, the NASDR proposed a requirement to
register all persons associated with or used by a member who
communicate with the public for the purpose of soliciting the purchase
of securities or related services or identifying prospective customers.
The proposal contained an exemption permitting unregistered persons to
communicate with existing customers of a member firm for three limited
activities: (1) extending invitations to firm-sponsored events; (2)
inquiring whether a customer wishes to speak with a registered person;
and (3) inquiring whether a customer wishes to receive investment
literature from the firm.
The proposed rule change herein, like its predecessor in NTM 97-58,
is designed to address the use of high pressure and aggressive cold
calls by unregistered persons, often using specially designed scripts.
It also addresses the NASDR's concern that members may not be
consistently applying the current cold calling requirements and that
members may be employing unregistered persons under the guise of
performing the limited functions described above, when in fact such
persons are engaged in much broader solicitation activities. Finally,
it addresses the NASDR's concern that unregistered persons soliciting
[[Page 70175]]
customers may provide inaccurate or misleading information to
customers.
Based upon the comments received in response to NTM 97-58, and
input provided by the various NASD standing-committees, the NASDR is
recommending an alternative approach. The proposed rule change is no
longer as much a general rule on ``cold calling'' per se as it is a
rule addressing the circumstances under which unregistered persons may
conduct limited marketing activities, such as extending invitations to
firm-sponsored events, inquiring whether a prospective or existing
customer wishes to speak with a registered person or receive investment
literature.
The proposed rule change represents a significant shift from the
position articulated in NTM 97-58. This shift stems from the NASDR's
conclusion after considering all of the input received in the
rulemaking process, that registration may not be the most appropriate
regulatory mechanism to address the NASDR's concerns. This point was
raised by many of the commenters and committees that considered the
initial proposal. In general, the commenters and committees believe
that registration would not address the substance of cold calls, which,
they believe, is what really should be of concern to the NASDR. The
commenters and committees also believe that registration should not be
required of persons who perform the limited functions permitted in NTM
88-50. Registration, they argue, would be a costly and impractical
solution to a problem that is more effectively addressed through
increased supervision and enforcement.
The New Proposal
The NASDR's proposed rule change codifies generally the current
restrictions governing the use of unregistered persons that engage in
marketing activities as set forth in NTM 88-50, and establishes more
comprehensive supervisory responsibilities of members towards such
unregistered persons. The NASDR believes that the proposed rule change
would achieve several important regulatory objectives. First, it would
educate members about their responsibilities regarding the use of
unregistered persons that engage in marketing activities. Second, it
would signal to the membership the NASDR's renewed attention to the
problem of marketing. Third, and perhaps most importantly, since the
new rule would require SEC approval, it would provide a clear, and in
some cases, an additional and more easily provable basis on which to
bring enforcement actions against firms and individuals that exceed the
narrow boundaries established for the use of unregistered persons to
engage in marketing activities.
The proposed rule change also seeks a more careful balance between
the burdens and benefits of registration. While avoid the expense of
registration, the NASDR believes the proposed rule change retains many
of the protections that registration would provide. Under the proposed
rule change, line NTM 88-50, members would be required to conduct a
reasonable background investigation to determine that no prospective
unregistered person who intends marketing to customers on behalf of the
member is subject to a disqualification as defined by the By-Laws. In
addition, under the proposed rule change, such unregistered persons
would continue to be deemed associated persons, and thus, subject to
the jurisdiction of the Association. The proposed rule change makes the
status of unregistered persons who perform limited marketing activity
more clear than NTM 88-50 by requiring all such persons to execute an
acknowledgment stating that they are associated persons and subject to
the Association's jurisdiction. Persons performing these functions,
however, would not be required to complete the series 7 examination--an
examination that the staff believes is unnecessary for the limited
activities permitted by unregistered persons. NASDR staff considered
implementing a specific ``cold calling'' exam but concluded that there
would not be sufficient material to make such an examination
meaningful.
While the proposed rule change was originally conceived to address
problems resulting from cold calling activity, the current proposal
covers activity occurring in electronic communications media generally.
In light of the rapid growth of the Internet and other electronic
communications media, the proposed rule change ensures that the
requirements imposed by these new rules cannot be circumvented by
moving marketing activity from the telephone to non-traditional media.
If, for example, a member uses an unregistered person to post a message
inviting the public to a seminar on an Internet bulletin board or
during a conversation in a chat room, such conduct should be subject to
the same requirements and supervision as communication over the
telephone.
The proposed rule change is based upon the premise, as articulated
in NTM 88-50, and set forth in NASD Rule 1031(b), that persons
associated with a member who are engaged in the investment banking or
securities business for the member, including the functions of
solicitation'' are required to register as a ``representative.'' Rule
1060 lists a series of exemptions from registration for certain
categories of persons associated with a member. Proposed new rule
1060(a)(5) would add a new category and exempt persons whose investment
banking or securities business is limited to marketing to customers
through the telephone or other electronic communications media for the
following: (1) extending invitations to firm-sponsored events at which
any substantive presentations and account or order solicitation will be
conducted by appropriately registered personnel; (2) inquiring whether
the prospective or existing customer wishes to discuss investments with
a registered person; and (3) inquiring whether the prospective or
existing customer wishes to receive investment literature from the
firm. By including marketing towards existing as well as prospective
customers, the new rule makes clear that contacts with existing
customers should be governed by the same restrictions as contacts with
prospective customers.
New rule 1060(a)(5) clarifies what unregistered persons may say in
connection with their marketing activities. Specifically, the rule
states that ``unregistered persons shall be permitted to mention the
products and services generally available from the member, provided
that they do not discuss the attributes or merits of any particular
investment products or services, pre-qualify prospective customers as
to financial status and investment history and objectives, or solicit
new accounts or orders.'' In addition, new rule 1060(a)(5) states that
it shall not affect the ability of administrative personnel to contact
customers regarding clerical or ministerial matters affecting a
customer's account.
Supervisory Responsibilities
The comprehensive supervisory responsibilities set forth in the
proposed rule change contain many of the supervisory responsibilities
set forth in NTM 88-50, with several significant additions. The
supervisory responsibilities contained in NTM 88-50 and codified in the
proposed IM-3010 are: (1) Instructing unregistered persons who are
marketing on behalf of a member concerning the scope of their
permissible activities; (2) conducting a reasonable investigation into
the background of any potential unregistered person to determine that
[[Page 70176]]
such person is not statutorily disqualified from becoming associated
with the member; and (3) compensating unregistered persons on an hourly
or salary basis only, without any bonuses or other incentives tied to
transactions.
The additional supervisory obligations that would be imposed by the
proposed rule change include a requirement for members to obtain an
acknowledgement from any unregistered person who intends marketing to
customers on behalf of the member stating that he or she: (1) Is an
associated person of the member; (2) as an associated person (a) is not
subject to a disqualification as defined in the By-Laws and (b) submits
to the jurisdiction of the Association; and (3) has been instructed by
the member, or a person designated by the member, concerning the scope
of permissible marketing activities in which such unregistered persons
may engage.
The proposed rule change also would require members to periodically
monitor the activities of unregistered persons marketing on their
behalf to confirm that such persons are complying with the limitations
placed upon them. The NASDR proposes allowing members to determine what
level and form of monitoring is appropriate, although we would expect
members to increase the frequency of monitoring in response to
complaints or other indicia that marketing abuses may be taking place.
Members may satisfy the monitoring requirements in a variety of
methods, including periodically ``listening in'' on marketing calls, or
contacting previously marketed persons to determine the scope of any
communication by the unregistered person. Whatever method members
choose, they would be required to maintain a written record of the
verification procedures used and the results of the periodic
monitoring.
The recordkeeping requirements of the proposed rule change are an
integral part of the supervisory system. The signed acknowledgements
and records of periodic monitoring will help provide assurance that the
restrictions placed upon unregistered marketers are being followed.
NASDR staff has also included a specific requirement for members to
maintain copies of all scripts used by unregistered persons calling on
their behalf. Scripts used by marketers frequently contain the issues
to be discussed and suggested responses to questions that may arise
during a conversation. From a regulatory perspective, scripts are often
very probative of the substance of a cold call or marketing effort, and
thus would be particularly useful in determining whether a member's use
of unregistered marketers is in compliance with the limitations imposed
by the proposed rule.
The proposed rule change also would require members to designate
one or more registered principals to be responsible for overseeing the
member's supervisory obligations relating to the employment and use of
unregistered persons engaged in marketing on behalf of the member. The
NASDR believes that firms are likely to be more diligent in supervising
unregistered persons if members designate specific individuals with
responsibility for overseeing such activity.
Additional Issues
Some banks and bank affiliated firms have argued that the proposed
rule change could unduly limit marketing activities by bank employees.
Although the NASDR preliminarily believes that the potential customer
protections that will be derived from the increased supervision of the
activities of unregistered persons outweigh these concerns, we would be
interested in receiving further comments on the advisability of
applying these rules to bank employees, as well as any possible bases
for excluding such employees. In particular, for example, would it be
appropriate to exclude entities that are otherwise regulated under
federal or state law, such as banks and insurance companies?
We also wish to obtain further public comment on whether the
proposed rule change should be modified to reach the activities of
unregistered third-party telemarketing firms that independently
generate leads and then sell such leads to member firms. Since the
Association's jurisdiction would not extend to communications by third-
party telemarketing firms that are not made on behalf of a particular
member, we are concerned about a potential loophole in our proposed
rule change in that members may be able to avoid application of the
proposed rule change simply by purchasing leads from third-party
telemarketing firms that independently generate leads and/or prequalify
customers but do not do so on behalf of any particular member. On the
other hand, if a member repeatedly purchases leads from a third-party
telemarketing firm, the NASDR would take the position that the third-
party telemarketing firm is impliedly acting on behalf of the member
and would be subject to the provisions of the proposed rule change.
2. Statutory Basis
The NASDR believes that the proposed rule change is consistent with
the provisions of Section 15A(b)(6) of the Act,\4\ which require that
the Association adopt and amend its rules to promote just and equitable
principles of trade, and generally provide for the protection of
investors and the public interest. The NASDR believes that the proposed
rule change codifying the Association's marketing and cold calling
restrictions, with the addition of specified supervisory requirements,
will sharply and effectively limit the marketing activities of
unregistered persons while ensuring the member firms closely supervise
and monitor the activities of unregistered persons marketing on their
behalf.
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\4\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition
The NASDR 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
NASD's Notice to Members 97-58 was published for comment in August
1997. Forty-three comments were received in response to the Notice. Of
the forty-three comment letters received, 14 were in favor of the
proposal and 25 were opposed, and 4 expressed no opinion.
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 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, including whether the proposed rule
change is consistent with the Act. In addition to any other issues that
the public may wish to address, the
[[Page 70177]]
Commission specifically requests comments on the following questions:
Should NASD member firms be permitted to use third-party
telemarketing firms for the limited marketing activities set forth in
the proposal (i.e., as unregistered marketers)?
To what extent are third-party telemarketing firms currently used
by member firms for cold calling or marketing purposes?
What types of member firms typically rely on third-party
telemarketing firms to conduct cold calling on their behalf (i.e.,
large firms, medium-sized, or small firms)?
The proposal requires member firms to ``periodically monitor'' the
calls made by unregistered persons on their behalf to ensure that the
discussions are limited to permissible topics. There is, however, no
requirement that such calls be tape recorded. How would member firms
monitor calls by unregistered persons working off-site at third-party
telemarketing firms or working for member firms off-site?
If a member firm can use third-party telemarketers, how can a
member firm be certain that unregistered persons working for third-
party telemarketing firms will limit their conversations with existing
and prospective members to the permissible topics?
Will the required ``reasonable background investigation'' be
sufficient to ensure that individuals who have been suspended from the
industry are not permitted to engage in limited marketing activities?
Would member firms be able to adequately supervise the limited
marketing activities of employees of third-party telemarketing firms?
What steps should firms take if a third-party telemarketer fails to
comply with these requirements?
What should the NASD do to ensure that such limited marketing
activities conducted off-site at third-party telemarketing firms are
appropriately supervised by member firms?
If the use of third-party telemarketing firms is permitted, the
proposal would require employees of third party telemarketing firms to
acknowledge in writing or electronically that they are associated
persons. The Commission notes that there is no requirement for an
electronic signature or any other heightened restrictions in place.
Will an electronic acknowledgment provide the member firm and the NASD
with sufficient information as to the true identity of the individual?
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 submissions, 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 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-98-44 and should be
submitted by January 8, 1999.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\5\
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\5\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 98-33558 Filed 12-17-98; 8:45 am]
BILLING CODE 8010-01-M
