Notice To Members 85-86

Request for Further Comments on a Proposed New Rule Governing the Prompt Payment for Investment Company Shares Sold to Customers by NASD Members

Published Date:

TO: All NASD Members and Other Interested Persons

LAST DATE FOR COMMENT: JANUARY 24, 1986

BACKGROUND

In Notice to Members 85-58, dated August 30, 1985, the NASD solicited comments from members and other interested persons on a proposed new rule (new paragraph (m) Article III, Section 26, NASD Rules of Fair Practice) that would govern the prompt payment by NASD members for investment company shares.

The new rule would require NASD members to transmit payments for investment company shares, which such members have sold to customers, to underwriters by the end of the fifth business day after receiving a purchase order from a customer (trade date +5). The rule would also require members who are underwriters to transmit payments for investment company shares, which they have received from customers or other members, to investment company issuers within one business day after receiving such payments (day of receipt +1).

The new rule would replace the NASD Board of Governors interpretation governing the prompt payment by members for shares of investment companies which appears at paragraph 5265 of the NASD Manual.

Forty comment letters were received from members and other interested persons in response to the notice. They contained a variety of comments and suggestions, which were reviewed and discussed by the NASD Investment Companies Committee, a standing committee of the NASD Board of Governors.

The Committee made the following recommendations in response to the major issues raised by commentators. Because one such recommendation involves a major change in the rule as originally proposed, the Committee requested, and the Board of Governors agreed, that the proposed amended rule should be distributed for a further comment period.

Clarification of the term "transmit" in the proposed rule —

The proposed rule will require members to transmit payments by the end of the time periods specified in the rule. Several commentators asked for clarification of the term "transmit." Would it mean, for example, placing a check in the mail by the end of the last day of the time period specified? It is the intent of the Committee that the term shall mean "payment of funds, by any means, by the end of the specific time periods delineated in the rule."

Adoption of the rule should be delayed until the proposed NSCC centralized and automated system for the clearance and settlement of investment company transactions is operating —

The proposed centralized system being developed by NSCC will provide for automatic settlement in a participant's account with NSCC on trade date +5 business days. Thus, participants processing transactions through NSCC will be in compliance with the provisions of the proposed rule.

The proposed rule, as revised, will primarily affect those members who will not process transactions through the NSCC system since the rule contemplates a somewhat more liberal settlement procedure.

Thus, the Committee believes that there is no reason to delay adoption of the rule.

The rule should require similar prompt payment by investment companies to dealers when investment company shares are liquidated —

Section 22(e) of the Investment Company Act of 1940 governs prompt payment by mutual funds or their agents when shares are liquidated. This section requires a mutual fund to pay liquidation proceeds within seven days after the tender of the security to the fund or its agent.

The Board of Governors prompt payment interpretation has never been applied to the liquidation of fund shares. The Committee believes that delays being experienced in the payment of liquidation proceeds are mainly due to the lack of uniform procedures and the large increase in the number of transactions in recent years. The Committee believes that the introduction of the NSCC automated system will provide the solution to most of the problems that are being experienced in this area of mutual fund activity.

A period of six business days from the order date to the transmittal date is too short —

Many commentators stated that, for members who use the U.S. mail in their investment company activities and who habitually receive checks from customers in payment for their purchases of mutual fund shares, a period of six business days (T +5) from receipt of the order to the transmittal date is too short. They claim that this time period does not take into account the fact that confirmations sometimes are not received by customers until several days after the trade date, customers' checks are often not received promptly and, even if they are, they often take several days to clear.

Imposing a T +5 standard, they claim, would mean that such members, particularly those who are small, would often not have received payment and would not have the necessary capital or the availability of such to enable them to transmit funds by the end of the fifth business day following the trade date.

The result would be that they would either have to make expensive correspondent arrangements, terminate their wire order activities or discontinue mutual fund activities entirely since they would be at a competitive disadvantage with larger well-capitalized members.

The Investment Companies Committee believes the views of these commentators have considerable merit. Hence, it is proposing a major change in the rule that it believes will be responsive to the needs of the members who will not participate in the NSCC system.

The Committee considers that paragraph (1) of the proposed rule should be amended to permit an alternative transmittal date related to the time a member receives payment from a customer.

The Committee recommends that the time a member has to transmit payments be one of the following, whichever is later: (1) the end of the fifth business day after the trade date; or (2) the end of the first business day following receipt of a customer's payment, provided, however, that members will be required to transmit payments by the end of trade date plus seven business days whether or not they have received payment from a customer [Exhibit I, paragraph (m)(l)].

Prompt payment by underwriters to investment companies —

Several members commented that the requirement in paragraph (2) of the proposed rule, which will require members who are underwriters to transmit payments received to issuers by the end of one business day following receipt of such payments, does not provide sufficient time for underwriters engaged in direct retail transactions with customers to ensure that they are in possession of "good funds" because of the time it takes for checks to clear. The Committee believes this should not present a problem to most underwriters and resolved not to amend this section of the proposed rule.

It was also agreed that paragraph (2) of the proposed rule should be amended to reflect the fact that payments are sometimes made by underwriters to the designated agents of issuers and not to the issuing mutual fund [Exhibit I, paragraph (m)(2B.

* * * * *

All members and other interested persons are invited to submit written comments on the proposed amended new rule and the proposed rescission of the prompt payment interpretation. Comments must be received no later than January 24, 1986, and should be directed to Mr. James M. Cangiano, Secretary, National Association of Securities Dealers, Inc., 1735 K Street, NW, Washington, D.C. 20006.

Comments received by the indicated date will be considered by the Investment Companies Committee and the NASD Board of Governors. If the proposed rule is approved by the Board, it must then be submitted to the membership for a vote. If approved by the membership, it must be filed with and approved by the Securities and Exchange Commission before becoming effective.

Questions relating to this notice should be directed to A. John Taylor, Vice President, Investment Companies/Variable Contracts, at (202) 728-8328.

Sincerely,

Frank J. Wilson
Executive Vice President
Legal and Compliance

Attachment

PROPOSED AMENDMENT TO ARTICLE III, SECTION 26 OF THE NASD RULES OF FAIR PRACTICE*

Prompt Payment for Investment Company Shares

(m)
(1) Members shall transmit payments for investment company shares, which such members have sold to customers, to underwriters or their designated agents by [(1)] the end of the fifth" business day following receipt of a customer order to purchase such shares [or by (2) the end of one business day following receipt of a customer's payment for such shares, whichever is the later date, provided, however, that members shall transmit payments to underwriters or their designated agents by the end of the seventh business day following receipt of a customer order to purchase such shares whether or not payment has been received from the customer].
(2) Members who are underwriters shall transmit payments for investment company shares, which such members have received from other members or customers, to investment company issuers [or their designated agents] by the end of the one business day following receipt of such payments.

* New language underlined; additional new language amending original proposed rule bracketed.