[Federal Register Volume 62, Number 85 (Friday, May 2, 1997)]
[Notices]
[Pages 24147-24151]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-11454]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-38548; File No. SR-NASD-97-24]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the National Association of Securities Dealers, Inc. Relating
to Supervision and Record Retention Rules
April 25, 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 April 11, 1997, 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. 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.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
NASD Regulation is proposing to amend National Association of
Securities Dealers, Inc. (``NASD'' or ``Association'') Rules 3010,
``Supervision,'' and 3110, ``Books and Records,'' to revise the NASD's
supervision and record retention rules to provide firms with
flexibility in developing reasonable procedures for the review of
correspondence with the public. Below is the text of the proposed rule
change. Proposed new language is in italics; proposed deletions are in
brackets.
Rule 3010. Supervision
(a) through (c) No change
(d) [Written Approval] Review of Transactions and Correspondence
(1) Supervision of Registered Representatives. Each member shall
establish procedures for the review and endorsement by a registered
principal in writing, on an internal record, of all transactions and
for the review by a registered principal of [all] incoming and outgoing
written and electronic correspondence of its registered representatives
with the public relating to the investment banking or securities
business of such member [pertaining to the solicitation or execution of
any securities transactions]. Such procedures should be in writing and
be designed to provide reasonable supervision of each registered
representative.\3\ Evidence that these supervisory procedures have been
implemented and carried out must be maintained and made available to
the Association upon request.
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\3\ Pursuant to a telephone conversation between Mary Revell,
Assistant General Counsel, NASD Regulation, Inc. and Katherine
England, Assistant Director, Division of Market Regulation, SEC, on
April 25, 1997, Commission staff has replaced the phrase
``reasonably supervise'' with the phrase ``provide reasonable
supervision of.''
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(2) Review of correspondence. Each member shall develop written
procedures that are appropriate to its business, size, structure, and
customers for the review of incoming and outgoing written and
electronic correspondence with the public relating to its investment
banking or securities business. Where such procedures for the review of
correspondence do not require pre-use review of all correspondence,
they must include provision for the education and training of
associated persons as to the firm's procedures governing
correspondence; documentation of such education and training; and
surveillance and follow-up to ensure that such procedures are
implemented and adhered to.
(3) Retention of correspondence. Each member shall retain
correspondence of registered representatives relating to its investment
banking or securities business in accordance with Rule 3110 (``Books
and Records''). The names of the persons who prepared outgoing
correspondence and who reviewed the correspondence shall be
ascertainable from the retained records and the retained records shall
be readily available to the Association, upon request.
(e) through (g) No change
Rule 3110. Books and Records
(a) Requirements
Each member shall make [keep] and preserve books, accounts,
records, memoranda, and correspondence in conformity with all
applicable laws, rules, regulations, and statements of policy
promulgated thereunder and with the Rules of this Association and as
prescribed by Rule 17a-3. The record keeping format, medium, and
retention period shall comply with Rule 17a-4 under the Securities
Exchange Act of 1934.
(b) through (g) No change
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory basis For, the Proposed Rule Change
In its filing with the Commission, NASD 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
In May 1996, the SEC issued an Interpretive Release on the Use of
Electronic Media by Broker-Dealers, Transfer Agents., and Investment
Advisers for Delivery of Information.\4\ That release expressed the
views of the SEC with respect to the delivery of information through
electronic media in satisfaction of requirements in the
[[Page 24148]]
federal securities laws, but did not address the applicability of any
self-regulatory organization (``SRO'') rules. In the release the SEC
did, however, strongly encourage the SROs to work with broker/dealer
firms to adapt SRO supervisory review requirements governing
communications with customers to accommodate the use of electronic
communications.\5\
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\4\ See Release Nos. 33-7288; 34-37182; IC-21945; IA-1562 (May
9, 1996); 61 FR 24644 (May 15, 1996) (File No. S7-13-96).
\5\ Id., note 5.
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On September 12, 1996, the New York Stock Exchange, Inc.
(``NYSE'') filed with the SEC a proposal to update its rules governing
supervision of its member firms' communications with the public.\6\ The
NYSE's proposal is designed to recognize the growing use of new
technology and new means of communication such as ``e-mail'' and the
Internet while still providing for appropriate supervision and review.
The NYSE's proposal currently is pending at the SEC.
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\6\ See securities Exchange Act Release No. 37941 (November 13,
1996), 61 FR 58919 (November 19, 1996) (File No. SR-NYSE-96-26)
(soliciting comment on the NYSE's proposed rule change).
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The NYSE's current rules require firms to review all
communications with the public relating to their business prior to use.
For example, a registered representative's correspondence to a customer
must be reviewed prior to being sent, and all incoming correspondence
must be reviewed by the firm before it is given to the representative.
Under the NYSE's proposal, prior review of all outgoing correspondence
and review of all incoming corrrespondence would no longer be required.
Instead, firms would be allowed flexibility in developing procedures
for review of such correspondence tailored to the nature and size of a
firm' busineess and customers. Other communications with the public,
such as advertisements, sales literature, and research reports, loud
continue to be subject to prior approval.
The NYSE's proposal would require firms to develop written
procedures for review of communications with the public that are
designed to provide reasonable supervision of each registered
representative. In addition, any firm that does not conduct pre-use
review of correspondence (whether electronic or manual) would be
required to regularly educate and train employees about the
organization's policies and procedures governing review of
communications, document such education and training, and conduct
surveillance to ensure compliance with such procedures.
The proposed rule change filed by the NYSE responds to the SEC's
request to adapt supervision rules to accommodate the use of electronic
communications. The proposed amendments to NASD rules governing
supervision of correspondence similarly would respond to this request
and would provide firms with flexibility in developing reasonable
procedures for the review of correspondence. The NASD's proposed
approach is designed to be consistent with the one proposed by the NYSE
and thereby help to ensure a coordinated regulatory framework for
supervision of manual and electronic correspondence.
Supervision of Registered Representatives. NASD Rule 3010(d)(1), as
revised to reflect comments received and recommendations from the
NASD's Membership Committee, \7\ provides, among other things, that a
firm must establish procedures for the review by a registered principal
of each registered representative's outgoing and incoming manual and
electronic correspondence with the public relating to the member's
investment banking or securities business. The procedures must be
designed to provide reasonable supervision of each registered
representative, must be described in the firm's written supervisory
procedures, and implementation and execution of these procedures must
be clearly evidenced. In developing these procedures, members should
specify, among other things, what types of correspondence will be pre-
or post-reviewed; where the reviews will be conducted; the position and
qualifications of persons who will conduct the reviews; the frequency
of reviews; the nature of type of review to be conducted; and how the
reviews will be documented.
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\7\ For a discussion of comment received on the proposed
changes and the recommendations of NASD's Membership Committee, see
infra notes 9-20 and accompanying test.
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Under the proposal , review of each item of correspondence no
longer will be required. Instead, firms could use reasonable sampling
techniques, such as random spot-checking of e-mail logs. In order for
this method to be effective, NASD Regulation expects that members
should require review of some portion of the electronic mail sent and
received by each registered representative, with special emphasis on
messags delivered to or received from customers of the members.
In addition, while written approval of correspondence no longer
would be mandated, firms should specify the means for evidencing
review. For example, firms could electronically review e-mail
correspondence relating to the firm's investment banking or securities
business and could electronically record evidence of the review.
Procedures for Review of Correspondence: As revised to reflect
comments received and recommendations from the NASD's Membership
Committee, NASD Rule 3010(d)(2) would require each member to develop
written procedures for review of incoming and outgoing correspondence
with the public relating to its investment banking or securities
business tailored to its structure and the nature and size of its
business and customer base. In developing supervisory procedures for
the review of correspondence with the public, members should consider
the following suggestions. For example, members should determine
whether it is more appropriate to implement uniform procedures or
procedures tailored to specific functions, offices or locations,
individuals, groups of persons, or specific registration categories. In
this regard, members may consider such factors as the number, size and
location of offices; the volume of communications overall and in
specific areas of the organization; the types of activities conducted
by registered representatives and other applicable persons; the nature
and extent of training provided; the complaint and overall disciplinary
record, if any, of registered representatives and other applicable
persons (with particular emphasis on complaints regarding written or
oral communications with clients); and the overall experience levels of
registered representatives and other applicable persons using
communications media.
In addition, reasonable procedures in some cases might require
review of all correspondence of particular individuals. The supervisory
system should provide specific processes for the receipt and handling
of incoming checks and customer complaints as well as standards for
correspondence indicating permitted and prohibited activities and any
restrictions imposed by the member upon such correspondence. The
procedures also should address communications with customers from
outside of the workplace.
While the proposed rule does not require review of all
correspondence, any member that does not conduct electronic or manual
pre-use review of each item of correspondence will be required to:
regularly educate and train its associated persons as to the firm's
procedures governing review of correspondence; document such
[[Page 24149]]
education and training; and monitor to ensure implementation and
compliance with such procedures. This provision is a departure from the
NASD's current rule, which requires members to review and endorse in
writing all correspondence, but allows such review and endorsement to
occur after use. However, the NASD's proposed rule is consistent with
the rule proposed by the NYSE. Also, the NASD's proposed rule provides
sufficient flexibility such that members that do not wish to conduct
prior review of correspondence have the option of conducting education
and training as to the firm's procedures instead. Accordingly, the
proposed rule would create a ``default'' standard that is more
stringent than the current rule in requiring pre-use review. The Notice
to Members announcing adoption of this rule will provide guidance to
members on how the education and training provisions should be
implemented.
Firms may incorporate the required education and training on
correspondence procedures into their Continuing Education Firm Element
training program.\8\ However, education and training must be timely and
must apply to all appropriate employees, including employees who may
not be included under the Continuing Education requirements.
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\8\ See NASD Rule 1120, ``Continuing Education Requirements.''
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Retention of Correspondence: Under amended NASD Rule 3010(D)(3),
each member must retain correspondence in accordance with amended NASD
Rule 3110. NASD Rule 3010(d)(3) also requires that the names of the
persons who prepared and reviewed correspondence must be ascertainable
from the retained records and the records must be made available to the
NASD upon request.
Books and Records: NASD Rule 3110(a) has been amended to recognize
that records must be made and preserved as prescribed by all applicable
rules, regulations and NASD rules and with Rule 17a-3 under the Act.
The record keeping format, medium, and retention period must comply
with Rule 17a-4 under the Act.\9\
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\9\ The SEC recently proposed for comment amendments to its
broker/dealer books and records rules. See Securities Exchange Act
Release No. 37850 (October 22, 1996), 61 FR 55593 (October 28, 1996)
(File No. S7-27-96).
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2. Statutory Basis
NASD Regulation believes that the proposed rule change is
consistent with the provisions of Section 15A(b)(6) of the Act,\10\
which requires, among other things, that the Association's rules be
designed to prevent fraudulent and manipulative acts and practices, to
promote just and equitable principles of trade, remove impediments to
and perfect the mechanism of a free and open market, and, in general,
to protect investors and the public interest and not be designed to
permit unfair discrimination between brokers or dealers. The NASD
believes that allowing broker/dealer firms to use new technology and
new means of communication, such as e-mail and the Internet, while
still providing for appropriate supervision and review, will further
these requirements.
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\10\ 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 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
The proposed rule change was published for comment in Notice to
Members 96-82 (December 1996) (``NTM 96-82''). The comment period
closed on January 30, 1997. Nineteen comment letters were filed on the
proposed rule.\11\
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\11\ NASD Regulation received the following comment letters: (1)
Letter from Brian C. Underwood, A.G. Edwards & Sons, Inc., to Joan
Conley, NASD Regulation, dated January 28, 1997 (``A.G. Edwards'');
(2) Letter from Rockell Metcalf, American Express Financial Advisors
Inc., to Joan Conley, NASD Regulation, dated January 30, 1997
(``AEFA''); (3) Letter from Neal E. Nakagiri, Associated Securities
Corp., to Joan Conley, NASD Regulation, dated January 20, 1997
(``Associated Securities''); (4) Letter from Rita Adler, CoreStates
Securities Corp., to Joan Conley, NASD Regulation, dated January 30,
1997 (``CSC''); (5) Letter from Brad Sutherland, D.A. Davidson &
Co., to Joan Conley, NASD Regulation, dated January 11, 1997 (``D.A.
Davidson''); (6) Letter (e-mail message) from David Fry dated
January 3, 1997 (``David Fry''); (7) Letter from R. Gerald Baker,
Everen Securities, to Joan Conley, NASD Regulation, dated January
30, 1997 (``Everen''); (8) Letter from Michael L. Michael, Fidelity
Investments, to Joan Conley, NASD Regulation, dated January 29, 1997
(``Fidelity''); (9) Letter from Adam N. Antoniades, First Allied
Securities Inc., to Joan Conley, NASD Regulation, dated January 29,
1997 (``First Allied''); (10) Letter from Alexander C. Gavis,
Investment Company Institute, to Joan Conley, NASD Regulation, dated
January 30, 1997 (``ICI''); (11) Letter from Thomas P. Koutris, John
Hancock Mutual Life Insurance Co., to Joan Conley, NASD Regulation,
dated January 31, 1997 (``John Hancock''); (12) Letter from Kenneth
S. Spirer, Merrill Lynch, to Joan Conley, NASD Regulation, dated
January 27, 1997 (``Merrill Lynch''); (13) Letter from Michael L.
Kerley, MML Investors Services, Inc., to Joan Conley, NASD
Regulation, dated January 27, 1997 (``MML''); (14) Letter from Peter
J. Bernota to Joan Conley, NASD Regulation, dated January 22, 1997
(``Peter J. Bernota''); (15) Letter from George P. Miller, PSA The
Bond Market Trade Association, to Joan Conley, NASD Regulation,
dated January 24, 1997 (requesting an extension of time to file
comments); (16) Letter from William P. Hayes and R. May Lee, PSA The
Bond Market Trade Association, to Joan Conley, NASD Regulation,
dated February 7, 1997 (``PSA''); (17) Letter from Stephen Putnam,
Robert Thomas Securities, to R. Clark Hooper, NASD Regulation, dated
January 9, 1997 (``Robert Thomas Securities''); (18) Letter from
Kenneth S. Spirer, R. Gerald Baker, C. Evan Stewart, and Robert C.
Errico, Securities Industry Association, to Joan Conley, NASD
Regulation, dated February 7, 1997 (``SIA''); and (19) Letter from
Henry H. Hopkins and David Roscum, T. Rowe Price, to Joan Conley,
NASD Regulation, dated February 11, 1997 (``T. Rowe Price'').
Copies of the Comment Letter received by NASD Regulation in
response to NTM 96-82 are available for inspection and copying at
NASD Regulation or at the Commission's Public Reference Room.
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The comments filed on the proposed rules were overwhelmingly
positive. The commenters praised NASD Regulation for proposing rule
amendments that will allow each firm the flexibility to develop
procedures for the review of correspondence tailored to the nature and
size of its business and customers. The commenters also commended NASD
Regulation for harmonizing its supervision requirements with those of
the NYSE. Commenters did, however, make some suggestions about how the
rule could be clarified or amended.
Correspondence with the public: NASD's current supervision rule
requires firms to establish procedures for the review of all of its
registered representatives' correspondence pertaining to the
solicitation or execution of any securities transactions. The rule
proposed in NTM 96-82 would require the review of registered
representatives' correspondence relating to the business of the member.
NASD Regulation received 12 comments on this change.\12\ Many of
the commenters requested a clarification that only correspondence with
the public must be reviewed. Otherwise, they stated, the rule could be
construed to apply to internal communications or to correspondence
between members and third parties other than customers. Also, this
would conform the rule to the intention stated in the text of NTM 96-
82. This clarification has been made by adding the words ``with the
public'' to paragraphs 3010 (d)(1) and (d)(2).
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\12\ See letters from A.G. Edwards, AEFA, Associated Securities,
D.A. Davidson, Everen, Fidelity, ICI, John Hancock, MML, Peter J.
Bernota, PSA, and T. Rowe Price.
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Three commenters believe the rule change is overly expansive,
burdensome, and unjustified.\13\ They urge NASD Regulation to retain
the language in the current rule. Notwithstanding these comments,
[[Page 24150]]
NASD Regulation has determined to retain the language as proposed, for
several reasons. First, conforming the rule language to the language in
the NYSE rule will help to ensure a coordinated regulatory approach to
the supervision of correspondence. Second, the amended language is
consistent with language in SEC Rule 17a-4, which requires a broker/
dealer to preserve records of all communications relating to its
business. Also, limiting the review requirement to correspondence
pertaining to securities transactions may be too narrow to capture
information important to an effective supervision program. Finally,
limiting the review requirement to correspondence with the public, as
described above, will significantly address the concerns raised by
these commenters.
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\13\ See letters from John Hancock, MML, and T. Rowe Price.
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One commenter asked if certain electronic communications, depending
on their content, could be treated as oral ``conversations'' rather
than correspondence, such that the content requirements of the NASD's
advertising rules would apply, rather than the supervision and record
retention rules.\14\ In response, NASD Regulation notes that the SEC in
its recent release on Reporting Requirements for Brokers or Dealers
under the Act on record retention requirements applicable to electronic
communications,\15\ has stated:
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\14\ See letter from A.G. Edwards.
\15\ See Securities Exchange Act Release No. 38245 (February 5,
1997), 62 FR 6469 (February 12, 1997) (File No. S7-21-93).
for record retention purposes under Rule 17a-4, the content of the
electronic communication is determinative, and therefore broker-
dealers must retain those e-mail and Internet communications
(including inter-office communications) which relate to the broker-
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dealer's ``business as such.''
Similarly, the proposed rule focuses on the content of electronic (and
manual) correspondence by requiring each member to develop supervisory
procedures for the review of written and electronic correspondence with
the public relating to its investment banking or securities business.
This obligation to review correspondence is not obviated by a firm's
classification of e-mail correspondence as equivalent to an oral
``conversation.''
Incoming correspondence: Three commenters discussed the proposed
requirement that both incoming and outgoing correspondence must be
reviewed.\16\ One commenter asked NASD Regulation to clarify that
incoming correspondence would be subject to review.\17\ NASD Regulation
has made this clarification by adding the words ``incoming and
outgoing'' to paragraphs 3010 (d)(1) and (d)(2).
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\16\ See letters from AEFA, John Hancock, and MML.
\17\ See letter from John Hancock.
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Two of the commenters are insurance-affiliated broker/dealers.\18\
They stated that it would be extremely difficult for an insurance-
affiliated broker/dealer to comply with the requirement to review
incoming correspondence. Most of their registered representatives are
primarily life insurance salespersons who conduct business in non-
branch locations (e.g., in their homes or at insurance company
offices). Also, virtually all correspondence is addressed to the
insurance company or to the agents personally, and most correspondence
pertains to the life insurance business. Both because of the location
where these agents/registered representatives conduct business and
because most of their correspondence is addressed to a non-broker/
dealer entity, these commenters maintain that it would be improper,
illegal, and impossible for a principal to open and review it.
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\18\ See letters from John Hancock and MML.
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NASD Regulation has determined to amend the rule as proposed in NTM
96-82 explicitly to require the review of incoming correspondence. The
proposed rule provides a firm with flexibility to develop procedures
for the review of correspondence tailored to its structure and the
nature of its business. Also, the proposed changes lessen the
regulatory burden by eliminating the requirement to review and endorse
each piece of correspondence. Supervisory review of incoming
correspondence in many circumstances may be particularly valuable in
detecting potential problems with a registered representative's conduct
or a customer complaint. NASD Regulation believes that a review of
incoming correspondence is a valuable method for early detection of
problems and believes that rule provides insurance-affiliated members
with the needed flexibility to devise appropriate procedures for
reviewing correspondence. Therefore, the proposed language has been
retained.
Education and training: Four commenters addressed this provision of
the proposed rule.\19\ Two of the commenters requested that firms be
allowed flexibility in developing appropriate education and training as
to the firm's procedures governing correspondence.\20\ Since the rule
already allows this flexibility by permitting firms to develop
procedures tailored to the nature and size of their business and
customers, NASD Regulation does not believe an amendment is necessary
to respond to this comment.
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\19\ See letters from D.A. Davidson, First Allied, ICI, and John
Hancock.
\20\ See letters from First Allied and John Hancock.
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In response to a request from one commenter,\21\ the staff wishes
to clarify that a member may fulfill its education and training
requirements in conjunction with compliance with NASD Continuing
Education requirements. This is consistent with the position the NYSE
has taken on this issue, as stated in its draft Information Memo,
submitted in conjunction with the NYSE's proposal.\22\
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\21\ See letter from ICI.
\22\ See supra note 4.
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Finally, at its meeting on February 19, 1997, the NASD's Membership
Committee discussed the proposed rule, the comments that have been
received on the proposal, and the changes the staff proposed to make to
respond to the comments. The NASD's Membership Committee was supportive
of all of the changes the staff recommended. However, the NASD's
Membership Committee asked staff to also consider revising the proposed
rule to require members to supervise and review only correspondence
relating to their investment banking or securities business instead of
correspondence relating to their business. NASD's Membership Committee
members stated that member firms may conduct a business in capacities
other than as broker/dealers and suggested that language be added to
clarify the rule so that it could not be interpreted to apply to areas
beyond the securities business of the member. Although this is a minor
department from the NYSE rule, which requires members to review
communications relating to the firm's business, NASD Regulation has
limited application of the rule to correspondence related to the
securities or investment banking business of a member.
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
[[Page 24151]]
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 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-97-24 and should
be submitted by [insert date 21 days from the date of publication].
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\23\
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\23\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-11454 Filed 5-23-97; 8:45 am]
BILLING CODE 8010-01-M
