SEC Approval of Amendments Relating to Periodic Account Statements

EXECUTIVE SUMMARY

On October 14, 1992, the Securities and Exchange Commission (SEC) approved an amendment adding new Section 45 to Article III of the Rules of Fair Practice requiring members to send account statements to customers at least quarterly. The amendments take effect on January 31, 1993. The text of the new rule language follows the discussion below.

BACKGROUND AND DESCRIPTION OF THE AMENDMENTS

On October 14, 1992, the SEC approved a rule change adding a new Section 45 to Article III of the NASD Rules of Fair Practice relating to periodic account statements. Under SEC Rule 15c3-2, broker/dealers have to notify customers every three months that the free credit balances in their accounts may either be used by the broker/dealers or paid on demand to the customers. The notification requirement, however, only applies if a customer has a free credit balance.

Because NASD members do not have to send periodic account statements to customers, some broker/dealers send only the free-credit-balance notice required by Rule 15c3-2. They do not send account statements of all securities positions, money balances, and account activity since the last statement. As a result, these customers are not advised of the current status of their accounts, regardless of any change in the status of those accounts.

The NASD believes that, in the interest of customer protection, customers should be more fully informed of the status of their accounts. The new rule requires members to send account statements at least once every quarter to customers having securities positions, funds, or any change in their account during the period since the previous statement was sent. The rule requires that the statement include a description of all securities positions, money balances, and account activity in the account during the period.

Subsection (a) of the rule requires each general securities member to send a statement of account describing all account activity to each customer at least once every quarter. Any account statements showing all account activity and sent more frequently than quarterly will satisfy the requirement.

Subsection (b) of the rule defines the term "account activity" to include all types of activity that may occur in a securities account with respect to "securities or funds in the possession or control of the member." Thus, this limitation exempts account activity relating to funds or securities not in control of the member. For example, direct participation program (DPP) securities are not covered since, after the initial purchase through the distributing broker/dealer, the general partner communicates directly with investors.

Subsection (c) defines the phrase "general securities member" as a member that calculates its net capital under SEC Rule 15c3-1(a), except for paragraphs (a)(2) or (a)(3) — that is, a broker/dealer required to maintain at least $25,000 in net capital. Subsection (c) further defines "general securities member" to exclude members who do not carry customer accounts or hold customer funds or securities. Thus, members whose business is limited to variable contract insurance products, mutual funds, and unit trusts, among other products, or who neither carry accounts nor hold customer funds or securities, are exempt from the rule. In these cases, responsibility for complying with the rule falls on the member carrying the account or holding the funds or securities for those members.

Both subsections (b) and (c) exempt, from the periodic account statement requirement, members that neither carry customer accounts nor hold customer funds or securities. The NASD does not believe members, whether limited or general broker/dealers, should have to report information they may not be able to obtain or independently confirm on securities or funds not in their possession. In the case of DPPs and similar products, when a customer purchases DPP units through a member, the customers' funds go to the general partner (through an escrow account), the general partner confirms admission to the partnership directly to the purchaser, and all subsequent communications are usually between the general partner and the investor.

Subsection (d) of the rule permits the NASD's Operations Committee to exempt any member from the provisions of the rule upon a showing of good cause. This would permit the NASD under unusual circumstances to exempt a member if application of the rule would be unnecessarily burdensome given the type of business it conducts and the nature of the accounts, securities, or funds involved, and if the goal of customer protection and information could be met under alternative arrangements.

Following publication of the rule change for member vote, the NASD received several inquiries from members who conduct business with institutional or governmental clients on a "receipt-versus-payment/delivery-versus-payment" (RVP/DVP) basis. These members maintain accounts for their customers, but they represent that they hold funds or securities only for the few days necessary to complete the transactions. These members believe that firms that conduct such business (i.e., an RVP/DVP type of business for institutional or corporate clients) should be eligible for an exemption from the new rule under Subsection (d).

While the NASD does not intend to grant blanket exemptions, members may apply to the NASD's Operations Committee for exemptions tailored to their specific circumstances. An exemption, if granted by the Committee, would generally be account-specific and would not apply to all the accounts of each member. To apply for an exemption, a member should send its written request detailing the reason for its request and the type of business it conducts to the NASD Operations Committee, c/o Financial Responsibility Department, National Association of Securities Dealers, Inc., 1735 K Street, NW, Washington, DC 20006-1506.

The amendments take effect on January 31, 1992. Questions concerning this Notice should be directed to Thomas R. Cassella, Vice President, Financial Responsibility at (202) 728-8237, or Elliott R. Curzon, Senior Attorney, Office of General Counsel at (202) 728-8451.

TEXT OF AMENDMENTS TO SECTION 45, ARTICLE III OF THE RULES OF FAIR PRACTICE

(Note: All language is new.)

Customer Account Statements

Sec. 45