Proposed Amendments to Article III, Sections 1-28 of the NASD Rules of Fair Practice — Last Voting Date: March 20, 1989

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IMPORTANT MAIL VOTE

EXECUTIVE SUMMARY

NASD members are invited to vote on extensive amendments to Article III, Sections 1 through 28 of the NASD Rules of Fair Practice that include a number of new sections. The amendments have been approved by the NASD Board of Governors and now require membership approval. Prior to becoming effective, the amendments must be filed with, and approved by, the Securities and Exchange Commission.

The proposed amendments include five entirely new sections to be added to Article III of the Rules of Fair Practice. The proposed new sections are identified in this notice by the letter designations Sections [A] through [E]. If approved by the membership and the SEC, the new sections will entirely replace certain current NASD Board of Governors' Interpretations.

The amendments to existing Sections 1 through 28 include proposals to delete several sections in their entirety, primarily because they duplicate existing standards already covered under SEC regulations.

Many of the remaining sections contain proposed language revisions that clarify standards and requirements or respond to members' comments. There are extensive changes in Section 4 to incorporate the "NASD Mark-Up Policy" (sometimes referred to as the "Five Percent Policy"), which currently is a Board of Governors' Interpretation under Section 4, as well as to Section 25 to incorporate existing statutory changes and SEC rulings affecting the latter section. Members are not being asked to vote on the existing sections in which no changes are being proposed, and the texts of these sections are reproduced in this notice solely for information.

The texts of the proposed amendments follow.

BACKGROUND

During the past several years, the NASD Ad Hoc Committee on Rule and By-Law Amendments (Committee) has been reviewing the NASD's By-Laws, rules, interpretations, policies, and resolutions and making recommendations. The Committee's initial review covered the NASD By-Laws and Code of Procedure that, following adoption by the NASD Board of Governors, were approved by the Securities and Exchange Commission (SEC) and have been in effect since early 1985.¹

The proposed amendments to Article III, Sections 1 through 28 of the NASD Rules of Fair Practice contained in this notice represent a further step in the Committee's review and have been approved by the NASD Board of Governors. The amendments are primarily designed to conform the current provisions to statutory changes made over the years, to clarify their applications, to codify certain Board of Governors' Interpretations and policies into new rules, and generally to make the provisions more current and workable.

THE PROPOSED AMENDMENTS

The proposed amendments represent a revision of the proposals as previously published for comment in Notice to Members 86-9 (February 7, 1986). The NASD received 14 written comments, which were reviewed and considered by the Board of Governors and the Committee. The Board of Governors and the Committee believe that a number of these comments raised valid concerns about the application of the amendments to several substantive areas of NASD regulation. Therefore, the Board of Governors and the Committee revised the proposed amendments to reflect these concerns.

The proposed amendments are limited to Sections 1 through 28 of Article III of the NASD Rules of Fair Practice and certain interpretations and other published material thereunder. Although the Board of Governors and the Committee reviewed all the Rules of Fair Practice, Sections 1 through 28 have been specifically selected for revision because they have been in existence for many years without any overall Board of Governors' review. Almost all these sections date from the NASD's inception, and some were adopted shortly thereafter.²

Any future changes to the balance of the Rules of Fair Practice, when and if they appear necessary, will be submitted separately for membership vote.³ The proposed amendments fall into two broad categories: (1) several entirely new sections; and (2) proposed amendments to, or deletions of, certain existing sections.

NEW SECTIONS REPLACING CURRENT BOARD INTERPRETATIONS

The proposed amendments include five entirely new sections to be added to Article III of the Rules of Fair Practice. The proposed new sections are identified in this notice and on the ballot by the letter designations Sections [A] through [E]. If approved by the membership and the SEC, the new sections will entirely replace certain current NASD Board of Governors' Interpretations.

The new sections are intended to incorporate and codify four current, long-standing, and important Interpretations of the Board of Governors, which now appear in the NASD Manual under Section 1 of Article III of the Rules of Fair Practice.⁴ They include the Interpretations under Section 1 entitled "Execution of Retail Transactions in the Over-the-Counter Market," "Prompt Receipt and Delivery of Securities," "Forwarding of Proxy and Other Materials," and "Free-Riding and Withholding."⁵

New Sections [A] through [E] to Article III represent both a codification and a revision to the language of the existing Board Interpretations. The Board of Governors and the Committee believe the language changes made in the Interpretations clarify the applicable standards and requirements. Substantive changes have been kept to a minimum, and most are in response to members' comments. The Board of Governors and the Committee believe that the new sections are long overdue and should result in a major improvement in communicating — to persons entering the securities industry as well as to persons now in the industry — the basic ethical standards to which they may look for guidance and the standards they must meet to remain in compliance with NASD rules.

CHANGES IN CURRENT SECTIONS

The amendments to existing Sections 1 through 28 include proposals to delete several sections in their entirety, primarily because they duplicate existing standards that are already covered under SEC regulations. Many of the remaining sections contain proposed language revisions that primarily clarify standards and requirements or respond to members' comments. There are extensive changes in Section 4 to incorporate the "NASD Mark-Up Policy," sometimes referred to as the "Five Percent Policy," into the section, which currently is a Board of Governors' Interpretation under Section 4, as well as to Section 25 to incorporate existing statutory changes and SEC rulings affecting this section.⁶

MATTERS NOT COVERED BY THE AMENDMENTS

Several Board of Governors' Interpretations, Resolutions, and similar material now appearing in the NASD Manual under Sections 1 through 28 of Article III are not included in the attached proposed amendments because they constitute a relatively small volume of published material, compared with the extensive texts of the Board of Governors' Interpretations being codified into new sections of the Rules of Fair Practice. For a variety of reasons, the Board of Governors and the Committee believe that this material does not lend itself easily to codification as new Rules of Fair Practice.

After considering previous comments by members, the Board of Governors decided to withhold any action to modify or rescind these Interpretations and other materials, pending further study and review.⁷ The materials not codified in the proposed amendments, therefore, will continue to be effective and binding on members and persons associated with members.

REQUEST FOR VOTE

The attached texts of the proposed amendments are published in the sequence in which they now appear in the NASD Manual. Each proposed amendment also contains paragraph and page references to indicate where the existing material can be found in the Manual and the item number on the ballot, if applicable.

Proposed new Sections [A] through [E] to Article III will replace the Board of Governors' Interpretations under Section 1 of Article III. The new sections, however, will be given numerical identifiers prior to publication in the NASD Manual.

An explanation and description of each amendment immediately follows the text of the proposed amendment.

These amendments are important and merit members' immediate attention. The Board of Governors believes these amendments to the Rules of Fair Practice are necessary and appropriate and recommends that members vote their approval. Please mark the attached ballot according to your convictions and return it in the enclosed, stamped envelope to The Corporation Trust Company. Ballots must be postmarked no later than March 20, 1989.

Questions concerning this notice may be directed to Dennis C. Hensley, NASD Vice President and Deputy General Counsel, at (202) 728-8294, or John F. Mylod, Jr., NASD Assistant General Counsel, at (202) 728-8288.

NASD RULES OF FAIR PRACTICE

(Note: New language is underlined, and deleted language is bracketed.)

CURRENT TEXT

NASD Manual, ¶ 2151, p. 2014

No Vote Required

Business Conduct of Members

Sec. 1. A member, in the conduct of his business, shall observe high standards of commercial honor and just and equitable principles of trade.

EXPLANATION

No change is being proposed to this section.

This is the broadest and most fundamental section of the NASD Rules of Fair Practice and the source of a great deal of the existing precedent that has evolved in NASD disciplinary actions. The section contains a long-accepted principle that expresses the basic statement of standards of ethical business conduct in the investment banking and securities businesses. Therefore, it would be unwise and without justification to amend the language.

The section also restates the requirements of the statute under which the NASD has been granted its self-regulatory authority.

CURRENT TEXT

Items 1 and 2 on ballot

NASD Manual, ¶ 2151.03, pp. 2037 — 2037-3

[...Interpretation of the Board of Governors]

[Execution of Retail Transactions in the Over-The-Counter Market]

[Background]

[.03 The Board of Governors, under its obligation to "remove impediments to and perfect the mechanism of a free and open market," has made a review of practices in the over-the-counter market that can affect the price of shares paid by public customers in retail transactions. This review has brought to light certain practices by members that may deny customers the benefit of the diversity and competition that may exist in the inter-dealer market]

[To make members more fully aware of their obligations in this area and to more expressly define the standards of fair practice pertaining, the Board of Governors has issued the following Interpretation:]

[Interpretation]

PROPOSED NEW SECTION [A] OF THE NASD RULES OF FAIR PRACTICE

Item 1 on ballot

Obligations in Effecting Customer Transactions In the Over-the-Counter Market

Sec. [A].

General

EXPLANATION

This new section will codify the language that now appears in the NASD Manual as an Interpretation of the Board of Governors — "Execution of Retail Transactions in the Over-the-Counter Market"— under Article III, Section 1 of the Rules of Fair Practice (Best Execution Interpretation). The new section will replace paragraphs A and C of the Best Execution Interpretation, which will be rescinded by the Board of Governors upon effectiveness of the new section. The new section is designated Section [A] and will be given a permanent section number and placement within Article III prior to effectiveness. The basic duty of "best execution" appears in current paragraph A, which has been codified as subsections (a) and (b) of new Section [A]; and the basic prohibition against "interpositioning," which is currently contained in paragraph B, has been codified as new Section [B] discussed below separately. The language defining the scope of the Best Execution Interpretation in current paragraph C has been incorporated into both new sections. The existing Interpretation of the Board of Governors was adopted in 1968 in response to a recommendation in the 1964 SEC Special Study of Securities Markets. The language of paragraph D relating to the execution of transactions in non-NASDAQ securities was added to the Interpretation effective September 1, 1988, and is proposed to be incorporated into new Section [A]. The Board of Governors believes that the Best Execution Interpretation is included with those existing interpretations and policies of the Board that establish basic standards of conduct and, therefore, merits codification and adoption as a new rule of fair practice. The new section appears on the ballot as Item 1.

Subsection (a):

The proposed recodification of the "best execution" part of the Interpretation clarifies the types of customer transactions covered. They are limited to agency and contemporaneous principal, i.e., so-called riskless principal transactions.

The rule contains a definition of "contemporaneous principal transaction." It appears that the original intent of the Interpretation was to cover principal trades that are the functional equivalent of agency transactions. The new definition covers only situations where, after a member has received a customer order, an offsetting purchase or sale is effected by the member.

The new definition parallels the language of SEC Rule 10b-10(a)(8), which requires disclosure of markups in confirmations for contemporaneous principal trades when the broker-dealer has the customer's order in hand and then effects the offsetting transaction. The NASD rule, however, also covers situations where the customer has indicated an interest in buying or selling a security but the member does not record the order to prevent evasion of the best-execution duty.

The proposed rule continues and clarifies the existing language that confines the Best Execution Interpretation's coverage to transactions where the offsetting trade is effected only in the inter-dealer market. The primary concern expressed in the Interpretation was for transactions effected by retail firms with wholesale firms. The current language in the Best Execution Interpretation states that the firm's duty is to ascertain the best inter-dealer market and "... buy or sell in such market..." The quoted phrase, however, is being deleted because it might imply an obligation to execute in the inter-dealer market. This is contrary to industry practice and presumably was never intended. There are many situations where effecting transactions outside the inter-dealer market is permissible. It is not uncommon for members to cross transactions with other customers' orders to buy or sell securities on behalf of customers from or to banks, other institutions, or even the issuer on some occasions. The substituted language is designed to clarify this point.

The revised language is not intended to impose a duty to ascertain the market outside the inter-dealer market since this would go beyond the apparent scope of the Interpretation. If, however, a member knows of a better market elsewhere and, without any justification, fails to execute the customer's order in such market, the member's conduct could be considered by an NASD District Business Conduct Committee or, if appropriate, the Market Surveillance Committee, to be inconsistent with high standards of commercial honor, in violation of the broad provisions of Article III, Section 1 of the Rules of Fair Practice.

By including the firm's duty to ascertain the market (in new Subsection (a)(l) above) and to obtain the most favorable price (in new Subsection (a)(2)), the rule clarifies that both duties are satisfied if the member uses reasonable diligence. The last sentence of existing paragraph C of the Interpretation has been rewritten to clarify that retail commissions and markups are to be evaluated separately from whether the duty of best execution has been satisfied.

This proposed new rule of fair practice is identical to that proposed for comment in Notice to Members 86-9, except for the added language to clarify that the "inter-dealer market" includes the "exchange markets" in dually traded securities. Also, a change in the title of the section reflects that the section protects both individual and institutional customers.

Subsection (b):

The "due diligence" factors to be considered are especially important because of the broad scope of the best-execution obligation. In Subsection (b)(l), the word "depth" has been added. The concepts of depth and liquidity are different. "Depth," meaning the ability of the market to rapidly absorb or supply a large block of securities, may not exist, even though the market may be liquid, due to the existence of several market makers willing to buy and sell a normal unit of trading.

The existing "pressure on available communications" has been repositioned to new Subsection (b)(2) since it appears to relate more to a particular member's situation rather than being a characteristic of the market for the security. In Subsection (b)(3), the word "order" has been substituted for "transaction" because "not held" orders, limit orders, all-or-none orders, and other types of orders require different handling.

The amount of the transaction is of obvious relevance and, although implicit under the existing language, is emphasized by placing it separately in new Subsection (b)(4).

The "type of security" is a factor not mentioned in the existing language. It has been added under Subsection (b)(5) because the market often differs depending on the type of security.

The word "primary" is deleted in Subsections (b)(6) and (b)(7) because it seems unwarranted to impose on members a duty to know which, if any, firms are the primary market makers in any given security. The requirement in Subsection (b)(7) could be satisfied by checking a NASDAQ Level 3 terminal.

Subsection (c):

This subsection is the identical language currently contained in paragraph D of the Interpretation with respect to the duty of members executing transactions in non-NASDAQ securities to obtain quotations from at least three dealers (or fewer if there are less than three dealers in the security) to determine the best inter-dealer market. The purpose and application of the provision, which became effective September 1, 1988, and certain other related requirements contained or to be contained shortly in other NASD rules and schedules, were previously announced in NASD Notices to Members 88-40 (June 1988) and 88-54 (July 1988).

PROPOSED NEW SECTION [B] OF THE NASD RULES OF FAIR PRACTICE

Item 2 on ballot

Interpositioning Prohibition

Sec. [B].

General

Exemptions

Obligations of Interposed Members

Definitions

EXPLANATION

New Section [B] will replace paragraphs B and C of the Best Execution Interpretation, which together constitute the "interpositioning" part of the Interpretation, which will be rescinded on adoption of the new section. The new section has been temporarily designated Section [B] of Article III of the Rules of Fair Practice and will be given a permanent section number and placement within Article III prior to effectiveness. The new section appears on the ballot as Item 2.

Except as noted below, proposed new Section [B] retains the language originally proposed for comment. The new section is a rewording of existing paragraph B of the Best Execution Interpretation and the language found under the heading "Comment." The added language "in any agency or contemporaneous principal transaction for or with a customer in the over-the-counter market," which appears in Subsection (a) of new Section [B], is intended to clarify that the restriction against interpositioning applies to both types of transactions. It also parallels the language of proposed Section [A] that establishes a general best-execution standard.

The existing Best Execution Interpretation covers any interposed third party. This provision allows the NASD to bring disciplinary actions when the interposed account is the personal account of the member's trader or other persons associated with a member. Subsection (a) of the proposed rule substitutes the words "any other conduit" for the current "third party" language because this appears more consistent with the concept of interpositioning. The use of the term "conduit" is, thus, intended to clarify that the prohibitions of Section [B] apply when the proposed intermediary is simply a channel between the member and the market in which the transaction is executed.

A major change from the language of proposed Section [B] as published for comment relates to the scope of the interpositioning prohibition. Under both the existing Interpretation and the originally proposed new section, a member is prohibited from interposing someone between the customer and the best available market unless it can be demonstrated that the price paid or received by the customer was "better than" the prevailing inter-dealer price. One commenter stated that if a customer is not prejudiced because the price received or paid is the same as the prevailing inter-dealer price, it is unnecessary to limit the ability of the member to act in the best interest of the customer. It was further pointed out that if a member deems it advantageous for legitimate business reasons to buy or sell a security from a non-market maker and the customer receives a price equal to the inter-dealer price, the customer cannot be prejudiced. Therefore, Subsection (a) of new Section [B] prohibits interpositioning unless the member can demonstrate that the price paid or received by the customer was "better than or equal to" the prevailing inter-dealer price. A further change in new Section [B] is elimination of the word "retail" before "customer" to clarify that the protections of the section apply to institutional as well as individual customers.

The words "cost or proceeds" in the Best Execution Interpretation have been deleted and new language added to clarify that the amount paid or received by the customer is the amount the member paid or received from the interposed party without any adjustment for commissions paid by the customer to the member or markups or markdowns applied by the member in the transaction with the customer. The phrase "as confirmed to the member" is expanded because, where the interposed person is not a broker-dealer, the member would not necessarily receive a receipt or bill labeled a "confirmation."

Proposed Subsection (b) is entirely new and replaces the last sentence of the third paragraph under the heading "Comment" in paragraph B of the Best Execution Interpretation. New Subsection (b) would explicitly exempt (1) principal disclosed clearing arrangements and (2) other correspondent arrangements involving "give ups" of the name of the member initiating the transaction through another member.

Proposed Subsection (c) is a revision of the fourth paragraph under the heading "Comment" in the Best Execution Interpretation. The language clarifies the responsibility of the interposed member and is considered appropriate considering that one of the traditional motives for inter-positioning is to reward the interposed firm for business or services.

Subsection (d) contains a definition of the phrase "best available market." Without a definition in the current Best Execution Interpretation, the phrase appears to place an uncertain standard on members, which could be unfair if members are required to become aware of the existence of some little-known or obscure market, such as a single investor willing to buy the security whose interest is not advertised in conventional quotations media. As a result of member comment, however, the definition originally proposed has been revised slightly to more closely parallel the general duty of best execution in proposed new Section [A].

CURRENT TEXT

Item 3 on ballot

NASD Manual, ¶ 2151.04, p. 2037-4 — 2037-5

[...Interpretation of the Board of Governors]

[Prompt Receipt and Delivery of Securities]

[04. It shall be deemed a violation of Article III, Section 1 of the Rules of Fair Practice of the Association for a member to violate the provisions of the following Interpretation thereof:]

PROPOSED NEW SECTION [C] OF THE NASD RULES OF FAIR PRACTICE

Item 3 on ballot

Prompt Receipt and Delivery of Securities

Sec. [C]

EXPLANATION

As originally proposed, new Section [C] would have codified the language that now appears in the NASD Manual as an Interpretation of the Board of Governors —"Prompt Receipt and Delivery of Securities" — under Article III, Section 1 of the Rules of Fair Practice (Prompt Receipt Interpretation) and would have included a new provision to cover short sales. However, on October 15,1986, the short-sale provision became effective as an amendment to the existing Prompt Receipt Interpretation. Proposed new Section [C] converts the Interpretation as amended into rule form with certain changes explained below.

Subsection (a) of new Section [C] incorporates the current provision in the Prompt Receipt Interpretation requiring that the customer placing a purchase order agree to accept a partial delivery, but modifies the existing language to make the requirement applicable only to purchase orders for more than a single unit of trading. The Board of Governors believes that it is unfair to require a customer who places an order for less than a unit of trading to accept a partial delivery.

The other change is in Subsection (b)(4) of new Section [C], which would expand the existing order-ticket-notation requirement when the selling customer has possession of the securities to also require an appropriate order-ticket notation when the securities are long in the customer's account or in the possession of another member or bank. The new section appears as Item 3 on the ballot.

The NASD has filed a proposed rule change with the SEC to amend the current language of Subsection (b)(2) to impose the same requirement on short sales by members effecting short sales for their own accounts. See rule filing SR-NASD-89-5 and Notice to Members 88-47 (July 1988) publishing the proposal for comment. The rule filing has not been approved by the SEC. If SR-NASD 89-5 is approved by the SEC, the amendment proposed herein will be made to the Interpretation as amended by that rule change.

CURRENT TEXT

Item 4 on ballot

NASD Manual, ¶2151.05, pp. 2037-5 — 2038

[... Interpretation of the Board of Governors]

[Forwarding of Proxy and Other Materials]

[Introduction]

[.05 A member has an inherent duty in carrying out high standards of commercial honor and just and equitable principles of trade to forward all proxy material, annual reports, information statements and other material required by law to be sent to stockholders periodically, which are properly furnished to it by the issuer of the securities, to each beneficial owner of shares of that issue which are held by the member for the beneficial owner thereof. For the assistance and guidance of members in meeting their responsibilities, therefore, the Board of Governors has promulgated this Interpretation. The provisions hereof shall be followed by all members and failure to do so shall constitute conduct inconsistent with high standards of commercial honor and just and equitable principles of trade in violation of Article III, Section 1 of the Rules of Fair Practice of the Association.]

[Interpretation]

[Section 1. No member shall give a proxy to vote stock which is registered in its name, except as required or permitted under the provisions of Section 2 or 3 hereof, unless such member is the beneficial owner of such stock.]

[Section 2. Whenever a person soliciting proxies shall timely furnish to a member:]

[This section shall not apply to beneficial owners residing outside of the United States of America though members may voluntarily comply with the provisions hereof in respect to such persons if they so desire.]

[Section 3. A member may give a proxy to vote any stock registered in its name if such member holds such stock as executor, administrator, guardian, trustee, or in a similar representative or fiduciary capacity with authority to vote.]

[A member which has in its possession or within its control stock registered in the name of another member and which desires to transmit signed proxies pursuant to the provisions of Section 2, shall obtain the requisite number of signed proxies from such holder of record.]

[Section 4. A member when so requested by an issuer and upon being furnished with:]

[This section shall not apply to beneficial owners residing outside of the United States of America though members may voluntarily comply with provisions hereof in respect to such persons if they so desire.]

[Section 5. The Board of Governors for the guidance of members is authorized to establish a suggested rate of reimbursement of members for expenses incurred in connection with transmitting the proxy solicitation to the beneficial owners of the securities pursuant to Section 2 hereof or in transmitting information statements or other material to the beneficial owners of securities pursuant to Section 4 hereof. Such shall be attached hereto by appendix.]

PROPOSED NEW SECTION [D] OF THE NASD RULES OF FAIR PRACTICE

Item 4 on ballot

Proxies

Sec. [D].

Restrictions on giving of proxies

Forwarding of proxy material to customers

Signed proxy and transmittal letter

Member as executor or similar representative capacity

Signed proxies for security in names of other members

Forwarding of annual reports and other material

Suggested rates of reimbursement

Beneficial owners residing outside the United States

EXPLANATION

This new section codifies the language that now appears in the NASD Manual as an Interpretation of the Board of Governors — "Forwarding of Proxy and Other Materials," under Article III, Section 1 of the NASD Rules of Fair Practice (Proxy Interpretation). The existing Proxy Interpretation was adopted in 1967 to establish requirements applicable to proxies covering "street name" stock. The new section appears as Item 4 on the ballot.

The introduction to the Proxy Interpretation is not included in new Section [D] since it merely restates some of the substantive provisions that are contained later in the Interpretation. Section [D] would contain new headings above each subsection for clarity. The heading "Restrictions on Giving of Proxies" above Subsection (a), for example, is intended to emphasize the fact that there are only very limited circumstances that allow a member to give a proxy to vote securities registered in its name. Subsection (a) also would make the restrictions applicable to securities registered in the name of a nominee of a member to prevent technical evasion of the restrictions. For the same reason, the restrictions would be made expressly applicable to voting in person since the current language appears limited to situations involving voting by proxy.

Subsection (b) provides that, upon being furnished with sufficient copies of proxy solicitation material and assurance of reimbursement of expenses, a member is required to forward the material to the beneficial owners. The requirement applies whether the proxies are being solicited by the issuer or someone else, provided assurance of expense reimbursement is received. The new language authorizing a member to cause the material to be transmitted is intended only to clarify that a member may contract with another person to forward the material. The new language also clarifies that a member is responsible only for forwarding materials if it or its nominee is the record holder. The deletion of the word "promptly" and substitution of "a five-day period" to furnish the material conforms to the requirement of SEC Rule 14b-l(b).

Subsection (c) requires a member to transmit with the solicitation material a signed proxy to be completed by the beneficial owner and mailed directly to the issuer or other person soliciting proxies. Exchange rules permit a member to request voting instructions from the beneficial owners and, if instructions are received, the member is required to vote the proxies in accordance with the instructions received. With the exception of certain corporate events, the failure to receive voting instructions allows a member to vote a proxy at its discretion. The Proxy Interpretation deliberately omits this alternative procedure, but it does allow a member that is also an exchange member to elect to follow the exchange's proxy rules.

The changes in the second paragraph of Subsection (c) are for clarification only. The redraft retains these provisions. The third paragraph has been moved to new Subsection (h). The language of proposed Subsection (d) is basically unchanged from the existing language.

The changes in Subsection (e) concerning securities in the possession of a member that are registered in the name of another member are designed to clarify that the member in whose name the securities are registered must comply with any request by the member in possession to be furnished with signed proxies.

The changes in new Subsection (f) that impose a duty under certain conditions to forward annual reports and other materials not part of the proxy material are designed to make the language similar to the exchange rules. Thus, as revised, the requirement would apply to any material being sent to security holders by an issuer. The current language is limited to material "required by law" to be sent by an issuer to its security holders.

Under Subsection (g), the NASD Board is granted authority to adopt an Appendix G to new Section [D] establishing suggested rates of reimbursement for the cost of forwarding materials. It is contemplated that this appendix will be the same as the existing appendix under the Proxy Interpretation. The current appendix is not included in this notice since a membership vote is not required. When new Section [D] becomes effective, the current appendix will be placed immediately after the new section.

CURRENT TEXT

NASD Manual, ¶ 2151.06, pp. 2O40 — 2407-3

Item 5 on ballot

[...Interpretation of the Board of Governors]

["Free Riding and Withholding"]

[Introduction]

[The following Interpretation of Article III, Section 1 of the Association's Rules of Fair Practice is adopted by the Board of Governors of the Association pursuant to the provisions of Article VII, Section 3(a) of the Association's By-Laws and Article I, Section 3 of the Rules of Fair Practice.]

[This interpretation is based upon the premise that members have an obligation to make a bona fide public distribution at the public offering price of securities of a public offering which trade at a premium in the secondary market whenever such secondary market begins (a "hot issue") regardless of whether such securities are acquired by the member as an underwriter, as a selling group member, or from a member participating in the distribution as an underwriter or a selling group member, or otherwise. The failure to make a bona fide public distribution when there is a demand for an issue can be a factor in artificially raising the price. Thus, the failure to do so, especially when the member may have information relating to the demand for the securities or other factors not generally known to the public, is inconsistent with high standards of commercial honor and just and equitable principles of trade and leads to an impairment of public confidence in the fairness of the investment banking and securities business. Such conduct is, therefore, in violation of Article III, Section 1 of the Association's Rules of Fair Practice and this Interpretation thereof which establishes guidelines in respect to such activity.]

[As in the case of any other Interpretation issued by the Board of Governors of the Association, the implementation thereof is a function of the District Business Conduct Committees and the Board of Governors. Thus, the Interpretation will be applied to a given factual situation by individuals active in the investment banking and securities business who are serving on these committees or on the Board. They will construe this Interpretation to effectuate its overall purpose to assure a public distribution of securities for which there is a public demand.]

[Interpretation]

[Except as provided herein, it shall be inconsistent with high standards of commercial honor and just and equitable principles of trade and a violation of Article III, Section 1 of the Association's Rules of Fair Practice for a member, or a person associated with a member, to fail to make a bona fide public distribution at the public offering price of securities of a public offering which trade at a premium in the secondary market whenever such secondary market begins regardless of whether such securities are acquired by the member as an underwriter, a selling group member or from a member participating in the distribution as an underwriter or selling group member, or otherwise. Therefore, it shall be a violation of Article III, Section 1 for a member, or a person associated with a member, to:]

[The obligations imposed upon members in their dealings with foreign broker-dealers or banks by this paragraph 8(b) can be fulfilled by having the foreign broker-dealer or bank to which sales falling within the scope of this Interpretation are made execute Form FR-1, or a reasonable facsimile thereof. This form, which gives a blanket assurance from the foreign broker-dealer or bank that no sales will be made in contravention of the provisions of this Interpretation, can be obtained at any District Office of the Association or at the Executive Office. The acceptance of an executed Form FR-1, or other written assurance, by a member must in all instances be made in good faith. Thus, if a member knows or should have known of facts which are inconsistent with the representations received, such will not operate to satisfy the obligations imposed upon him by this paragraph.]

[Scope and Intent of Interpretation]

[In addition to the obvious scope and intent of the above provisions, the intent of the Board of Governors in the following specific situations is outlined for the guidance of members.]

[Issuer Directed Securities]

[This Interpretation shall apply to securities which are part of a public offering notwithstanding that some or all of those securities are specifically directed by the issuer to accounts which are included within the scope of paragraphs 3 through 8 above. Therefore, if a person within the scope of those paragraphs to whom securities were directed did not have an investment history with the member or registered representative from whom they were to be purchased, the member would not be permitted to sell him such securities. Also, the "disproportionate" and "insubstantial" tests would apply as in all other situations. Thus, the directing of a substantial number of securities to any one person would be prohibited as would the directing of securities to such accounts in amounts which would be disproportionate as compared to sales to members of the public. This Interpretation shall also apply to securities which are part of a public offering notwithstanding that some of those securities are specifically directed by the issuer on a non-underwritten basis. In such cases, the managing underwriter of the offering shall be responsible for insuring compliance with this Interpretation in respect to those securities.]

[Notwithstanding the above, sales of issuer directed securities may be made to restricted persons without the required investment history after receiving permission from the Board of Governors. Permission will be given only if there is a demonstration of valid business reasons for such sales (such as sales to distributors and suppliers or key employees, who are in each case incidentally restricted persons), and the member seeking permission is prepared to demonstrate that the aggregate amount of securities so sold is insubstantial and not disproportionate as compared to sales to members of the public, and that the amount sold to any one of such persons is insubstantial in amount.]

[Investment Partnerships and Corporations]

[A member may not sell securities of a public offering which trade at a premium in the secondary market whenever such secondary market begins ("hot issue"), to the account of any investment partnership or corporation, domestic or foreign (except companies registered under the Investment Company Act of 1940) including but not limited to, hedge funds, investment clubs, and other like accounts unless the member complies with either of the following alternatives; ]

[The member shall maintain a copy of the names and business connections of all persons having any beneficial interest in the account or a copy of the current opinion of counsel in its files for at least three years following the member's last sale of a new issue to the account, depending upon which of the above requirements the member elects to follow. For purposes of this section, a list or opinion shall be deemed to be current if it is based upon the status of the account as of a date not more than 18 months prior to the date of the transaction.]

[The term beneficial interest means not only ownership interests, but every type of direct financial interest of any persons enumerated in paragraphs (1) through (4) hereof in such account, including, without limitation, management fees based on the performance of the account.]

[Violations by Recipient]

[In those cases where a member or person associated with a member has been the recipient of securities of a public offering to the extent that such violated the Interpretation, the member or person associated with a member shall be deemed to be in violation of Article III, Section 1 of the Rules of Fair Practice and this Interpretation as well as the member who sold the securities since their responsibility in relation to the public distribution is equally as great as that of the member selling them. In those cases where a member or a person associated with a member has caused, directly or indirectly, the distribution of securities to a person falling within the restrictive provisions of this Interpretation, the member or person associated with a member shall also be deemed to be in violation of Article III, Section 1 of the Rules of Fair Practice and this Interpretation. Receipt by a member or a person associated with a member of securities of a hot issue which is being distributed by an issuer itself without the assistance of an underwriter and/or selling group is also intended to be subject to the provisions of this Interpretation.]

[Violations by Registered Representative Executing Transaction]

[The obligation which members have to make a bona fide public distribution at the public offering price of securities of a hot issue is also an obligation of every person associated with a member who causes a transaction to be executed. Therefore, where sales are made by such persons in a manner inconsistent with the provisions of this Interpretation, such persons associated with a member will be considered equally culpable with the member for the violations found taking into consideration the facts and circumstances of the particular case under consideration.]

[Disclosure]

[The fact that a disclosure is made in the prospectus or offering circular that a sale of securities would be made in a manner inconsistent with this Interpretation does not take the matter out of its scope. In sum, therefore, disclosure does not affect the proscriptions of this Interpretation.]

[Explanation of Terms]

[The following explanation of terms is provided for the assistance of members. Other words which are defined in the By-Laws and Rules of Fair Practice shall, unless the context otherwise requires, have the meaning as defined therein.]

[Public Offering]

[The term public offering shall mean all distributions of securities whether underwritten or not; whether registered, unregistered or exempt from registration under the Securities Act of 1933, and whether they are primary or secondary distributions, including intra- state distributions and Regulation A issues, which sell at an immediate premium, in the secondary market. It shall not mean exempted securities as defined in Section 3(a)(12) of the Securities Exchange Act of 1934.]

[Immediate Family]

[The term immediate family shall include parents, mother-in-law or father-in-law, husband or wife, brother or sister, brother-in-law or sister-in-law, son-in-law or daughter-in-law, and children. In addition, the term shall include any other person who is supported, directly or indirectly, to a material extent by the member, person associated with the member or other person specified in paragraphs 2, 3, or 4 above.]

[Normal Investment Practice]

[Normal investment practice shall mean the history of investment of a restricted person in an account or accounts maintained with the member making the allocation. In cases where an account was previously maintained with another member, but serviced by the same registered representative as the one currently servicing the account for the member making the allocation, such earlier investment activity may be included in the restricted person's investment history. Usually the previous one-year period of securities activity is the basis for determining the adequacy of a restricted person's investment history. Where warranted, however, a longer or shorter period may be reviewed. It is the responsibility of the registered representative effecting the allocation, as well as the member, to demonstrate that the restricted person's investment history justifies the allocation of hot issues. Copies of customer account statements or other records maintained by the registered representative or the member may be utilized to demonstrate prior investment activity. In analyzing a restricted person's investment history the Association believes the following factors should be considered:]

[Disproportionate]

[In respect to the determination of what constitutes a disproportionate allocation, the Association uses as a guideline 10% of the member's participation in the issue, however acquired. It should be noted, however, that the 10% factor is merely a guideline and is one of a number of factors which are considered in reaching determinations of violations of the Interpretation on the basis of disproportionate allocations. These other factors include, among other things:]

[the size of the participation;]

[the offering price of the issue;]

[the amount of securities sold to restricted accounts; and,]

[the price of the securities in the aftermarket.]

[It should be noted that disciplinary action has been taken against members for violations of the Interpretation where the allocations made to restricted accounts were less than 10% of the member's participation. The 10% guideline is applied as to the aggregate of the allocations.]

[Notwithstanding the above, a normal unit of trading (100 shares or 10 bonds) will in most cases not be considered a disproportionate allocation regardless of the amount of the member's participation. This means that if the aggregate number of shares of a member's participation which is allocated to restricted accounts does not exceed a normal unit of trading, such allocation will in most cases not be considered disproportionate. For example, if a member receives 500 shares of a hot issue, he may allocate 100 shares to a restricted account even though such allocation represents 20% of that member's participation. Of course, all of the remaining shares would have to be allocated to unrestricted accounts and all other provisions of the Interpretation would have to be satisfied. Specifically, the allocation would have to be consistent with the normal investment practice of the account to which it was allocated and the member would not be permitted to sell to restricted persons who were totally prohibited from receiving hot issues.]

[Insubstantiality]

[This requirement is separate and distinct from the requirements relating to disproportionate allocations and normal investment practice. In addition, this term applies both to the aggregate of the securities sold to restricted accounts and to each individual allocation. In other words, there could be a substantial allocation to an individual account in violation of the Interpretation and yet be no violation on that ground as to the total number of shares allocated to all accounts. The determination of whether an allocation to a restricted account or accounts is substantial is based upon, among other things, the number of shares allocated and/or the dollar amount of the purchase.]

[SALES BY ISSUERS IN CONVERSION OFFERINGS]

[Definitions]

[Conditions for exemption]

[Sales to members, associated persons of members, and certain related persons]

[Sales to Other Restricted Persons]

PROPOSED NEW SECTION [E] OF NASD RULES OF FAIR PRACTICE

Item 5 on ballot

Free-Riding and Withholding

Sec. [E].

Application

EXPLANATION

New Section [E] codifies the language that now appears in the NASD Manual as an Interpretation of the Board of Governors — "Free-Riding and Withholding" — under Article III, Section 1 of the NASD Rules of Fair Practice (Free-Riding and Withholding Interpretation). Because of the length and complexity of the Free-Riding and Withholding Interpretation and new Section [E], each subsection is discussed separately. The new section appears as Item 5 on the ballot.

Subsection (a) of new Section [E] is based on the current introduction to the Free-Riding and Withholding Interpretation, but eliminates what appears to be unnecessary language. It also clarifies that the provision applies both to purchases of "hot issues" by associated persons and members that are not participating in the offering as well as to purchases and sales by members and associated persons who are participants in the offering.

A major change in the subsection over the provision earlier submitted for comment is the addition of language to define "hot issue securities" as securities of a public offering that trade at a premium in the secondary market within a reasonable time during the initial phase of trading in such secondary market. The change has been made in response to several comments and is designed to introduce a greater degree of specificity into the definition by clarifying that the time period used to determine whether an offering is a "hot issue" following the commencement of aftermarket trading is not open ended and is determined by a standard of reasonableness that takes into account all relevant facts and circumstances.

PROPOSED NEW TEXT

Withholding by members

EXPLANATION

This provision expands upon the existing prohibition and incorporates certain language now appearing in the Introduction to the Free-Riding and Withholding Interpretation.

PROPOSED NEW TEXT

Sales to associated persons of brokers and dealers and certain other persons

EXPLANATION

Subsection (c)(l) of new Section [E] parallels the existing language of the Free-Riding and Withholding Interpretation, with certain changes. The current language that prohibits sales to any officer, director, general partner, or employee of a member has been retained but the existing language also prohibiting sales to any "person associated with a member" has been deleted. New language has been added to specifically cover "any other natural person in the investment banking or securities business who is directly or indirectly controlling or controlled by a member" as persons to whom "hot issues" may not be sold. The new language codifies the NASD's longstanding interpretation that limited partners, non-voting stockholders, and subordinated lenders are not covered unless they are in a control relationship with a member.

Subsection (c)(2) of Section [E] carries forward the existing restrictions concerning sales to members of the immediate family of persons covered by Subsection (c)(l). The restrictions are combined with language now appearing in the proviso clause following paragraph 5 of the Free-Riding and Withholding Interpretation that permits sales to members of the immediate family under certain circumstances. The prohibition on selling a "hot issue" to any of the enumerated persons contained in both subsections (c)(l) and (c)(2) has been expressly made applicable to an "associated person of a member," although the existing language of the Free-Riding and Withholding Interpretation speaks only of sales by members. This is intended to clarify the responsibilities of registered representatives and other associated persons in making sales of "hot issues" to ensure compliance with new Section [E], which appears under the heading "Violations by Registered Representative Executing Transaction" in the Free-Riding and Withholding Interpretation.

The substitution of the "associated person" language also clarifies that the responsibility to ensure compliance with new Section [E] goes beyond the registered representative who executes the sale. The addition of the words "cause to sell" codifies the long-standing NASD position that members and associated persons who direct other participants in the offering to make sales are not relieved of responsibility because the sales are executed by someone else.

PROPOSED NEW TEXT

Sales to persons assisting in the distribution

EXPLANATION

Subsection (d) of proposed new Section [E] carries forward the existing restrictions of paragraph 3 of the Free-Riding and Withholding Interpretation and also combines into a single provision language now appearing in the proviso clause following paragraph 5 that allows sales where there is an investment history and the amount sold to the restricted person is insubstantial. In addition, pursuant to proposed Subsection (g) following, aggregate sales to all restricted and prohibited persons must be insubstantial and and not disproportionate. Subsection (d) also clarifies the Board's intent in adopting paragraph 3 that the restriction on sales of "hot issues" applies only to attorneys and accountants performing services for the managing underwriter. It does not apply to attorneys and accountants for participating underwriters or selected dealers. The proposed Subsection also clarifies the Board's intent that the restriction on sales applies only where the attorney or accountant is performing services with respect to the particular public offering being sold and does not apply to attorneys and accountants simply because they performed services in prior public offerings handled by the same managing underwriter.

PROPOSED NEW TEXT

Sales to officers and employees of financial institutions

EXPLANATION

Proposed Subsection (e) of new Section [E] carries forward the existing restrictions of paragraph 4 of the Free-Riding and Withholding Interpretation and also combines into a single provision language appearing in the proviso clause following paragraph 5. The listing of financial institutions has been enlarged to include "trust company." The language has also been changed to clarify that the restriction applies to sales to officers and employees of foreign banks and other foreign institutions. The new language also clarifies that the restrictions of Subsection (e) apply to sales to the institution's officers and employees and do not apply to sales to the institution for which they work when purchasing for its own account.

A major change in new Subsection (e) from the original proposal published for comment relates to the restricted status of officers and employees of financial institutions that are engaged in a public offering of their own securities. This change is in response to a comment received that officers and employees of financial institutions have a valid business reason for desiring to purchase the securities issued by their employers or issued by affiliates of their employers. The existing restrictions prevent the senior officers of the specified institutions, and employees involved in buying and selling securities for such employer institutions, from purchasing the publicly offered securities of their employer, or its affiliates, if they do not have an investment history with the member making the sales or the amount desired to be purchased is considered not insubstantial.

Accordingly, proposed Subsection (e) now expands the language of the proviso clause at the end of the subsection to allow purchases by any person subject to the provisions of the subsection if the issuer of the security is the employer, or an affiliate of the employer, or if they are members of the immediate families of persons who are employees or senior officers of the issuer or an affiliate of the issuer. The effect of this change is to exempt persons covered by Subsection (e)(ii) from the requirements that they have an investment history and that the amount sold to any such person is insubstantial. It is intended, however, that such persons will continue to be considered restricted persons under Subsection (g) of proposed Section [E], discussed below, which imposes an aggregate limitation on the amount of securities a member may sell to all restricted persons.

Under the expanded provision language, persons who now are included as members of the immediate families of senior officers and employees of financial institutions would be granted the same exemption both with respect to purchases of their own employers' securities and with respect to purchases of securities issued by financial institutions.

PROPOSED NEW TEXT

Sales to beneficial interest accounts

EXPLANATION

Subsection (f) carries forward existing paragraph 5 of the Free-Riding and Withholding Interpretation with certain language changes to clarify that the exception that permits sales of "hot issues" to beneficial interest accounts, if the investment history and insubstantiality tests are met, does not apply to any beneficial interest account in which the beneficial interest is held by a member, an officer, director, or employee of a member or immediate family members, if supported by such officers, directors, or employees.

PROPOSED NEW TEXT

Overall limitation on sales

EXPLANATION

Proposed Subsection (g) is based on the part of the proviso following paragraph 5 of the Free-Riding and Withholding Interpretation that places an overall limitation on aggregate sales to restricted persons. The requirement has been placed in a separate subsection to clarify that it is separate and distinct from the requirement that a restricted person can receive a "hot issue" security only if the person has an investment history and the amount sold to the person is insubstantial. The new structure is designed to clarify the existence of four separate tests, i.e., (1) investment history, (2) sales insubstantial as to each recipient, (3) total sales not disproportionate, and (4) total sales insubstantial. In addition, new Subsection (g) attempts to clarify that the disproportionate and substantiality tests are to be measured against the selling member's sales, rather than the amount of the offering.

PROPOSED NEW TEXT

Sales to non-participating members

EXPLANATION

Proposed Subsection (h) incorporates the part of paragraph 6 of the Free-Riding and Withholding Interpretation restricting sales of "hot issues" to broker-dealers that are members of the NASD. The part dealing with sales to non-member broker-dealers has been separated and moved to new Subsection (m). The new provision applies to any "non-participating member" in the distribution since this was the original intended scope of paragraph 6 of the Interpretation.

PROPOSED NEW TEXT

Sales to foreign and domestic banks, foreign brokers and dealers, and other conduits for undisclosed principals

EXPLANATION

The provisions of Subsection (i) are designed to eliminate duplicative language by combining the existing language of paragraph 7 of the Free-Riding and Withholding Interpretation, dealing with domestic banks and other conduits for undisclosed principals, and paragraph 8 thereof, dealing with foreign banks and foreign broker-dealers. The language is broadened to expressly cover foreign trust companies and other foreign conduits. The reference to foreign broker-dealers that are not registered with the SEC is intended to clarify that the restrictions are not applicable to foreign broker-dealers that are registered with the SEC and that are members and covered by Subsection (h) if they are members, or by Subsection (m) if they are non-members. New Subsection (h)(2) simply makes explicit that if any of the ultimate purchasers are restricted persons, a member is absolutely prohibited from making a sale of a "hot issue" security to the conduit.

In response to comments received, the language of Subsection (i) has been revised to clarify that if a member has obtained a blanket agreement under paragraph (1)(A) of the subsection, the member is not required to obtain a new agreement for each offering. Under paragraph 8 of the Interpretation, the obligations to obtain assurances have always been deemed satisfied by a blanket agreement from foreign banks, and the language of the new subsection, as revised, is intended to make this equally applicable to domestic banks.

PROPOSED NEW TEXT

Sales to certain investment companies

EXPLANATION

The provisions of Subsection (j) are based on current language that appears after the text of the Free-Riding and Withholding Interpretation under the heading "Scope and Intent of Interpretation" and the subheading "Investment Partnerships and Corporations." It has been reworded to clarify the provision and to broaden its scope to cover legal entities other than corporations and partnerships to reflect the original intent of the provision.

The last sentence of the existing language in the Free-Riding and Withholding Interpretation, which defines "beneficial interest," also has been moved to a new section of definitions.

PROPOSED NEW TEXT

Sales directed by issuers and others

EXPLANATION

The provisions of Subsection (k) are based on current language that appears after the text of the Free-Riding and Withholding Interpretation under the heading "Scope and Intent of Interpretation" and the subheading "Issuer Directed Securities." It has been reworded to clarify that members selling issuer-directed shares must comply in all respects with the applicable requirements to the same extent as if the sales had not been directed. It also has been broadened to cover sales directed by underwriters and others.

Subsection (k), as originally circulated for comment, unintentionally omitted language from the Free-Riding and Withholding Interpretation that gave the Board of Governors authority to grant exemptions to permit issuer-directed sales under limited circumstances. Accordingly, the authority to grant exemptions now appears in Subsection (k) as it was originally intended. The provision has been clarified to cover both prohibited and restricted persons.

PROPOSED NEW TEXT

Responsibility for non-underwritten securities

EXPLANATION

The provisions of Subsection (i) are based on the last two sentences of the first paragraph under the existing Free-Riding and Withholding Interpretation under the subheading "Issuer Directed Securities." It also incorporates the Board's authority to grant exemptions under certain circumstances as contained in the Interpretation and to clarify that the exemptive authority covers both issuer-directed and non-underwritten sales.

PROPOSED NEW TEXT

Sales to non-member brokers and dealers

EXPLANATION

The provision of Subsection (m) is based on the first part of paragraph 6 of the existing interpretation.

PROPOSED NEW TEXT

Receipt of hot issue securities by associated persons of members

EXPLANATION

The provision of Subsection (n) is based on the first and third sentences of language in the existing Free-Riding and Withholding Interpretation that appears under the heading "Scope and Intent of Interpretation" and the subheading "Violations by Recipients." The changes are intended to make the requirements more specific. The second sentence of the existing language that imposes liability on any member or person associated with a member who causes a "hot issue" to be sold to a restricted or prohibited person is codified in the phrase "cause to be sold" that appears throughout new Section (E).

PROPOSED NEW TEXT

Disclosure no defense

EXPLANATION

The provision of Subsection (o) is based on language in the existing Free-Riding and Withholding Interpretation that appears under the heading "Scope and Intent of Interpretation" and the subheading "Disclosure."

PROPOSED NEW TEXT

Definitions

EXPLANATION

These definitions are based on the language of the definitions appearing in the existing Free-Riding and Withholding Interpretation except that the term "established investment practice" in Subsection (p)(3) has been substituted for the existing "normal investment practice" because it appears more consistent with the intent of the requirement. The term "beneficial interest" has also been taken from its current location in the Free-Riding and Withholding Interpretation under the subheading "Investment Partnerships and Corporations."

PROPOSED NEW TEXT

Sales by issuers in conversion offerings

EXPLANATION

The provisions of Subsection (q) parallel those of the amendment to the Free-Riding and Withholding Interpretation that became effective September 25,1986. See NASD Notice to Members 86-73 (October 16,1986) for the background and an explanation of the amendment.

PROPOSED AMENDED TEXT

NASD Manual, ¶ 2152, p. 2051

Item 6 on ballot

Recommendations to Customers

Sec. 2.

In recommending to a customer the purchase, sale, or exchange of any security, a member or person associated with a member shall have reasonable grounds for believing that the recommendation is suitable for [such] the customer upon the basis of the facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs.

EXPLANATION

Section 2 contains a minor language change and the addition of a specific reference to "associated persons."

CURRENT TEXT

NASD Manual, ¶ 2153, p. 2054

No Vote Required

Charges for Services Performed

Sec. 3.

Charges, if any, for services performed, including miscellaneous services such as collection of monies due for principal, dividends, or interest; exchange or transfer of securities; appraisals, safekeeping, or custody of securities, and other services, shall be reasonable and not unfairly discriminatory between customers.

EXPLANATION

No change is being proposed to this section.

CURRENT TEXT

NASD Manual, ¶ 2154, pp. 2054-2058

[Fair Prices and Commissions]

[Sec. 4.]

[In "over-the-counter" transactions, whether in "listed" or "unlisted" securities, if a member buys for his own account from his customer, or sells for his own account to his customer, he shall buy or sell at a price which is fair, taking into consideration all relevant circumstances, including market conditions with respect to such security at the time of the transaction, the expense involved, and the fact that he is entitled to a profit; and if he acts as agent for his customer in any such transaction, he shall not charge his customer more than a fair commission or service charge, taking into consideration all relevant circumstances including market conditions with respect to such security at the time of the transaction, the expense of executing the order and the value of any service he may have rendered by reason of his experience in and knowledge of such security and the market therefore.]

[... Interpretation of the Board of Governors]

[NASD Mark-up policy]

[The question of fair mark-ups or spreads is one which has been raised from the earliest days of the Association. No definitive answer can be given and no interpretation can be all-inclusive for the obvious reason that what might be considered fair in one transaction could be unfair in another transaction because of different circumstances.]

[However, it was recognized that the amount of mark-up was at least a starting point from which an answer to the question could be sought and that progress might be made if the general practice of the business on mark-ups could be established. To find this out, the Association, in 1943, made a membership-wide questionnaire examination of mark-ups in retail or customer transactions. Questionnaires were filed by 82 percent of the membership covering transactions which varied widely with respect to price, dollar amount, type of security, and degree of market activity. They included both listed and unlisted securities, with the latter, however, in the substantial majority. This information revealed that 47 percent of the transactions computed were made at markups of 3 percent or less and 71 percent of the transactions were effected at mark-ups of 5 percent or less.]

[In a letter to the membership on October 25, 1943, the Board of Governors made known the results of its survey and expressed its philosophy on what constitutes a fair spread or profit. The Board stated that it would be impractical and unwise, if not impossible, to define specifically what constitutes a fair spread on each and every transaction because the fairness of a mark-up can be determined only after considering all of the relevant factors. Under certain conditions a mark-up in excess of 5 percent may be justified, but on the other hand, 5 percent or even a lower rate is by no means always justified. The Board instructed District Business Conduct Committees to enforce Section 1 of Article III of the Rules of Fair Practice with respect to mark-ups, keeping in mind that 71 percent of the transactions computed from the questionnaires were effected at a mark-up of 5 percent or less. The philosophy which the Board expressed has since been referred to as the "5% Policy."]

[The Policy has been reviewed by the Board of Governors on numerous occasions and each time the Board has reaffirmed the philosophy expressed in the letter to members of October 25, 1943. The Board is aware, however, of the need for continually re-examining the mark-up policy and its application in the light of current economic conditions and with the benefit of experience gained from enforcement of the existing Policy. The Board has carefully considered the Policy adopted in 1943 and subsequent interpretations with respect thereto. It can find no justification for a change in the basic Policy. However, it recognizes that any clarification will materially aid members in complying with the Policy and the various committees in fulfilling their responsibility to exercise judgment in determining the fairness of mark-ups.]

[Based upon its review of the entire matter, the Board has adopted the Interpretation set forth below.]

[The Interpretation]

[Article III, Section 1 of the Rules of Fair Practice states that:]

["A member, in the conduct of his business, shall observe high standards of commercial honor and just and equitable principles of trade."]

[Article III, Section 4 of the Rules of Fair Practice states that:]

[ A member, in the conduct of his business, shall observe high standards of commercial honor and just and equitable principles of trade.]

[Article III, Section 4 of the Rules of Fair Practice states that:]

[In 'over-the-counter' transactions, whether in 'listed' or 'unlisted' securities, if a member buys for his own account from his customer, or sells for his own account to his customer, he shall buy or sell at a price which is fair, taking into consideration all relevant circumstances, including market conditions with respect to such security at the time of the transaction, the expense involved, and the fact that he is entitled to a profit; and if he acts as agent for his customer in any such transaction, he shall not charge his customer more than a fair commission or service charge, taking into consideration all relevant circumstances including market conditions with respect to such security at the time of the transaction, the expense of executing the order and the value of any service he may have rendered by reason of his experience in and knowledge of such security and the market therefore.]

[In accordance with Article VII, Section 3(a) of the By-Laws, the following interpretation under Article III, Sections 1 and 4 of the Rules of Fair Practice has been adopted by the Board:]

[It shall be deemed conduct inconsistent with just and equitable principles of trade for a member to enter into any transaction with a customer in any security at any price not reasonably related to the current market price of the security or to charge a commission which is not reasonable.]

PROPOSED NEW SECTION 4 TO THE NASD RULES OF FAIR PRACTICE

Item 7 on ballot

Fair Prices and Commissions

Sec. 4.

Principal Transactions with Retail Customers

Prevailing Market Price

NASDAQ and Exchange Securities

Non-NASDAQ and Non-Exchange Securities

Contemporaneous Transactions — Independent Competitive Market

Contemporaneous Transactions — No Independent Competitive Market

Quotations of Other Brokers and Dealers

Transactions by Other Brokers and Dealers

"Riskless Principal" Transactions

Definition

Agency Transactions with Retail Customers

Amount of Mark-ups or Mark-downs and Commissions

Mark-ups in Proceeds Transactions

Exemptions

EXPLANATION

New Section [4] will replace current Article III, Section 4 of the Rules of Fair Practice, which establishes general standards of fairness required of members in transactions with customers. The major significance of the new section is that it will also codify and replace the NASD Mark-Up Policy adopted by the Board of Governors as an Interpretation of Article III, Section 4 and the broad ethical standards of conduct required under Article III, Section 1 of the Rules of Fair Practice. The Policy was adopted in 1943 and has been in place since then without any major revisions.

Proposed Subsections (a), (b), and (c) of new Section [4] deal with principal transactions with retail customers. Subsection (a) carries forward the existing language of Article HI, Section 4 that states that prices in principal transactions must be fair. Subsection (b) incorporates the language of the Mark-Up Policy that states that a "fair price" is one that is reasonably related to the prevailing market price of the security. Subsection (c), which provides general guidelines as to the term "prevailing market price," is entirely new and has no counterpart in the current Mark-Up Policy.

A substantive change has been made in new Section [4] as originally proposed for comment that relates to the definition of "current market price" to be used in computing the level of markups and mark-downs. The basic concept underlying the definition in Subsection (c) is similar to the originally proposed language circulated for comment and is intended to establish somewhat flexible standards that, in appropriate cases, will allow a member to demonstrate that the current market price should be based on a review of other factors not expressly mentioned.

The guidelines contained in Subsection (c) being submitted for vote would use both inter-dealer quotations and actual inter-dealer trades. The determination of which method would be used depends on the nature of the market in which the security is traded. Under Subsection (c)(l), the current market price of securities for which quotations are disseminated in NASDAQ or by a national securities exchange will normally be considered the best asked quotation appearing in the primary inter-dealer quotation system in the case of a principal sale to a customer. If the member purchases a security from a customer for which quotations are disseminated by NASDAQ or a national securities exchange, the current market price will normally be the best bid quotation appearing in the primary inter-dealer system. It is believed that for such securities NASDAQ or exchange quotations should be the norm, as such securities are subject to firm quotation rules and must meet minimum qualification requirements for inclusion in NASDAQ or trading on a national securities exchange.

If a security is a non-NASDAQ and non-exchange-traded security, the market price is determined by a descending priority scale which starts at a member's transaction prices with other brokers and dealers. These securities, which comprise all non-NASDAQ and non-exchange-traded securities, should not be measured against quotations in the first instance as they are generally less actively traded securities and are not subject to firm-quotation rules. Under Subsection (c)(2)(A), the norm for determining "current market price" for these securities if there is an independent market away from the member is considered to be the member's contemporaneous sale prices to other broker-dealers, in the case of a principal sale to a customer, and its contemporaneous purchase prices from other broker-dealers, in the case of a purchase from a customer. The term "contemporaneous transaction" is defined by Subsection (c)(2)(F) to be an inter-dealer transaction by the member the day of or the day before or a reasonable time before the retail principal transaction depending on the context of the market for the security. Under Subsection (c)(2)(C), the current market price for non-NASDAQ and non-exchange-traded securities in which the member has had no inter-dealer transactions is considered to be the available quotations appearing in the inter-dealer quotation system, but only if such quotations are accurate reflections of the true market for the security. If reliable quotations are not available, the norm for determining "current market price" under Subsection (c)(2)(E) is the actual transaction prices of other brokers and dealers. Notwithstanding these standards under Subsection (c)(2)(F), any "riskless principal transaction" in any non-NASDAQ or non-exchange-traded security shall be the cost of purchasing the security to fill a customer buy order or, in the case of a customer sell order, the proceeds from the sale to satisfy a customer sell order.

The method to be used in computing "current market price" under proposed Subsection (d) of Section [4] is substantially different from that originally proposed for comment. Under the original proposal, the cost of purchasing or proceeds from the sale of the security would have been the norm, regardless of the market in which the security was traded. Several commenters strongly objected to the original proposal because it failed to recognize bona fide quotations as a proper basis for determining "current market price," despite the existence of active trading markets in many NASDAQ and exchange-traded securities. In light of these and similar objections, the Board of Governors decided to distinguish active inter-dealer markets from less active markets and to introduce an element of certainty into members' pricing decisions. The structure currently proposed in Subsection (c) is based on whether the security is a NASDAQ security or exchange-traded security in which firm quotations are mandated or is a security where quotations appear, but is not subject to firm-quotation requirements.

A member's responsibility when executing agency transactions for customers is covered by Subsection (d), which contains substantially the same language that appears in the second half of existing Article III, Section 4 of the Rules of Fair Practice.

The language under the heading "Relevant Factors" in the Mark-Up Policy is incorporated into Subsection (e), which sets forth the factors that should be considered in determining whether the amount of a mark-up for a given transaction is fair and reasonable. It also applies to the fairness of the amount of commission in an agency transaction as does the existing Mark-Up Policy, although some of the factors appear primarily directed at principal transactions.

Subsections (e)(l)(i) and (ii) are intended to clarify that the percentage of mark-up, or commission, while a major consideration, is only one of a number of factors that should be taken into account. It also incorporates the basic concept of a "Five Percent Policy" currently appearing under the "General Considerations" section of the Mark-Up Policy. Subsections (e)(2) through (7) are simply a rewording of the existing language in rule format. Subsection (e)(8) has been added to reflect the fact that, in a principal transaction, a risk position may entitle a member to a higher mark-up than would be allowed in a "riskless" transaction.

The language of the Mark-Up Policy under the heading "Transactions to Which the Policy is Applicable" would be eliminated as unnecessary, with one exception. The exception is the unique handling of proceeds transactions, and the existing language would be carried forward and clarified. Subsection (g) carries forward the existing language, but clarifies that the amended rule does not apply to municipal securities, which are covered by Municipal Securities Rulemaking Board rules, or to securities being publicly offered where the fairness of compensation is governed by the Corporate Financing Interpretation (and the corresponding pending rule) or by Article III, Sections 26 and 29, in the case of mutual funds and variable annuities.

CURRENT TEXT

NASD Manual, ¶ 2155, p. 2071

No Vote Required

Publication of Transactions and Quotations

Sec. 5.

No member shall publish or circulate, or cause to be published or circulated, any notice, circular, advertisement, newspaper article, investment service, or communication of any kind which purports to report any transaction as a purchase or sale of any security unless such member believes that such transaction was a bona fide purchase or sale of such security; or which purports to quote the bid price or asked price for any security, unless such member believes that such quotation represents a bona fide bid for, or offer of, such security. If nominal quotations are used or given, they shall be clearly stated or indicated to be only nominal quotations.

EXPLANATION

No change is being proposed to this section.

CURRENT TEXT

NASD Manual, ¶ 2156, p. 2075

No Vote Required

Offers at Stated Prices

Sec. 6.

No member shall make an offer to buy from or sell to any person any security at a stated price unless such member is prepared to purchase or sell, as the case may be, at such price and under such conditions as are stated at the time of such offer to buy or sell.

EXPLANATION

No change is being proposed to this section.

CURRENT TEXT

NASD Manual, ¶ 2157, p. 2075

No Vote Required

Disclosure of Price in Selling Agreements

Concessions

Sec. 7.

Selling syndicate agreements or selling group agreements shall set forth the price at which the securities are to be sold to the public or the formula by which such price can be ascertained, and shall state clearly to whom and under what circumstances concessions, if any, may be allowed.

EXPLANATION

No change is being proposed to this section.

CURRENT TEXT

NASD Manual, ¶ 2158, p. 2075—2075-3

No Vote Required

Securities Taken in Trade

Sec. 8.

EXPLANATION

Section 8 was revised a few years ago as part of the "Papilsky" rule revisions. The Board of Governors proposes that no change be made in the current language.

CURRENT TEXT

NASD Manual, ¶ 2159, p. 2075-6

No Vote Required

Use of Information Obtained in Fiduciary Capacity

Sec. 9.

A member who, in the capacity of paying agent, transfer agent, trustee, or in any other similar capacity, has received information as to the ownership of securities, shall under no circumstances make use of such information for the purpose of soliciting purchases, sales, or exchanges, except at the request and on behalf of the issuer.

EXPLANATION

No change is being proposed to this section.

PROPOSED AMENDED TEXT

NASD Manual, ¶ 2160, p. 2075-6,2075-7

Item 8 on ballot

Influencing or Rewarding Employees of Others

Sec. 10.

EXPLANATION

The only amendment to Section 10 is an increase in the maximum allowable gift amount from $50 to $100 per individual per year.

CURRENT TEXT

NASD Manual, ¶ 2161, p. 2075-7

No Vote Required

Payment Designed to Influence Market Prices,

Other Than Paid Advertising

Sec. 11.

No member shall, directly or indirectly, give, permit to be given, or offer to give, anything of value to any person for the purpose of influencing or rewarding the action of such person in connection with the publication or circulation in any newspaper, investment service, or similar publication, of any matter which has, or is intended to have, an effect upon the market price of any security, provided that this rule shall not be construed to apply to matter which is clearly distinguishable as paid advertising.

EXPLANATION

No change is being proposed to this section.

CURRENT TEXT

NASD Manual, ¶ 2162, p. 2076

Item 9 on ballot

[Disclosure on Confirmations]

[Sec. 12.]

[A member at or before the completion of each transaction with a customer shall give or send to such customer written notification disclosing: (1) whether such member is acting as a broker for such customer, as a dealer for his own account, as a broker for some other person, or as a broker for both such customer and some other person; and (2) in any case in which such member is acting as a broker for such customer or for both such customer and some other person, either the name of the person from whom the security was purchased or to whom it was sold for such customer and the date and time when such transaction took place or the fact that such information will be furnished upon the request of such customer, and the source and amount of any commission or other remuneration received or to be received by such member in connection with the transaction.]

EXPLANATION

The Board of Governors recommends that Section 12 be deleted because the confirmation requirements of SEC Rule 10b-10 more than adequately cover the provisions of this section.

CURRENT TEXT

NASD Manual, ¶ 2163, p. 2078

Item 10 on ballot

[Disclosure of Control]

[Sec. 13.]

[A member controlled by, controlling, or under common control with the issuer of any security, shall, before entering into any contract with or for a customer for the purchase or sale of such security, disclose to such customer the existence of such control, and if such disclosure is not made in writing, it shall be supplemented by the giving or sending of written disclosure at or before the completion of the transaction.]

EXPLANATION

When originally circulated for comment, Section 13 was to remain unchanged. However, after further consideration, the Board of Governors recommends that it be deleted since it duplicates SEC Rule 15c 1-5.

CURRENT TEXT

NASD Manual, ¶ 2164, p. 2078

Item 11 on ballot

[Disclosure of Participation or Interest in Primary or Secondary Distribution]

[Sec. 14.]

[A member who is acting as a broker for a customer or for both such customer and some other person, or a member who is acting as a dealer and who receives or has promise of receiving a fee from a customer for advising such customer with respect to securities, shall, at or before the completion of any transaction for or with such customer in any security in the primary or secondary distribution of which such member is participating or is otherwise financially interested, give such customer written notification of the existence of such participation or interest.]

EXPLANATION

When originally proposed, Section 14 would have remained unchanged. After further consideration, the Board of Governors recommends that the section be deleted since it duplicates SEC Rule 15cl-6.

PROPOSED AMENDED TEXT

NASD Manual, ¶2165, p. 2078

Item 12 on ballot

Discretionary Accounts

Sec. 15.

Excessive transactions

Authorization and acceptance of account

Approval and review of transactions

Exception

EXPLANATION

As originally proposed, the existing requirement that limits the grant of discretion to a particular individual was left unchanged and members were asked to comment on whether a member firm should be allowed to exercise discretion. After reviewing the comments, the Board of Governors determined that it appears appropriate to allow members to exercise discretion. However, in an effort to ensure that discretion will be properly delegated, the amendment would require that member discretion be exercised only by an authorized person or persons within the member's organization.

CURRENT TEXT

NASD Manual, ¶ 2166, p. 2079

Item 13 on ballot

[Offerings "At the Market"]

[Sec. 16.]

[A member who is participating or who is otherwise financially interested in the primary or secondary distribution of any security which is not admitted to trading on a national securities exchange, shall make no representation that such security is being offered to a customer "at the market" or at a price related to the market price unless such member knows or has reasonable grounds to believe that a market for such security exists other than that made, created, or controlled by such member, or by any person for whom he is acting or with whom he is associated in such distribution, or by any person controlled by, controlling, or under common control with such member.]

EXPLANATION

Although no change was proposed in Section 16 when originally circulated for comment, the Board of Governors considered comments from the SEC and others and recommends that the section be deleted since it duplicates SEC Rule 15cl-8.

CURRENT TEXT

NASD Manual, ¶ 2167, p. 2079

Item 14 on ballot

[Solicitation of Purchases on an Exchange to Facilitate a Distribution of Securities]

[Sec. 17.]

EXPLANATION

The Board of Governors recommends that Section 17 be deleted since it duplicates SEC Rule 10b-2.

CURRENT TEXT

NASD Manual, ¶ 2168, p. 2079

No Vote Required

Use of Fraudulent Devices

Sec. 18.

No member shall effect any transaction in, or induce the purchase or sale of, any security by means of any manipulative, deceptive, or other fraudulent device or contrivance.

EXPLANATION

No change is being proposed to this section.

PROPOSED AMENDED TEXT

NASD Manual, ¶ 2169, p. 2083-2091

Item 15 on ballot

Customers' Securities or Funds

Sec. 19.

Improper use

General Provisions

Authorization to lend

Segregation and identification of securities

Prohibition against guarantees

Sharing in accounts; extent permissible

EXPLANATION

Several commenters suggested deleting this section since it partially duplicates certain provisions in SEC Rule 15c3-3. Therefore, the language in Subsection (b) that duplicates the SEC's rule is proposed to be deleted.

CURRENT TEXT

NASD Manual, ¶ 2170, p. 2095

Item 16 on ballot

[Installment or Partial Payment Sales]

[Sec. 20.]

[Prohibition]

[Member acts as agent]

[Member acts as principal]

[Regulation T satisfied]

[Hypothecation]

EXPLANATION

The provisions of Section 20 are inconsistent with Federal Reserve Board Regulation T, notwithstanding the attempted saving language in Subsection (a)(3), and are redundant with SEC Rule 15c3-3. It therefore appears appropriate to delete this section.

PROPOSED AMENDED TEXT

NASD Manual, ¶ 2171, p. 2095-2

Item 17 on ballot

Books and Records

Sec. 21.

Requirements

Marking of customer order tickets

Information on accounts

Record of written complaints

"Complaint" defined

EXPLANATION

The Board believes the signature of the person with discretion under Subsection (c) is unnecessary on new account forms.

CURRENT TEXT

NASD Manual, ¶ 2172, p. 2097

Item 18 on ballot

[Disclosure of Financial Condition]

[Sec. 22.]

EXPLANATION

Section 22 duplicates the provisions of SEC Rule 17a-5 that require brokers and dealers to send certain periodic financial reports to their customers. Therefore, this duplicative provision is proposed to be deleted.

CURRENT TEXT

NASD Manual, ¶ 2173, p. 2097

Item 19 on ballot

[Net Prices to Persons Not in Investment Banking or Securities Business]

[Sec. 23.]

[No member shall offer any security or confirm any purchase or sale of any security, from or to any person not actually engaged in the investment banking or securities business at any price which shows a concession, discount, or other allowance, but shall offer such security and confirm such purchase or sale at a net dollar or basis price.]

EXPLANATION

This provision is proposed to be deleted since the requirements of Section 23 are adequately covered by SEC Rule 10b-10.

CURRENT TEXT

NASD Manual, ¶ 2174, pp. 2097-2098

No Vote Required Selling Concessions

Sec. 24.

In connection with the sale of securities which are part of a fixed price offering:

EXPLANATION

The Board of Governors recommends that Section 24, adopted as part of the "Papilsky" rules, remain unchanged. On January 27, 1989, the SEC approved an amendment to the Interpretation of the Board of Governors — "Bona Fide Research Exclusion" — published in Notice to Members 88-72 (October 1988), which amends the exclusion from bona fide research in Section 24(b) by reference to the standard established by the SEC in Securities Exchange Act Release No. 23170 (April 30, 1986).

CURRENT TEXT

NASD Manual, ¶ 2175, p. 2101

Item 20 on ballot

[Dealing with Non-Members]

[Sec. 25.]

[Transactions with foreign non-members]

["Non-member broker or dealer"]

PROPOSED NEW TEXT

Dealing with Non-Members

Sec. 25.

Prohibition

Transactions with foreign non-members

"Non-member broker or dealer"

Payments to members of other registered securities associations and to bank municipal securities dealers

Receipt of payments from non-member brokers or dealers or from bank municipal securities dealers

EXPLANATION

The proposed changes are primarily designed to conform Section 25 to statutory amendments and SEC interpretations.

Section 15A(e) of the Securities Exchange Act of 1934 (Exchange Act) expressly authorizes the NASD to adopt a rule such as Section 25 that requires members to treat brokers and dealers that are non-members on terms and conditions no more favorable than are accorded the general public. Section 25 has existed since the NASD's inception, and the statutory language is almost identical to Subsection (a) of Section 25. The only change in the statutory language was made by the Securities Acts Amendments of 1975, which expressly authorized the NASD to apply the Section 25 restrictions to members' dealings with non-member brokers and dealers other than banks in the area of municipal securities. The remaining sections of the NASD's Rules of Fair Practice do not address members' municipal securities transactions since rulemaking authority in this area was granted to the Municipal Securities Rulemaking Board (MSRB), with the NASD having responsibility for enforcing MSRB rules.

The language added to Subsection (b)(l) of Section 25 is intended to clarify that the restrictions also apply to municipal securities. It is intended to make clear that, although a member may grant a municipal securities concession to a bank, it is prohibited from paying the same concession to non-member brokers and dealers.

The proposed changes to Subsection (b)(2) have two purposes. In Aetna proceeding, the SEC issued an order partially abrogating Section 25 and, in particular, Subsection (b)(2). (See 44 S.E.C. 896 (1972).) The SEC found that the statutory provision authorizing Section 25 did not allow the NASD to construe it to prevent member dealers in a public offering from receiving selling concessions from a non-member underwriter. The SEC also held that the NASD could not apply Section 25 to prevent a member and non-member broker or dealer from participating in a "parallel distribution" if the issuer makes separate commission payments to a member and a non-member. (Plaza Securities, 45 S.E.C. 449 (1974).) The added language at the end of the subsection is intended to codify this construction. The other language changes are intended to eliminate any misunderstanding that Section 25 does not apply to private placements.

The changes in Subsection (c) are designed to conform the provision to the current statutory requirements with respect to eligibility for membership and to eliminate an anomaly created by a construction of the NASD By-Laws that has not been followed for many years. The 1975 Securities Acts Amendments amended Section 15A(b)(3) of the Exchange Act to provide that, unless there is a bar or other statutory disqualification or failure to satisfy examination or other qualification requirements, the NASD must admit to membership any broker or dealer that is registered with the SEC. The statutory language thus eliminates an older provision authorizing the NASD to restrict membership on a geographic basis.

The new language of Subsection (c) simply codifies the statutory provisions. It also clarifies that if a registered foreign broker or dealer is ineligible for reasons apart from registration (for example, a failure to pass qualification examinations), the broker-dealer shall be treated the same way as a non-member United States broker-dealer must be treated.

As originally proposed, Section 25 would have deleted existing language requiring that, in making sales to a foreign broker-dealer that is a non-member, a member must obtain an agreement that such foreign non-member broker-dealer, in making resales to purchasers in the United States, will agree to comply with Subsections (a) and (b) as if it were a member. The Board of Governors decided to retain this requirement in Section 25 to prevent evasion if a member should allow a concession to a foreign broker or dealer that, in turn, could re-allow such concession to a non-member registered broker or dealer.

The added language at the beginning of Subsection (d) that defines the term "non-member broker or dealer" is intended to clarify that it has been construed to cover unregistered firms which are "... required to be registered ..." and are, therefore, conducting an unlawful broker-dealer business. In December 1983, amendments to the Exchange Act became effective that rescinded the SECO program regulating registered non-member brokers and dealers. Thereafter, all registered brokers and dealers were required to become NASD members, except certain exchange members with gross annual income from over-the-counter transactions of under $1,000. Therefore, it appears that the primary effect of the first sentence of Subsection (d) should be with respect to dealings with unregistered brokers and dealers. The existence of brokers and dealers that should be registered does not appear to be an isolated problem. The NASD staff is aware of situations — such as investment advisers receiving transaction-related compensation, purchaser representatives whose fees appear to be based on the amount purchased by an investor rather than being related to the evaluative effort, finders who receive fees from issuers for referring investors, and real estate and other syndicators who continuously engage in sales of limited partnerships — sometimes acquiring a sales force for this sole purpose.

A new sentence has been added to expressly state that a revoked or suspended member is a non-member broker or dealer during the period of the revocation or suspension penalty. This position is currently stated in the Board of Governors' Interpretation following Section 25.

The added language at the end of Subsection (e) and a part of the language added at the beginning of Subsection (d) is intended to conform to Section 15A(e)(3)(B) of the Exchange Act, added by the 1975 Securities Acts Amendments, prohibiting the NASD from applying Section 25 to prevent members from granting discounts, allowances, or special terms to municipal securities dealers that are banks, or divisions or departments of banks, in connection with transactions in municipal securities.

Subsection (f) is entirely new and codifies the SEC's partial abolition of Section 25 in the Aetna proceeding. The new language also codifies Section 15A(e)(3)(B) of the Exchange Act, which prohibits the NASD from applying Section 25 to prevent members from receiving discounts, allowances, or special terms from municipal securities dealers, which are banks, or divisions or departments of banks, in connection with transactions in municipal securities.

PROPOSED AMENDED TEXT

NASD Manual, ¶ 2176, pp. 2105-3 —2106

Item 21 on ballot

Investment Companies

Sec. 26.

Application

Definitions

Conditions for discounts to dealers

Sales charge

Selling dividends

Withhold orders

Purchase For Existing Orders

Refund of sales charge

Purchases as principal

Repurchase from dealer

Execution of investment company portfolio transactions

Dealer concessions

Prompt Payment for Investment Company Shares

EXPLANATION

No comments were received on Section 26 as originally proposed. The Board of Governors recommends that the section be approved without change, except to raise the minimum permissible gift amounts from $50 to $100 in Subsection (1).

Subsequent to the time the proposed amendments herein were circulated for comment, a new Subsection (m) was approved by the SEC with respect to prompt payment for investment company shares.

CURRENT TEXT

NASD Manual, ¶ 2177, pp. 2107-2108

No Vote Required

Supervision

Sec. 27.

Supervisory System

Written procedures

Internal inspections

Written approval

Qualifications investigated

Definitions

EXPLANATION

No change is being proposed to this section.

PROPOSED AMENDED TEXT

NASD Manual, ¶ 2178, pp. 2110-2111

Item 22 on ballot

Transactions For Personnel of Another Member

Sec. 28.

[Determine adverse interest]

Obligations of executing member

Obligations of associated persons concerning an account with a member

Obligations of associated persons concerning an account with an investment adviser, bank, or other financial institution

Exemption for transactions in investment company shares and unit investment trusts

EXPLANATION

Subsequent to the time the proposed amendments were circulated for comment, Section 28 was amended to include certain changes that already are effective and reflected in the language of the section published in the NASD Manual and reproduced above. The proposed amendments would further change Section 28 to eliminate Subsection (a). The Board of Governors believes that the current requirement that an executing member affirmatively determine whether a particular transaction may adversely affect the interests of the employer member is unnecessary. The employer member's interests appear adequately protected by the requirements of existing Subsection (b) that state the employer member be notified by the executing member. The Board believes that the protection given the employer member should be strengthened by amending existing Subsection (b)(2) to require that copies of all confirmations be sent to the employer member, regardless of whether they are requested by the employer member.

¹Securities Exchange Act of 1934, Release Nos. 21843 (March 12,1985) and 21838 (March 12, 1985); and NASD Notice to Members 85-27 (April 15, 1985).

² Sections 1 through 25 of Article III of the NASD Rules of Fair Practice were part of the NASD's original registration statement approved when the SEC granted the NASD's application for registration as a national securities association. In the Matter of National Association of Securities Dealers. Inc.. 5 S.E.C. 627 (1939). Sections 26-28 were adopted shortly after such date..

³The proposed amendments do not cover Sections 29 et seq. of Article III of the Rules of Fair Practice. These provisions are comparatively new sections and, therefore, are more current in their scope and purpose. The proposed amendments also do not cover Articles I, II, IV, V, and VI of the Rules of Fair Practice, which cover matters other than basic ethical standards of conduct, e.g., definitions and procedural matters.

⁴The Board Interpretations relating to Section 1 and covered by this notice now appear at ¶ 2151.03-2151.06 (pp. 2037-2047-3), NASD Manual (CCH). The Board Interpretation relating to Section 4 now appears at ¶(2154 (pp. 2054-2058), NASD Manual (CCH).

⁵The one Board Interpretation under Section 1 not covered by the amendments is entitled "Review of Corporate Financing." This interpretation already has been codified into a new section of the Rules of Fair Practice and appoved by a separate membership vote. A filing has been made and is pending approval before the SEC. NASD Notice to Members 83-24 (May 19,1983); SR-NASD-83-27 (December 27, 1983).

⁶ Current Section 25 now appears at ¶2175 (p. 2101) NASD Manual (CCH).

⁷These Interpretations and similar material were included in the original amendments circulated for comment in NASD Notice to Members 86-9 (February 7, 1986). Some commenters expressed concern over the statement that the Committee and Board of Governors were considering deleting some of these materials or placing them in an "omnibus notice" to be sent separately to all members.

The commenters believed that these provisions establish important guidelines and standards that members should have readily available. In light of these comments, the Board of Governors and the Committee are continuing to study various ways of dealing with these materials, including a possible new manual of interpretations to be furnished to members, which could contain interpretations issued by both the NASD and the SEC.