TO: All NASD Members and Other Interested Persons
LAST DATE FOR COMMENT: MARCH 1, 1988.
EXECUTIVE SUMMARY
The NASD requests comments on proposed amendments to Article HI, Section 27 of the NASD Rules of Fair Practice that would (1) prescribe specific supervisory practices and procedures for all member firms and (2) revise the definitions of "office of supervisory jurisdiction" (OSJ) and "branch office." These amendments would provide that all members establish a supervisory system meeting specified minimum standards. These standards focus upon the creation of a supervisory "chain of command," in which qualified supervisory personnel are appointed to carry out the firm's supervisory obligations, and regular inspections of the firm's business activities and offices, including annual OSJ inspections, periodic branch office inspections, and annual compliance meetings with registered representatives. Certain existing obligations under Section 27 will remain unchanged under the proposed amendments.
The definition of an OSJ would include not only offices with supervisory responsibilities, but also those offices at which other specified functions take place that the NASD believes should be supervised directly by a registered principal. A branch office would be defined as any location identified by means other than business cards, letterhead, or telephone directory line listings as a business location of the member.
The text of the proposed amendments is attached.
BACKGROUND
In recent years, the NASD has become increasingly concerned that many persons associated with NASD members are engaging in the offer and sale of securities to the public without adequate ongoing supervision. In particular, the potential for significant regulatory problems exists when registered representatives conduct business at locations that are not subject to regular examination by the member and operate without direct oversight of qualified supervisory personnel.
In addition to these concerns, the NASD has considered whether certain aspects of a firm's business should be subject to on-site supervision by a registered principal so that the member can properly discharge its regulatory obligations. Further, the NASD has from time to time considered whether the definition of "branch office" in the By-Laws should be revised.
The NASD's concern about off-site employment was discussed in detail in Notice to Members 86-65 (September 12, 1986), which emphasized existing NASD rules that most directly apply to off-site employment. That notice stated that the NASD was continuing to study the need to revise requirements for designating OSJs and branch offices and for on-site supervision by registered principals.
On June 29, 1987, the NASD issued Notice to Members 87-41, which requested comments on (1) proposed amendments to the definitions of "OSJ" and "branch office" and (2) proposed requirements for on-site registered principals at a business location based upon the number of persons and the extent to which such location was advertised or otherwise designated as an office of the member.
As a result of the comments received in response to Notice to Members 87-41, the NASD developed proposed amendments to Article III, Section 27 of the Rules of Fair Practice that set forth specific minimum requirements for supervisory practices and procedures for NASD members. These proposals would impose additional requirements upon members; however, the NASD has observed that many members have implemented these or similar measures to meet their existing obligations to ensure compliance with applicable laws, regulations, and rules.
These proposals reflect the NASD Board's continuing commitment to facilitate more effective supervision by members while accommodating their diverse modes of operation.
DESCRIPTION AND ANALYSIS OF PROPOSED AMENDMENTS
Proposed Amendments to Supervision Rules
The proposed amendments substantially expand the specificity of Article III, Section 27 of the NASD Rules of Fair Practice with respect to a member's supervisory obligations. The NASD believes that the new provisions will assist members in ensuring compliance with applicable laws, regulations, and rules by requiring that firms review their businesses and construct and document a supervisory system designed to detect and prevent violations in the various areas of business.
The proposals also contain certain minimum required supervisory procedures and practices that the NASD believes to be necessary in any firm, regardless of size or type, in order to supervise adequately an investment banking and/or securities business.
The amendments require each firm to establish and maintain supervisory procedures and practices that provide for, at a minimum, the following:
(1) Establishment and maintenance of written supervisory and review procedures as specified in the proposed amendments;
(2) Designation of appropriately registered principals for each type of business in which the firm engages to carry out the firm's supervisory obligations;
(3) Designation as an OSJ for each location that meets the OSJ definition and any other locations for which such designation is appropriate to enable the firm to supervise properly;
(4) Designation of one or more appropriately registered principal(s) in each OSJ, including the main office, and one or more appropriately registered representative(s) or principal(s) in each branch office to carry out the supervisory responsibilities and activities assigned to that office by the member;
(5) Assignment of each registered person to a supervisor;
(6) Establishment of procedures intended to ensure that all supervisory personnel are properly qualified;
(7) Attendance of each registered representative, individually or collectively and not less than annually, at an interview or meeting held by the firm to review compliance matters relevant to the activities of such representative(s);
(8) Designation and identification to the NASD of one or more compliance principals who shall review the firm's supervisory practices and procedures and recommend to senior management appropriate action to ensure the member's compliance with applicable securities laws and regulations and with the rules of the NASD; and
(9) Establishment of a schedule for examining the firm's branch offices that takes into account the nature of the activity,volume of business, and number of persons at each office.
The proposed amendments would require that each firm maintain written supervisory procedures that describe the supervisory system implemented according to the above requirements and that list the names, registration statuses, and locations of the required supervisory personnel and the specific responsibilities assigned to each. A copy of the member's supervisory procedures, or the relevant parts thereof, would be required to be kept and maintained at each OSJ and at each other location where supervisory activities are conducted on behalf of the member. The member would be required to amend its written supervisory procedures, as appropriate, within a reasonable time after changes occur in applicable laws, regulations, and rules, and as changes occur in the firm's supervisory system. The member would be required to communicate these changes throughout its organization.
Members also would be required to conduct an inspection, at least annually, of the businesses in which it engages for purposes of detecting and preventing violations of, and to ensure compliance with, applicable laws, regulations, and rules. At a minimum, this would include the periodic examination of customer accounts to detect and prevent irregularities and abuses and an annual examination of each OSJ. Branch offices would be examined in accordance with the schedule set forth in the member's supervisory procedures and the member would be required to retain a written record of its inspection cycles and the date each inspection was conducted.
Proposed Amendments to Definitions of "Office of Supervisory Jurisdiction" and "Branch Office"
An "office of supervisory jurisdiction" (OSJ) is currently 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 any 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:
(1) Order execution and/or market making;
(2) Origination (structuring) of public offerings or private placements;
(3) Maintaining custody of firm or customers' funds and/or securities;
(4) Acceptance (approval) of new accounts on behalf of the member;
(5) Approval of customer orders;
(6) Approval of advertising or sales literature for use by persons associated with the member, pursuant to Article HI, Section 35(b)(l) of the Rules of Fair Practice;
(7) Approval of correspondence of associated persons pertaining to the solicitation or execution of any securities transactions; or
(8) Responsibility for supervising the activities of persons associated with the member at one or more other offices of the member.
The NASD is aware that some members have procedures whereby the functions described in (4) through (7) above are performed preliminarily at local or regional offices prior to obtaining final approval at another location. The proposed revisions are intended to require OSJ designation for any office at which the approval that constitutes formal action by the member takes place.
The term "branch office" is currently defined in Article I, Section (c) of the NASD By-Laws as ". . . an office which is owned or controlled by a member, and which is engaged in the investment banking or securities business." An Explanation of the Board of Governors in Schedule C to the NASD By-Laws reiterates this definition and also provides that a place of business of a person associated with a member is considered a branch office if the member: (1) directly or indirectly contributes a substantial portion of the operating expenses of such place of business; and/or (2) authorizes a listing in any publication or other media, including a professional dealers digest or telephone directory, that designates a place as an office or if the member designates any such place as an office to another organization.
The proposed amendment would define "branch office" as any business location of the member identified by any means other than business cards, letterhead, or telephone directory line listings as a location at which the investment banking or securities business is conducted on behalf of the member.
* * * * *
The NASD encourages all members and 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 March 1, 1988. Comments received by this date will be considered by the NASD Qualifications Committee and the National Business Conduct Committee. Any changes to the NASD Rules of Fair Practice approved by the NASD 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 can be directed to either Dennis C.Hensley, NASD Vice President and Deputy General Counsel, at (202) 728-8245,or Jacqueline D. Whelan, Senior Attorney, NASD Office of the General Counsel, at (202)728-8270.
Sincerely,
Frank J. Wilson
Executive Vice President
and General Counsel
ARTICLE III, SECTION 27 OF THE NASD RULES OF FAIR PRACTICE
CURRENT TEXT
Supervision
Sec 27.
Written procedures
(a) Each member shall establish, maintain and enforce written procedures, which will enable it to supervise properly the activities of each registered representative and associated person to assure compliance with applicable securities laws, rules, regulations and statements of policy promulgated thereunder and with the rules of this Association.
Responsibility of member
(b) Final responsibility for proper supervision shall rest with the member. The member shall designate a partner, officer or manager in each office of supervisory jurisdiction, including the main office, to carry out the written supervisory procedures. A copy of such procedures shall be kept in each such office.
Written approval
(c) Each member shall be responsible for keeping and preserving appropriate records for carrying out the member's supervisory procedures. Each member shall review and endorse in writing, on an internal record, all transactions and all correspondence of its registered representatives pertaining to the solicitation or execution of any securities transaction.
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.
Qualifications investigated
(e) Each member shall have the responsibility and duty to ascertain by investigation the good character, business repute, qualifications and experience of any person prior to making such a certification in the application of such person for registration with this Association.
"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.
PROPOSED NEW TEXT
Sec. 27.
Supervisory system
(a) Each member shall establish and maintain a system which will enable it to supervise properly the activities of each registered representative and associated person to assure compliance with applicable securities laws and regulations, and with the rules of this Association. Final responsibility for proper supervision shall rest with the member. A member's supervisory system shall provide, at a minimum, for the following:
(1) The establishment and maintenance of written procedures as required by paragraphs (b) and (c) of this Section.
(2) The designation, where applicable, of an appropriately registered principal(s) with authority to carry out the supervisory responsibilities of the member for each type of business in which it engages as set forth in its membership application, as amended.
(3) The designation as an office of supervisory jurisdiction ("OSJ") of each location that meets the definition contained in paragraph (d) of this Section. Each member shall also designate such other locations as OSJs as necessary for the member to supervise properly, taking into consideration the nature and complexity of its activities, the .number and experience of its associated persons, the geographic dispersion of its personnel and locations, and the requirements of this Section.
(4) The designation of one or more appropriately registered principals in each OSJ, including the main office, and one or more appropriately registered representatives or principals in each non-OSJ branch office, with authority to carry out the supervisory responsibilities assigned to that office by the member.
(5) The assignment of each registered person to an appropriately registered representative(s) and/or principal(s) who shall be responsible for supervising that person's activities.
(6) Assurance that all supervisory personnel are properly qualified by virtue of experience or training to carry out their assigned responsibilities.
(7) The attendance of each registered representative, either individually or collectively, no less than annually, at an interview or meeting held by the member to review compliance matters relevant to the activities of the representative.
(8) Each member shall designate and specifically identify to the Association one or more Compliance Principals who shall review the supervisory system, procedures, and inspections required by this Section and recommend to senior management appropriate action to assure the member's compliance with applicable securities laws and regulations,and with the rules of this Association.
Written procedures
(b)
(l) Each member shall establish, maintain and enforce written procedures which will enable it to supervise properly the types of business in which it engages and to supervise the activities of registered representatives and associated persons to assure compliance with applicable securities laws and regulations, and with the applicable rules of this Association.
(b)
(2) The member's written supervisory procedures shall identify the supervisory system required pursuant to Section 27(a) above, setting forth the names, registration status and locations of the required supervisory personnel and the specific responsibilities of each supervisory person as these relate to the types of business engaged in, applicable securities laws and regulations, and the rules of this Association.
(b)
(3) A copy of a member's written supervisory procedures, or the relevant portions thereof, shall be kept and maintained in each OSJ and at each location where supervisory activities are conducted on behalf of the member. Each member shall amend its written supervisory procedures as appropriate within a reasonable time after changes occur in applicable securities laws and regulations, including the rules of this Association, and as changes occur in its supervisory system, and each member shall be responsible for communicating amendments through its organization.
Internal inspections
(c) Each member shall conduct an inspection, at least annually, of the businesses in which it engages, as contained in its membership application, as amended, for the purpose of detecting and preventing violations of and to ensure compliance with applicable securities laws and regulations, and with the rules of this Association. 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. Each branch office of the member shall be inspected according to the cycle set forth in the firm's written supervisory and inspection procedures. In establishing such cycle, the firm shall give consideration to the nature and complexity of the securities activities for which the location is responsible, the volume of business done and the number of associated persons assigned to the location. Each member shall retain a written record of its inspection cycles, and the date on which each inspection is conducted.
Written approval
(d) Each member shall review and endorse in writing, on an internal record, all transactions and all correspondence of its registered representatives pertaining to the solicitation or execution of any securities transaction.
Qualifications investigated
(e) Each member shall have the responsibility and duty to ascertain by investigation the good character, business repute, qualifications and experience of any person prior to making such a certification in the application of such person for registration with this Association.
Definitions
(f)
(l) "Office of Supervisory Jurisdiction" means any office of a member at which any one or more of the following functions take place:
(i) order execution and/or market making;
(ii) origination (structuring) of public offerings or private placements;
(iii) maintaining custody of firm or customer's funds and/or securities;
(iv) acceptance (approval) of new accounts on behalf of the member;
(v) approval of customer orders;
(vi) approval of advertising or sales literature for use by persons associated with the member, pursuant to Article III, Section 35(b)(l) of the Rules of Fair Practice;
(vii) approval of correspondence of associated persons pertaining to the solicitation or execution of any securities transactions, pursuant to Article III, Section 27(c) of the Rules of Fair Practice; or
(viii) responsibility for supervising the activities of persons associated with the member at one or more other branch offices of the member.
(f)
(2) "Branch Office" means any location identified by any means other than business cards, letterhead, or telephone directory line listings as a location at which the investment banking or securities business is conducted on behalf of a member.
Note: The proposed new text of Section 27 would replace the current text in its entirety. Subsections (c) and (e) of the current text have been retained as subsections (d) and (e) in the proposed new text. Portions of current subsections (b) and (d) have been incorporated into proposed new subsections (a) and (c), respectively. Current subsections (a) and (f) have been subsumed into the proposed new text.
