Notice To Members 94-6

Solicitation Of Member Comment On Proposed Amendments To The Foreign Associate Provisions Of Schedule C To The NASD By-Laws;

Published Date:

Comment Period Expires March 31, 1994

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Executive Summary

At its January 1994 meeting, the NASD Board of Governors approved the issuance of a Notice to Members soliciting comment on amendments to the foreign associate provisions in Part X of Schedule C to the NASD By-Laws. These amendments would substantially conform NASD requirements for foreign associates to certain interpretations under NYSE Rule 345 recently approved by the Securities and Exchange Commission (SEC). In addition, the proposals would require all foreign associates, including "foreign finders," to file full Form U-4 registration documents with the NASD, thereby standardizing the registration process for foreign associates in keeping with those in effect for all other registration categories. Comments received on or before March 31, 1994, will be considered before final action by the Board on the proposed amendments. If approved by the Board, the amendments will be filed with the SEC. It is anticipated that the SEC will also publish the proposed amendments before acting on them. SEC approval of the amendments is required before they can become effective.

Background

The NASD and the NYSE have consistently limited the payment of finders fees by members. Permission to do so has only been granted in isolated circumstances, where the amount paid was nominal in relation to the referral, and the recipient did not routinely engage in making referrals to brokerage firms. The SEC recently approved an NYSE interpretation to Rule 345 that permits NYSE members to pay transaction-related compensation to non-registered foreign finders who are not subject to the jurisdiction of the United States securities laws. In approving the interpretation, the SEC said an NYSE member paying such referral fees must:

  • Assure itself that the foreign per son who will receive the compensation (the finder) is not required to register in the U.S. as a broker/dealer and that the compensation arrangement does not violate applicable foreign law.

  • Provide the customer with a descriptive document that discloses what compensation is being paid to the finder.

  • Retain the customer's written acknowledgements of the compensation.

  • Maintain records reflecting payments to foreign finders.

  • Keep available for NYSE inspection the agreements between members and persons receiving the compensation.

  • Maintain transaction confirmations indicating that a referral or finders fee is being paid.

The NASD generally prohibits the payment of compensation to non-registered persons. However, the foreign associate classification in Part X of Schedule C to the By-Laws includes a mechanism that permits members to pay compensation to non-registered foreign finders. Under this provision, foreign associates:

  • Do not have to be registered in the standard manner requiring a Form U-4 filing.

  • Are exempt from the requirement that they pass a qualification examination.

  • Cannot be citizens, nationals, or residents of the United States or any of its territories or possessions.

  • Must conduct all of their securities activities outside the jurisdiction of the United States.

  • Must not engage in any securities activities with or for a United States citizen, national, or resident.

  • Must not be subject to a statutory disqualification.

  • Must consent to service of process for any proceeding instituted by the NASD.

Foreign associates are not registered in the Central Registration Depository as part of the normal registration process. Members are required, however, to file an application for classification as a foreign associate, a simplified form that the NASD maintains in a separate file.

There are two distinctions between the NASD and NYSE approaches. First, the NASD requires an actual filing by the member to activate foreign associate status. The NASD's surveillance ability is further enhanced by the requirement that members notify us through a separate filing, in the event they terminate the employment of a foreign associate. Second, the NYSE has incorporated a series of procedures in its interpretation to deter abusive practices. The NASD does not have comparable procedures in Schedule C to the By-Laws.

NASD Proposal

The NASD believes it is important that NASD and NYSE rules in this area be consistent and recommends that certain amendments be approved in Schedule C to the NASD By-Laws to accomplish this. The NASD also believes there is great value in the requirement for an application filing as a means to screen out statutorily disqualified persons and to set the stage for closer cooperation among international regulators in the registration process. The NASD recommends, therefore, that the filing requirement for foreign associates be stepped-up to a full Form U-4 registration filing consistent with every other registration category used by the NASD. The NASD also proposes to expand the foreign associate provisions in the case of foreign finders to include the procedural protections in the new interpretation to NYSE Rule 345.

Request For Comments

The Board is soliciting comments from members and interested parties so that the ramifications of the Board action may be thoroughly reviewed. Comments must be received no later than March 31, 1994, and addressed to Grant Callery, General Counsel, NASD, 1735 K Street, NW, Washington, DC, 20006–1500. Questions regarding this Notice should be directed to Frank J. McAuliffe, Vice President, Membership & Qualifications at (301) 590-6694.

Text Of Proposed Amendments To Part X Of Schedule C To The NASD By-Laws

PART X

FOREIGN ASSOCIATES

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

All persons associated with a member who are designated as Foreign Associates shall [not] be required to be registered [and] but shall be exempt from the requirement to pass a Qualification Examination. Persons associated with a member including persons who receive referral fees or transaction-related compensation based upon the business of customers they direct to a member(s) (a "finder"), may [shall] be designated as Foreign Associates if they meet the following criteria:

(1) They are not citizens, nationals, or residents of the United States or any of its territories or possessions;
(2) They will conduct all of their securities activities in areas outside the jurisdiction of the United States and they will not engage in any securities activities with or for any citizen, national or resident of the United States[.];

[Prior to the time the exemption provided for in this paragraph may become effective, the member desiring to employ any such person must file with the Corporation, a form designated "Application for Classification as a Foreign Associate" for each such person and must certify that such person meets the above two criteria, as well as that:]
(3) Such person is not subject to any of the prohibitions to registration with the Corporation contained in Article II, Section 4 of the By-Laws of the Corporation;
(4) Service of process for any proceeding instituted by the Corporation in respect to such person may be sent to an address designated by the member[.];
(5) In the event that a Foreign Associate is a finder, as described above, the member must also ensure that the following conditions are met:
(a) The member has assured itself that the foreign person who will receive the compensation (the "finder") is not required to register in the U.S. as a broker-dealer and has further assured itself that the compensation arrangement does not violate applicable foreign law:
(b) Customers referred by such Foreign Associate must receive a descriptive document, similar to that required by Rule 206(4)-3(b) of the Investment Advisers Act of 1940. that discloses what compensation is being paid to the Foreign Associate;
(c) Customers must provide written acknowledgement to the member of the existence of the compensation arrangement and such acknowledgement is retained and made available for inspection by the NASD:
(d) Records reflecting payments to Foreign Associates are maintained on the member's books and actual agreements between the member and Foreign Associates are available for inspection by the NASD; and
(e) The confirmation of each transaction indicates that a referral or finders fee is being paid pursuant to an agreement.
Further, in the event of the termination of the employment of a Foreign Associate, the member must notify the Corporation immediately by filing a notice of termination as required by Article IV, Section 3 of the By-Laws.