Notice To Members 90-12

Proposed Amendments to Article III, Sections 2 and 21 (c) of the Rules of Fair Practice Re: Customer Account Information; Last Voting Date: April 5, 1990

Published Date:
Last Voting Date: April 5, 1990

SUGGESTED ROUTING*

Senior Management
Institutional
Legal & Compliance
Mutual Fund
Operations
Options
Registration
Trading
Training

*These are suggested departments only. Others may be appropriate for your firm.

MAIL VOTE

EXECUTIVE SUMMARY

The NASD requests members to vote on proposed amendments to Article III, Sections 2 and 21 (c) of the Rules of Fair Practice ("Rules") that would operate prospectively to require NASD members to make reasonable efforts to obtain certain information pertaining to customer accounts. In the case of noninstitutional accounts, the proposed amendment to Section 21 (c) would require NASD members to make reasonable efforts to obtain the necessary additional information prior to the settlement of the initial transaction in the account, including discretionary and corporate accounts. Existing requirements regarding institutional accounts are retained, and the new rule requires that the names of any persons authorized to transact business on behalf of the entities should be obtained, if the customer is a corporation, partnership, or other legal entity.

The proposed amendment to Section 2 requires NASD members to make reasonable efforts to obtain certain additional information prior to the execution of a transaction recommended to a noninstitutional customer. Both proposed amendments exclude transactions and accounts when the investments are limited to money market mutual funds. The text of each proposed amendment follows this notice.

BACKGROUND AND SUMMARY OF AMENDMENTS

Pursuant to Article III, Section 21(c) of the Rules, the accounts of all customers are required to be maintained in such form and manner as to show name; address; age; signatures of the introducing representative and member, partner, officer, or manager accepting the account for the member; and a customer's association with or employment by another member. In discretionary accounts, the customer's occupation must be noted, along with the signature of each person authorized to exercise discretion in such account. When recommending to a customer the purchase, sale, or exchange of any security, Article III, Section 2 currently requires that a member have reasonable grounds for believing that the recommendation is suitable for the customer on the basis of any facts disclosed by the customer as to his other security holdings, financial situation, and needs.

The NASD Board of Governors believes that these procedures should be strengthened to require additional information on each account and that sufficient information be obtained to permit the member firm to make more informed determinations about accounts and investment recommendations.

The Board therefore proposes to amend Section 21(c) to require a member to make reasonable efforts to obtain, prior to the settlement of the initial transaction in a noninstitutional customer account, the tax identification or Social Security number of the customer and the occupation and name and address of the employer of each customer for each account, in addition to the above-listed information currently required to be obtained. In addition, if the customer is a corporation, partnership, or other legal entity, the member also must obtain the names of any persons authorized to transact business on behalf of such entity. With respect to discretionary accounts, the member would be required to obtain the signature of each person authorized to exercise discretion in the account and the date such discretion is granted.

Moreover, Section 2 is proposed to be amended to provide that, prior to the execution of a transaction recommended to a noninstitutional customer, a member must make reasonable efforts to obtain information concerning that customer's financial status, tax status, investment objectives, and such other information used or considered to be reasonable and necessary by the member or registered representative in making recommendations to the customer.

The proposed amendments exclude transactions and accounts in which investments are limited to money market mutual funds.

The Board believes that the proposed amendments to Article III, Sections 2 and 21(c) of the Rules will provide extra protection for both customers and firms. The requirement of "reasonable effort," can be met by prepared questionnaires for customers to complete and return or by telephone inquiry. It is not necessary to obtain a written statement from a customer in each instance in order to be in compliance with the rule.

The requirement of Section 21(c) that information be obtained prior to the settlement of the initial transaction and of Section 2 that information be obtained prior to the execution of a transaction recommended to a noninstitutional customer will also allow some freedom in opening new accounts. In addition, it may be advisable for members to keep a record of efforts that they have made to obtain a customer's tax identification or Social Security number, as required by Section 103.35, Part 103 of Title 31 of the Code of Federal Regulations adopted by the Treasury Department, effective June 1972.

COMMENTS RECEIVED

The proposed amendment to Article III, Section 21(c) of the NASD Rules of Fair Practice was published for comment in NASD Notice to Members 88-91 (November 1988).* The NASD received 10 comments on the proposed amendment.

One of the commenters unqualifiedly supported the proposal. The remaining nine commenters generally supported the proposal with suggested modifications: five would prefer to delete employment information requirements; two suggested the deletion of tax-status information; two questioned the need for time and date of approval information on discretionary orders; two stated that discount broker-dealers should be exempt from the proposed requirements; and two questioned the application of the proposal to investment company securities accounts.

The Board considered these comments and determined that the proposed requirements for additional account information would benefit the public, were not onerous and, thus, no exemption should be granted to either investment company securities accounts or discount brokers. An exemption was provided, however, for transactions and accounts in which investments are limited to money market mutual funds. For similar reasons, the Board decided that the employment and tax status information requirements were important issues that would not impose an undue burden on members.

However, the Board did delete the requirement of time and date approval for each discretionary order, substituting instead a requirement that a record be kept of the date on which discretion was granted for each account. The Board also extended the definition of the term "institutional account" to include registered investment advisers and entities with total assets of at least $50 million. In addition, the Board clarified the proposal to state that the names of persons authorized to act on behalf of partnerships and other legal entities, in addition to corporations, should be obtained, and that this requirement should apply to both institutional and noninstitutional accounts.

The Board of Governors thus believes that the proposed amendments to Article III, Sections 2 and 21(c) of the NASD Rules are necessary and appropriate and recommends that members vote their approval. Prior to becoming effective, the proposed amendments also must be approved by the Securities and Exchange Commission.

Please mark the enclosed 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 April 5, 1990.

Questions concerning this notice can be directed to Deborah F. McIlroy, Senior Attorney, NASD Office of General Counsel, at (202) 728-8816.

PROPOSED AMENDMENT TO ARTICLE III, SECTION 2 OF THE NASD RULES OF FAIR PRACTICE

(Note: New language is underlined; deleted language is in brackets).

Recommendation to Customers

Sec. 2. (a) In recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such 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.
(b) Prior to the execution of a transaction recommended to a non-institutional customer, other than transactions with customers where investments are limited to money market mutual funds, a member shall make reasonable efforts to obtain information concerning:
(i) the customer's financial status;
(ii) the customer's tax status;
(iii) the customer's investment objectives; and
(iv) such other information used or con-sidered to be reasonable and necessary by such member or registered representative in making recommendations to the customer.

PROPOSED AMENDMENT TO ARTICLE III, SECTION 21(c) OF THE NASD RULES OF FAIR PRACTICE

(Note: New language is underlined; deleted language is in brackets).

Books and Records

Sec. 21.

* * * *

[Information on accounts

(c) Each member shall maintain accounts of customers in such form and manner as to show the following information: name, address, and whether the customer is legally of age; the signature of the registered representative introducing the account and the signature of the member or the partner, officer, or manager accepting the account for the member. If the customer is associated with or employed by another member, this fact must be noted. In discretionary accounts, the member shall also record the age or approximate age and occupation of the customer as well as the signature of each person authorized to exercise discretion in such account.]

Customer Account Information

(c) Each member shall maintain accounts opened after (effective date of amendment) as follows:
(1) for each account, each member shall maintain the following information:
(i) customer's name and residence;
(ii) whether customer is of legal age;
(iii) signature of the registered representative introducing the account and signature of the member or partner, officer, or manager who accepts the account; and
(iv) if the customer is a corporation, partnership, or other legal entity, the names of any persons authorized to transact business on behalf of the entity;
(2) for each account other than an institutional account, and accounts in which investments are limited to transactions in money market funds, each member shall also make reasonable efforts to obtain, prior to the settlement of the initial transaction in the account, the following information to the extent it is applicable to the account:
(i) customer's tax identification or Social Security number;
(ii) occupation of customer and name and address of employer; and
(iii) whether customer is an associated person of another member; and
(3) for discretionary accounts, in addition to compliance with subsections (1) and (2) above, and Article III, Section 15(b) of these rules, the member shall;
(i) obtain the signature of each person authorized to exercise discretion in the account; and
(ii) record the date such discretion is granted.
(4) For purposes of this section and Article III, Section 2, the term "institutional account" shall mean the account of:
(i) a bank, savings and loan association, insurance company, or registered investment company;
(ii) an investment adviser registered under Section 203 of the Investment Advisers Act of 1940; or
(iii) any other entity (whether a natural person, corporation, partnership, trust, or otherwise) with total assets of at least $50 million.

*The original proposal did not include an amendment to Section 2. Rather, the amendment to Section 21(c) originally proposed a subsection that encompassed information to be obtained prior to a recommendation made to a noninstitutional customer. After further discussion, the Board concluded that, organizationally, the requirements pertaining to recommendations to customers should be contained in Section 2, rather than Section 2l(c).