Notice To Members 92-2

SEC Approval of Amendments to Schedule C of the NASD By-Laws Relating to Applications for Membership

Published Date:

January 01, 1992

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EXECUTIVE SUMMARY

On December 13, 1991, the Securities and Exchange Commission (SEC) approved amendments to Schedule C of the NASD By-Laws relating to the premembership interview process for applicants for NASD membership. The amendments establish time limits for certain actions by applicants and extend restrictions on membership to successor owners of member firms. The amendments will take effect February 1, 1992, and will apply to all applications in process on that date. The text of the amendments follows this Notice.

DESCRIPTION OF AMENDMENTS

The SEC has approved amendments to Part I, Section 1 of Schedule C to the NASD By-Laws, which sets forth the application review process for new member applications ("the premembership interview process" or "PMI process"). The amendments provide for deadlines for the consideration of applications and extend the effectiveness of membership restrictions to successors to the ownership or control of the applicant.

Sixty-Day Limitation-Section 1(a)

As part of the PMI process, the district office staff reviews an application prior to the actual interview. In the event an application is materially inadequate, the applicant will be notified in writing of the inadequacies and of the information that is required to remedy the inadequacy. Once an applicant has been notified of the inadequacy or of the additional information required, it is the applicant's obligation to provide the information in a timely fashion. Furthermore, it is important that the processing of an application not be unduly delayed and that information needed to properly evaluate an application should be promptly supplied. The amendment to Section 1(a) to Schedule C will allow the NASD to terminate an application after 60 days when the applicant has failed to respond to a request from the NASD for information, or when the applicant has failed to amend a materially inadequate response pursuant to a request from the NASD.

12-Month Limitation-Section 1(e)

Certain applications contain deficiencies that cannot be corrected sufficiently to gain approval within 12 months of the application date. Under Section 1(b), the NASD is required to schedule a PMI "within a reasonable time" after the NASD receives the necessary information. In addition, under Section 1(d), the NASD is required to notify an applicant whether its application has been granted, denied, or granted with restrictions within 30 days of the conclusion of the applicant's PMI or the receipt of further information or documents. Sections l(b) and l(d), therefore, impose substantial obligations on the NASD to act quickly to complete the application process.

The NASD believes it appropriate to impose similar promptness obligations on applicants by permitting the NASD to terminate dormant or persistently inadequate applications, thereby expediting the PMI process for all applicants. Section 1(b) has been amended, therefore, to allow the NASD to terminate an application if the applicant does not complete the review process within twelve (12) months of the filing of the application, thereby cutting off further consideration when the applicant fails to take the actions required to be completed in connection with the application. Termination will not occur if the delay in approval of the application is caused by the NASD.

Implementation of Amendments to Sections l(a) and l(b)

Both of the amendments to Sections l(a) and l(b) are designed to streamline the application review process. The normal communication between the NASD and the applicant during the PMI process will include notice of the deadlines imposed by these amendments and the consequences of the failure to meet the deadlines. The NASD does not intend to terminate pending applications after 60 days under Section 1 (a) when the applicant has responded to a request for information by stating that it is in the process of preparing a full response or indicates it is taking steps to complete all of the examinations, agreements, and other requirements necessary for NASD approval of the membership application. The NASD's intention is to terminate applications only if there is no response or if there is clear evidence of dilatory conduct on the part of the applicant.

In addition, the NASD does not intend to terminate applications under Section 1(b) solely because the application has not been processed to completion in 12 months. As with requests for information, a complete failure to proceed with an application, or obviously dilatory conduct will be necessary before the NASD terminates an application. Finally, if an application is terminated pursuant to the proposed amendments to Sections l(a) and l(b), the applicant will be free to reapply for membership by submitting a new application along with the appropriate application fee.

The NASD will apply this limit to all new applications and applications in process on the effective date (February 1, 1992). The NASD, however, will not terminate any application that was in process at the time this rule change becomes effective for six months following the effective date. Any applications filed after the effective date will be subject to the 12-month deadline.

Successor Ownership-Section 1(e)

The approval of an application for membership may include restrictions on the member's business activities consistent with the member's financial capacity, internal procedures, and the experience of its management. Such restricted approval is called a "restrictive agreement" and, pursuant to Section 1(e), the applicant's approval for membership in the NASD is contingent on its agreeing to abide by the restrictions.

If the ownership or control of the member changes, the NASD believes that the new owners or controlling persons should understand that the restrictive agreement continues to limit the member's business. The NASD has, therefore, amended Section 1 (e) to state that all restrictions placed on an applicant's business will remain in effect until modified pursuant to Section 3 of Part I to Schedule C, and will bind all successors to the applicant. This amendment codifies the NASD's view that a restrictive agreement is binding on the member firm, not just the principals, and that changes in ownership or control of the member do not operate to remove or reduce the limitations in the restrictive agreement. The amendment will emphasize the NASD's requirement that restrictive agreements can be amended only after the approval of a written request to modify the agreement submitted to the district in which the member has its principal place of business.

* * * * *

Questions concerning this Notice may be directed to Elliott R. Curzon, Office of General Counsel, at (202) 728-8451 and John F. Vaughn, Assistant Director, Membership at (301) 590-6865.

TEXT OF AMENDMENTS TO SCHEDULE C OF THE BY-LAWS

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

I

APPLICATIONS FOR MEMBERSHIP

(1) Premembership Interviews

(a) An applicant for membership in the Corporation shall furnish to the District Office for the District in which it has or intends to have its principal place of business:

(1) a copy of its current submission to the Securities and Exchange Commission pursuant to Rule 15b1-2(c) under the Securities Exchange Act of 1934;

(2) its most recent trial balance, balance sheet, supporting schedules and computation of net capital;

(3) a copy of its written supervisory procedures;

(4) a list of all officers, directors, general partners, employees and other persons who will be associated with it at the time of admission to membership;

(5) a description of business activities in which it intends to engage; and

(6) such other relevant information and documents as may be requested by the District Office.

Unless otherwise determined by the District committee, an applicant's failure to respond or a materially inadequate response to a request for in-formation by the District Office within sixty (60) days of the request shall result in the termination of that application.

(b) Before an applicant shall be admitted to membership in the Corporation, and within a reasonable time after receipt of the foregoing information, the District Office shall schedule a premembership interview at which the responsible personnel of the applicant, as determined by the District Office, shall personally appear at the District Office. At such interview, the applicant shall demonstrate, in accordance with the criteria listed in Section 1(c) hereof, the appropriateness of its admission to membership in the Corporation to conduct the type of business intended in the manner specified in its submission. Unless otherwise determined by the District committee, an applicant shall have twelve (12) months, from the date of application made in accordance with Section 1(a) above, to complete the premembership review process-Failure to complete requirements for review by the District committee by that date shall result in the termination of that application.

(c) The premembership interview shall address the applicant's business plans to determine their adequacy and consistency with the federal securities laws and the rules of the Corporation; good business practices in the investment banking or securities business; a member's fiduciary obligation to its customers; and the public interest and the protection of investors. The premembership interview shall review, among other things [,]:

(1) the nature, adequacy, source and permanence of applicant's capital and its arrangements for additional capital should a business need arise;

(2) the applicant's proposed recordkeeping system;

(3) the applicant's proposed internal procedures, including compliance procedures;

(4) the applicant's familiarity with applicable NASD rules and federal securities laws;

(5) the applicant's capability to properly conduct the type of business intended in view of the[:];

A. number, experience and qualifications of the persons to be associated with it at the time of its admission to member ship [;],

B. its planned facilities[;],

C. arrangements, if any, with banks, clearing corporations and others, to assist it in the conduct of its securities business[;],

D. supervisory personnel, methods and procedures; and

(6) other factors relevant to the scope and operation of its business.

(d) Within thirty (30) days after the conclusion of such premembership interview, or if further in formation and/or documents are requested, within thirty (30) days of the receipt of such information or documents, the District Office shall notify the applicant in writing whether its application has been granted, denied, or granted subject to restrictions on its business activities, and provide the rationale for such determination.

(e) In all cases where restrictions are placed on its business activities, the applicant shall, prior to approval of membership, execute a written agreement with the Corporation agreeing to abide by the restrictions specified in the determination and approval. These restrictions shall remain in effect agreeing not to modify its business activities in any and are binding on the applicant and all successors way inconsistent with such agreement without first to the ownership or control of the applicant until notifying the Corporation and receiving its written modified pursuant to paragraph (3) below.