Notice To Members 87-41

Proposed Amendments to Definitions of "Branch Office" and "Office of Supervisory Jurisdiction" Under the NASD By-Laws, Schedule C to the By-Laws, and the Rules of Fair Practice

Published Date:

TO: All NASD Members and Other Interested Persons

LAST DATE FOR COMMENT: AUGUST 14, 1987.

EXECUTIVE SUMMARY

The NASD requests comments on proposed amendments to the definitions of "branch office" and "office of supervisory jurisdiction." Under the proposed amendments, any office at which certain specified functions take place would be defined as an office of supervisory jurisdiction; branch offices would be defined by the number of individuals located therein and whether the location is advertised as an office of the firm. Offices where three or fewer registered persons are employed and that are not advertised or listed as offices of the member would be defined as "non-branch business offices."

The proposed amendments are intended to address certain regulatory problems noted by the NASD in situations where there is an absence of on-site supervision by registered principals. The amendments would retain the requirement of an annual inspection of each office of supervisory jurisdiction and would establish requirements for the inspection of branch offices and the employment of on-site principals.

The proposed amendments are attached as Exhibits A, B, and C.

BACKGROUND

In recent years, the NASD has become increasingly concerned with the operation by member firms of business locations that are not subject to on-site supervision by a registered principal or to regular examination by the firm. This concern was discussed in detail in Notice to Members 86-65 (September 12, 1986) regarding the employment and supervision of off-site personnel, which emphasized those existing NASD rules most directly applicable to off-site employment. The notice stated that the NASD was continuing to study the possible revision of requirements for designating branch offices and for on-site supervision by principals.

After studying patterns of past disciplinary cases involving deficiencies in supervisory structure, the NASD Qualifications Committee and the National Business Conduct Committee concluded that it is necessary to revise the current definitions of "branch office" and "office of supervisory jurisdiction." The primary intent of the proposed changes is to require a minimum supervisory structure that facilitates closer supervision by principals with clear responsibilities.

DESCRIPTION AND ANALYSIS OF PROPOSED AMENDMENTS

An "office of supervisory jurisdiction" (OSJ) is presently defined in Article III, Section 27 of the NASD Rules of Fair Practice as "... any office designated as directly responsible for the review of the activities of registered representatives or associated persons in such office and/or in other offices of the member." Under the proposed amendments, an OSJ would be any business location of a member firm at which one or more of the following functions take place:

  • Order execution and/or market making;
  • Origination of underwritings or private placements;
  • Maintaining custody of firm or customers' funds and/or securities;
  • Acceptance (approval) of new accounts on behalf of the member;
  • Review and approval of customer orders;
  • Origination of advertising or sales literature, including the authorization of such material developed by an organization or person other than the member;
  • Review and endorsement of correspondence of associated persons pertaining to the solicitation or execution of any securities transaction; or
  • Responsibility for supervising the activities of persons associated with the member at one or more other offices of the member, as defined below.

Thus, the proposed amendments broaden the range of functions which, if undertaken at a particular business location, would cause that location to be designated as an OSJ. Further, the designation as an OSJ would be mandatory, rather than by the firm's choice. An OSJ would be required to have at least one individual on site who is fully qualified to act in a principal capacity with respect to any functions undertaken by the office. Also, as presently provided, each OSJ would be required to be examined annually by the firm's main office.

The term "branch office" is presently defined in Article I, Section (c) of the NASD By-Laws as "... an office located in the United States which is owned or controlled by a member, and which is engaged in the investment banking or securities business."1/ An Explanation of the Board of Governors set forth in Schedule C to the NASD By-Laws reiterates this definition and provides further that a place of business of a person associated with a member shall be considered a branch office if the member:

  • Directly or indirectly contributes a substantial portion of the operating expenses of such place of business; and/or
  • Authorizes the listing in any publication or other media of such place of business as an office of the member or designates it as such with any organization.

The proposed amendments would define a "branch office" as a place of business at which persons registered with the member engage in the investment banking or securities business where either:

  • Four or more registered individuals are located, in which case at least one individual located at the office must be qualified to function in a principal capacity with respect to all activities occurring therein; or
  • Three or fewer registered individuals are located and the office is advertised in the media, listed in any publication or directory, or designated with any securities regulatory body by the individuals or by the member as an office of the member, in which case either:
    • One of the registered individuals located at the office must be qualified to act in a principal capacity with respect to all of the activities occurring therein; or
    • The office must be examined at least once every six months by a registered principal from the main office or an OSJ responsible for the branch.

In addition, a branch office with a resident principal would be required to be examined annually by a principal from the firm's main office or an OSJ designated as responsible for the branch.

Thus, as summarized above, the proposed amendments would significantly change the designation and operation of branch offices, including the establishment of a quantitative standard by which branch offices are defined and the institution of requirements for on-site registered principals and regular branch office examinations.

Offices at which three or fewer registered persons engage in the investment banking or securities business and that are not advertised or designated as offices of the member would be designated as "non-branch business locations." Advertising in any form, including a listing in a telephone directory, would make this category unavailable. Non-branch business locations would not be required to have a registered principal on the premises, but the firm would be required to conduct an annual personal compliance interview with each registered person operating at the non-branch business location. The interview may take place at the non-branch business location or elsewhere, but it must be conducted by a registered principal, who may be associated with the firm's main office, an OSJ, or a branch office.

At this time, the Board of Governors has not endorsed amendments that would require a particular ratio of registered principals to registered representatives or limit the number of branch offices for which a given OSJ may be responsible. The Board does, however, invite comments on such proposals.

* * * *

The NASD encourages all members and other interested persons to comment on the proposed amendments. Comments should be directed to:

Mr. Lynn Nellius
Secretary
National Association of Securities Dealers, Inc.
1735 K Street, N.W.
Washington, D.C. 20006-1506

Comments must be received no later than August 14, 1987. Comments received by this date will be considered by the NASD Qualifications Committee. Any changes to the NASD By-Laws and Rules of Fair Practice approved by the Board must be submitted to the membership for a vote. Thereafter the proposed amendments must be filed with and approved by the Securities and Exchange Commission before becoming effective.

Questions concerning this notice may be directed to Jacqueline D. Whelan, Attorney, NASD Office of General Counsel, at (202) 728-8270.

Sincerely,

Frank J. Wilson
Executive Vice President and General Counsel

Attachments

Exhibit A

PROPOSED AMENDMENTS TO NASD BY-LAWS*

ARTICLE I

Definitions

When used in these By-Laws, and any rules of the Corporation, unless the context otherwise requires, the term:

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(c) "branch office" means [an office located in the United States which is owned or controlled by a member, and which is engaged in the investment banking or securities business;] any location at which activities for which membership in the Corporation is required are conducted on behalf of a member and at which either four or more registered persons are located or at which three or fewer registered persons are located and such location is advertised in any media, listed in any publication or directory, or designated with any regulatory organization, by the member or by such individuals, as a business location of the member;

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(m) "non-branch business location" means any location at which activities for which membership in the Corporation is required are conducted on behalf of a member and at which three or fewer registered persons are located and which is neither advertised in any media, listed in any publication or directory, nor designated with any regulatory organization, by the member or by such individuals, as a business location of the member.
(n) "office of supervisory jurisdiction" means any location of the member at which any one or more of the following functions take place:
(i) order execution and/or market making;
(ii) origination of under writings or private placements;
(iii) maintaining custody of firm or customers' funds and/or securities;
(iv) acceptance (approval) of new accounts on behalf of the member;
(v) review and approval of customer orders;
(vi) origination of advertising or sales literature, including the authorization of such material developed by an organization or person other than the member;
(vii) review and endorsement of correspondence of associated persons pertaining to the solicitation or execution of any securities transaction; or
(viii) responsibility for supervising the activities of persons associated with the member at one or more other offices (as defined in Sections (c) and (m) above) of the member.

Note: Current Sections (m), (n), and (o) would be redesignated as Sections (o), (p), and (q).

Exhibit B

PROPOSED AMENDMENTS TO SCHEDULE C TO THE NASD BY-LAWS*

••• Explanation of Board of Governors______________________________

[Distinction Between Branch Office and Office of Supervisory Jurisdiction;] Appointment of Executive Representative; [Standards for Determining Branch Offices]

Identification and Registration of Offices

[The term "office of supervisory jurisdiction" defined in Section 27 of Article III of the Rules of Fair Practice means any office designated by the member in its memorandum of supervisory procedures, established pursuant to Article III, Section 27 of the Rules. Such office shall be directly responsible for the review of the activities of Registered Representatives and persons associated with the member in that office and/or in other offices of the member.]

The term "executive representative" as found in Section 3 of Article III of the By-Laws means that person designated by the member to represent, vote and act for the member in all the affairs of the Corporation. Pursuant to the provisions of Section 8 of Article III of the By-Laws, every member who maintains a registered branch office in a district of the Corporation other than the one in which its main office is located, is entitled to one vote on all matters pertaining solely to the district in which such registered branch office is located, including the election of members of the Board of Governors from such district. Should a member maintain more than one branch office in a district, it is entitled to only one vote in that district. Therefore, each member shall designate one executive representative and shall designate one "district executive representative" for each district other than the one in which the main office is located in which the member maintains a registered branch office.

[The term "branch office" defined in Article I of the By-Laws means any office, including a corporate subsidiary of a member located in the United States and other than the main office which is owned or controlled by a member and engaged in the investment banking or securities business.]

Each member is under a duty to insure that its membership application with the Corporation is kept current at all times by supplementary amendments to its original application and that any offices other than the main office are properly [designated] identified and registered, if required, with the Corporation. Each member must also determine in light of the requirements of Article III, Section 27 of the Rules of Fair Practice the form of its own written supervisory procedures, and, accordingly, which offices are to be [designated as office of supervisory jurisdiction] responsible for carrying out the written procedures.

Each member must [designate] identify to the [Association] Corporation those offices of supervisory jurisdiction, including the main office, and must register those offices which are deemed to be branch offices in accordance with the standards set forth in Article I of the By-Laws. [found hereafter. A branch office would be considered an office of supervisory jurisdiction only if designated as such and only if specified supervisory activities are assigned to it under the member's written procedures. Members should note that the term "branch office" of itself does not carry any implication that branch office personnel are required to perform any supervisory function. The term "branch office" is merely to designate and identify for registration purposes the various offices of a member other than the main office and as such are required to be registered and as to which a registration fee should be paid.] If an office falls within the definition of both an office of supervisory jurisdiction and a branch office, it must be designated to the Corporation in each category and it must be registered as a branch office and the applicable registration fee for a branch office must be paid.

[In determining whether an office or the activities of a person associated with a member in an area constitutes a branch office of a member, the following standards shall be used:

[1. It shall be considered a branch office if the member directly or indirectly contributes a substantial portion of the operating expenses of any place used by a person associated with a member who is engaged in the investment banking or securities business, whether it be commercial office space or a residence. Operating expenses, for purposes of this standard, shall include items normally associated with the cost of operating the business such as rent and taxes.
2. It shall be considered a branch office if the member authorizes a listing in any publication or any other media, including a professional dealer's digest or a telephone directory, which listing designates a place as an office or if the member designates any such place with an organization as an office.]

Exhibit C

PROPOSED AMENDMENTS TO NASD RULES OF FAIR PRACTICE*

Supervision

Sec. 27

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Registered Principals; review of activities and annual inspection

(d) Each member shall review the activities of each office, which shall include the [periodic] examination of customer accounts to detect and prevent irregularities or abuses [and at least an annual inspection of each office of supervisory jurisdiction]. At least one registered principal qualified to act in a principal capacity with respect to all of the activities occurring at such office shall be located at each office of supervisory jurisdiction and each branch officer provided, however, that a member may elect, in the case of a branch office at which three or fewer registered persons are located, to examine the office at six-month intervals in lieu of employing a resident registered principal. Each office of supervisory jurisdiction and each branch office at which a registered principal is located shall be examined annually by the member. Each member annually shall conduct a personal compliance interview with each registered person employed at a non-branch business location. Each member shall maintain a record of its examination of each branch office and of its interview with each registered person in each non-branch business location.

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["Office of supervisory jurisdiction"

(f) "Office of supervisory jurisdiction" means any office designated as directly responsible for the review of the activities of registered representatives or associated persons in such office and/or in other offices of the member.]

1/ On May 11, 1987, the NASD Board of Governors adopted an amendment to this definition that eliminates the language "located in the United States." This amendment has been submitted to the membership for a vote. (See NASD Notice to Members 87-37, dated June 16, 1987.)

* New text is underlined; deleted text is bracketed.