[Federal Register Volume 61, Number 92 (Friday, May 10, 1996)]
[Notices]
[Pages 21517-21521]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-11747]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-37169; File No. SR-NASD-96-15]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by National Association of Securities Dealers, Inc. Relating to
Schedule A to the By-Laws To Amend the Allowable Exclusions and
Deductions From the Definition of Gross Revenue for Member Assessment
Purposes
May 6, 1996.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''),\1\ notice is hereby given that on April 4, 1996, the
National Association of Securities Dealers (``NASD'' or
``Association'') filed with the Securities and Exchange Commission
(``Commission'') the proposed rule change as described in Items I, II,
and III below, which Items have been prepared by the NASD. 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)
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
Following is the text of the proposed rule change. Proposed new
language is italicized; deletions are in brackets.
NASD By-Laws
Schedule A
* * * * *
Section 5 Gross Revenue for Assessment Purposes
(a) Gross revenue is defined for assessment purposes as total
income as reported on FOCUS form Part II or IIA with the following
exclusions:
[ ] (1) Other income unrelated to the securities business;
[ ] [Interest and dividends;]
[ ] (2) Commodities income;
[ ] (3) Advisory fees, investment management fees and
finders' fees not directly involving the offering of securities; proxy
fees; vault service fees; safekeeping fees; transfer fees; and fees for
financial advisory services for municipalities;
[ ] (4) Commissions derived from transactions executed on
a registered national securities exchange or a foreign securities
exchange (Note 1);
[ ] (5) Profits or losses derived from transactions of
which both the purchase and sale are executed on a registered national
securities exchange, including arbitrage (Note 1); and
[ ] (6) Profits and losses derived from transactions in
certifications of deposit and commercial paper, which is defined to
include drafts, bills of exchange, and bankers acceptances.
(b) In addition, members may deduct:
[ ] (1) Any commissions, concessions or other allowances
paid to another member in connection with the execution or clearance of
transactions included in reported revenue. For example, a member acting
as a clearing agent for another member shall deduct net amounts allowed
to the non-clearing member; [and]
[ ] (2) 25% of gross wrap fees charged to and received
from customers and paid or allocated to investment managers or
advisors[.]; and
[ ] (3) Interest and dividend expense but not in excess of
related interest and dividend revenue or, alternatively, the member may
deduct 40% of interest earned by the member on customer securities
accounts; provided, however in addition the member may deduct the first
$50,000 of net interest and dividend revenue.
Note 1: Income not subject to exclusion for members for whom the NASD
is the designated examining authority.
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 self-regulatory organization
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 self-regulatory organization
has prepared summaries, set forth in Sections A, B, and C below, of the
most significant aspects of such statements.
[[Page 21518]]
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
Gross revenue is defined for member assessment purposes under
Section 5 of Schedule A to the NASD By-Laws (``Section 5'') as total
income reported on FOCUS form Part II or IIA. Members, however, are
allowed certain exclusions. Income derived from interest and dividends
is currently an allowable exclusion under Section 5.
The NASD surveyed members' FOCUS filings for 1994 and conducted
discussions with a number of member firm representatives, from which
the NASD determined that, along with the normal interest income from
customer margin accounts and interest and dividends from trading and
investment positions, a significant portion of interest revenue for
certain members is associated with the member's trading strategies
involving, for example, repurchase, reverse repurchase, and stock loan/
borrow transactions, which are considered over-the-counter revenues
from the securities business.
The NASD is proposing to amend Section 5 of Schedule A by deleting
a provision which currently allows a member to exclude its interest and
dividends from gross revenue for assessment purposes. The proposed rule
change, however, would add a new provision to allow a member to deduct
from gross revenue for assessment purposes either: (i) its interest and
dividend expenses but not in excess of related interest and dividend
revenue; or, alternatively, (ii) 40% of interest earned by the member
on customer securities accounts. The first deduction is intended to
allow the member to subtract directly-related expenses from interest
and dividend revenue to be included in the definition of gross revenue.
The alternative deduction is intended to eliminate the potential for
inequitable allocation of assessments on those members whose interest
and dividend revenue is obtained without significant expenses related
to trading strategies, (e.g., if a member derives interest revenue
primarily from margin accounts and finances this lending through its
own capital). It would also be consistent with the assessment of
interest and dividend revenue by the Securities Investor Protection
Corporation (``SIPC''), which permits an alternative offset to gross
interest and dividend revenue consisting of 40% of interest earned on
customer securities accounts. The proposed rule change, in addition,
would allow a member to deduct from its gross revenue the first $50,000
of net interest and dividend revenue in order to continue to encourage
the accumulation of net capital, particularly by smaller members.
Based on NASD data, the NASD estimates that the proposed rule
change, if adopted for 1995, would have generated assessment revenue of
$3 million based on the budgeted level of assessment revenue of $39
million for that year.
The proposed rule change would also amend Section 5 to provide
alphabetical references to its two primary subsections and by replacing
all bullets referencing its secondary subsections with numerical
references.
The NASD is proposing that the proposed rule change take effect for
the 1996 assessment based on revenues generated in calendar year 1995.
2. Statutory Basis
The NASD believes that the proposed rule change is consistent with
the provisions of Section 15A(b)(5) of the Act \2\ which requires that
the rules of the association provide for the equitable allocation of
reasonable dues, fees and other charges among members in that the
proposed rule change would recognize interest and dividend revenue as a
part of a member's gross revenue for assessment purposes, while
recognizing that expenses incurred in connection with such interest and
dividend revenue should be allowed to be deducted from such revenue
(e.g. as part of ``matched transactions''). It would also allow members
whose business incurs less direct expense in connection with interest
and dividend revenue to alternatively deduct 40% of interest earned by
the member on customer securities accounts. It would, in addition,
allow members to deduct from their gross revenue the first $50,000 of
net interest and dividend revenue for assessment purposes in order to
continue to encourage the accumulation of net capital. The proposed
rule change also would be consistent with the SIPC's assessment of such
revenue.
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\2\ 15 U.S.C. 78o-3.
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B. Self-Regulatory Organization's Statement on Burden on Competition
The NASD published for comment in Notice to Members 95-94 (October
27, 1995) (``NTM 95-94'') a proposal to include net interest and
dividends in the definition of gross revenue for assessment purposes
under Section 5.\3\ One commentor argued that the proposed rule change
contained in NTM 95-94 discriminates against fixed income firms which
finance mostly liquid collateral (i.e., governments and mortgages) and
will make the small, match-book spreads of these firms even smaller,
thereby forcing certain firms to move their match-book business and
proprietary trading accounts to a non-regulated entity. The commentor
also argued that the proposed rule change would be unfair to small
members whose ratio of ``other qualified revenue'' to ``revenue from
sales of shares'' may be higher than large companies. The NASD modified
the proposed rule change published for comment to address such concerns
by allowing a member to choose from one of two alternative deductions
relating to its interest and dividend revenue and, in addition, to
deduct from its gross revenue the first $50,000 of net interest and
dividend revenue.
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\3\ A copy of NTM 95-54 was submitted as Exhibit 2 to the NASD's
proposal and is available for inspection and copying in the
Commission's Public Reference Room.
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Based on the foregoing, the NASD does not believe that the proposed
rule change will result in any burden on competition that is not
necessary or appropriate in furtherance of the purposes of the Act, as
amended.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
Twenty comment letters were received in response to NTM 95-94.\4\
Of the twenty commentors, four commentors supported but expressed
certain concerns, and sixteen opposed the proposed rule change. The
commentors are referenced by the number attached to their comment
letter in the list of comment letters attached at Exhibit 3.
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\4\ Copies of the comment letters were submitted as Exhibit 3 to
the NASD's proposal and are available for inspection and copying in
the Commission's Public Reference Room.
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1. Definition of Non-Securities Business Revenue
Commentors (Nos. 1, 4, 11, 13, and 14) argue that dividends from a
member's pure investment account are not revenue generated from the
securities business but the fruit of hard work from previous years. The
NASD believes that a member's proprietary investment account is
retained business capital maintained to generate gross revenue for the
member's securities business. Such proprietary accounts play an
integral part in the member's securities business and are subject to
NASD regulatory oversight. Revenue from such proprietary accounts are
part of the member's securities business and,
[[Page 21519]]
therefore, are appropriate for inclusion in the definition of gross
revenue for assessment purposes.
One insurance commentor (No. 12) argues that it should only be
assessed for interest and dividend revenue relating to the interest and
dividends attributable to the capital necessary to operate its
securities business. The NASD's position is that an insurance company's
interest and dividend revenue from its insurance business will not be
included in the definition of gross revenue for assessment purposes.
2. Effect on Net Capital
Commentors (Nos. 1, 3, 4, 11 and 20) argue that the NTM 95-94
proposal would discourage members from accumulating passive investments
that increase the firm's net capital and protect public investors. The
NASD amended the proposed rule change contained in NTM 95-94 to address
such concerns by allowing a member to deduct from its gross revenue the
first $50,000 of net interest and dividend revenue in addition to
allowing the member to deduct one of two other alternative deductions
provided by the proposed rule change.
3. Equitable Allocation of Dues, Fees and Assessments
NTM 95-94 stated that the proposed rule change was partially
intended to fund the increased costs associated with implementing the
recommendations of the Rudman Committee. Commentors (Nos. 1, 10, 12 and
19) argue that the proposed rule change inequitably allocates the
regulatory costs resulting from the Rudman Committee recommendations to
firms with significant passive investments which are not used by such
firms in their securities business. One commentor recommends that, in
order to equitably allocate such Rudman Committee related-costs, the
NASD should determine the interest assessment on a firm-by-firm basis
by considering such factors as the firm's standing with the NASD, the
historical audit performance, the risks and liquidity associated with a
firm's trading and collateral positions, whether or not a firm has
significant customer or institutional business, and the firm's credit
and risk management policies.
The NASD notes that the proposed rule change is only partially
intended to fund certain Rudman recommendations and its overall intent
is to fund the NASD's broader regulatory budget requirements. The NASD
believes that using gross revenue for assessment purposes has
historically provided for the equitable allocation of reasonable
assessments among members. The proposed rule change's inclusion of
interest and dividends from retained capital and certain trading
situations in the definition of gross revenue is appropriate because
the NASD is required to oversee the related-securities activity. The
proposed rule change, therefore, is part of the same assessment
approach that has historically been followed by the NASD and the
securities industry. The proposed rule change, as already noted, would
also be consistent with current SIPC assessment provisions. The NASD,
therefore, believes that the members' arguments for changing the basis
of such assessments are not justified.
4. Discrimination Against Certain Members
As previously noted, one commentor (No. 10) argues that the
proposed rule change contained in NTM 95-94 discriminates against fixed
income firms which finance mostly liquid collateral (i.e., governments
and mortgages) and will make the small, match-book spreads of these
firms even smaller, thereby forcing certain firms to move their match-
book business and proprietary trading accounts to a non-regulated
entity. The commentor also argues that it would be unfair to small
members whose ratio of ``other qualified revenue'' to ``revenue from
sales of shares'' is higher than large companies. The NASD has modified
the proposed rule change published for comment to address such concerns
by allowing a member to deduct from its gross revenue the first $50,000
of net interest and dividend revenue in addition to allowing the member
to deduct one of two other alternative deductions provided by the
proposed rule change.
The NASD further believes that a member could not use a non-
regulated entity to handle its U.S. match-book business because this
would subject such an entity to registration as a broker/dealer under
Section 15 of the Act. This would also be true for the handling of the
member's proprietary trading accounts.
5. Clearing Capital
Commentors (No. 6, 8, and 15) expressed concerns regarding
potential assessments on their clearing capital. Two commentors (6 and
8) argue that members that put up clearing capital to be in business
should not be assessed on the interest on this capital, or
alternatively assessed only on yearly income above some amount, perhaps
$100,000. One commentor (No. 15) only supports the proposed rule change
because it believes its security deposits with clearing brokers would
be exempt. It is the position of the NASD that a member's clearing
capital serves the function of capital in any business, i.e., to run
the business and increase gross revenue for the business. Further, the
requirements for clearing capital are subject to NASD regulatory
oversight and, therefore, justified for inclusion in gross revenue for
assessment purposes. The NASD, however, has amended the proposed rule
change contained in NTM 95-94 to allow a member to deduct from its
gross revenue the first $50,000 of net interest and dividend revenue in
order to address the concerns of smaller members regarding this matter.
6. NASD Assessment Discounts
One Commentor (No. 19) argues that the NASD currently ``discounts''
member assessments, presumably because the current system, without
change, already provides more funds than is necessary for operations.
The commentor, therefore, argues that the NASD does not need a new
funding category. The NASD believes that its practice of discounting
member assessments provides the NASD with the flexibility to equitably
return to its members a portion of assessments during business cycles
wherein the aggregate gross revenue of the securities industry is
normal or better, while ensuring the NASD with sufficient funds to meet
the regulatory mandates of the Act during business cycles in which
gross revenue of the securities industry has significantly decreased.
This practice of discounting member assessments has proven to be an
effective funding method for oversight of the securities industry and,
therefore, has proven itself to be an important part of the investor
protections provided by the NASD to the securities markets. In
addition, the NASD's definition of gross revenue for assessment
purposes should equitably include all categories of revenue from a
member's securities business. The NASD believes that the inclusion of
net interest and dividend revenue from the member's retained capital
and trading strategies, in the definition of gross revenue for
assessment purposes, is appropriate in assessing all gross revenue from
the securities business regulated by the NASD.
7. NASD SIPC Rationale
One commentor (No. 19) argues that the administrative and
compliance activity of the NASD is separated too far in its nature from
the insurance activity of the SIPC to provide a compelling argument
that NASD's fund raising be consistent with SIPC. The NASD notes
[[Page 21520]]
that in further conforming its assessment policy to SIPC's, the
Association is not intending to imply that its business is equivalent
to SIPC's, but rather that the proposed rule change is based on
assessment policy that has already been found to be an equitable
allocation of reasonable assessments among members of the securities
industry.
8. Net Interest Revenue Derived From Exchange-Listed Securities
One commentor (No. 7) states that a substantial amount of its net
interest revenue is derived from margin loans secured by exchange-
listed securities and securities lending activities involving exchange-
listed securities. The commentor notes that Schedule A, Section 5 of
the NASD By-Laws excludes income from the sale of exchange-listed
securities, and therefore, argues that net interest revenue from such
exchange listed securities should also be excluded. The commentor also
notes that it would be extremely difficult, if not impossible, to break
out net interest revenue as to its source of origin, i.e., exchange
versus non-exchange securities. The NASD believes that interest derived
from margin loans and securities lending activities, involving
exchange-listed securities or customer accounts including such
securities, does not itself represent an exchange transaction but
rather a regulated over-the-counter transaction. Such non-exchange
activity is significantly different than the current Section 5
exclusion from gross revenue regarding member commissions, trading or
investment gains derived from transactions executed on a registered
national securities exchange or a foreign securities exchange. The NASD
also acknowledges and agrees with the impracticality of segregating
such income between exchange and non-exchange business.
9. Request for NASD Audited Annual Financial Income Statement and
Balance Sheet/Simplified Revenues Assessment
Two commentors (Nos. 2 and 5) argue that the NASD should provide a
detailed accounting to demonstrate the need for additional revenues.
One commentor (No. 2) argues for an audited annual financial income
statement and balance sheet of the NASD corporate body to erase
misperceptions that a surplus may already exist. The NASD, in response
to the first comment, notes that an audited financial accounting of the
association's activities is provided annually to the membership and the
interested public in the organization's annual report. With respect to
the second comment, the NASD maintains a level of working capital and
equity which is prudent in its business judgment in order to ensure
that the NASD is able to fulfill its regulatory mandates.
One commentor (No. 2) argues that if the need for additional
assessment revenues exists, then the additional revenues can be
obtained ``by simply increasing the current assessment by 7.7%.'' The
NASD believes it is more appropriate and equitable to include interest
and dividends revenue in gross revenue as provided by the proposed rule
change before increasing the assessment percentage on gross revenue for
all members. The NASD believes that the proposed rule change enhances
the equitable allocation of assessments by adding certain interest and
dividend revenue derived from retained capital and certain trading
practices to the definition of gross revenue for assessment purposes.
A commentor (No. 5) argues that if the need for additional revenue
is shown to be temporary, then the assessment should be temporary. The
NASD does not intend the proposed rule change to be temporary and notes
that the purpose of the proposed rule change is to meet ongoing
budgetary requirements.
10. Member Vote
One commenter (No. 1) argues that the inclusion of any new revenue
category should be subject to membership vote. The NASD notes that
Article VI, Section1 of the By-Laws permits the Board of Governors to
make changes in member assessments without recourse to the membership
for approval. This provision of the By-Laws was adopted by the Board of
Governors and approved by the Commission as an appropriate regulatory
function of the NASD under the Act. The proposed rule change is,
however, subject to publication for comment by the SEC and the SEC will
exercise its independent review function in determining whether to
approve or disapprove the proposed rule change.
11. Other Comments
Four commentors (Nos. 9, 16, 17, and 18) supported the proposed
rule change contained in NTW 95-94 as providing more consistent
treatment of net interest and dividend revenue. The commentors argue,
however, that since additional revenue will be received by the NASD
under the proposed rule change, an offset should take place through a
reduction in other member charges. They argue that the proposed rule
change comes at a time when firms are looking to eliminate costs,
increase efficiency and protect capital. Another commentor (No. 3)
argues that the NASD should attempt to meet its budgetary challenges as
its membership is doing, i.e., investigating more efficient ways of
accomplishing objectives and cutting costs. The NASD concurs with the
latter commentor and continues to address budgetary challenges by
increasing the efficiency of oversight of the broker/dealer industry.
However, increased efficiencies of NASD operations alone, as suggested
by the former commentors, do not meet the budgetary challenges required
to fund the commitment of greater resources to the NASD's broker/dealer
regulation activities in compliance with the regulatory mandate of the
Act, as amended.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 35 days of the date of 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. 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 to 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 the file number in the caption
above and should be submitted by May 31, 1996.
[[Page 21521]]
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority, 17 CFR 200.30-(a)(12).
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 96-11747 Filed 5-9-96; 8:45 am]
BILLING CODE 8010-01-M
