Comment Period Expires February 15, 1995
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Executive Summary
The National Association of Securities Dealers, Inc. (NASD) requests comment on proposed amendments to the NASD Rules of Fair Practice to adopt rules governing broker/dealers operating on the premises of financial institutions. The proposed rules adopt investor protection principles that are substantially similar to those embodied in a recent no-action letter issued by the staff of the Securities and Exchange Commission (SEC) to the Chubb Securities Corporation (the Chubb Letter). In particular, the Chubb Letter addresses broker/dealer networking agreements with financial institutions. The proposed rules respond to continuing concerns about the lack of clear guidance for NASD members in the nature of specific rules or regulations that address the activities of bank-affiliated and networking broker/dealers operating on the premises of financial institutions. The text of the proposed rules follows this Notice.
Background
On November 24, 1993, the SEC staff issued the Chubb Letter that describes the SEC's policy regarding certain broker/dealers operating on the premises of financial institutions. Following the release of the Chubb Letter, on February 15, 1994, the four banking agencies—the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision— issued an Interagency Statement on Retail Sales of Non-deposit Investment Products (the Interagency Statement). The Interagency Statement adopts many of the investor protection concepts of the Chubb Letter and directs banks to follow these principles when making direct sales of securities to customers and overseeing the activities of NASD members selling securities on the premises of financial institutions.
To assist members doing business on the premises of financial institutions in their efforts to comply with the NASD Rules of Fair Practice, the federal securities laws, and applicable banking regulations, Notice to Members 94-47 advised these members of the policies described in the Chubb Letter and the Interagency Statement. Bank-affiliated members and members participating in bank networking arrangements previously had been advised by the NASD to take precautions to protect investors by addressing issues of investor confusion.
In particular, Notice to Members 94-16 reminded members of mutual fund sales practice obligations, citing the explosive growth of fund sales by bank-affiliated and networking broker/dealers. Similarly, Notice to Members 93-87 provided members guidance for reinvestment of maturing certificates of deposits in mutual funds, focusing on NASD members affiliated with financial institutions or participating in networking arrangements. Among other things, Notice to Members 93-87 described the specific disclosure requirements for money market, fixed income, and equity funds, and pointed out specific concerns that may arise in connection with sales of mutual funds on bank premises.
Regulatory Need For The Proposed Rules
Although the Chubb Letter provides regulatory guidance for some members operating on the premises of financial institutions, the NASD believes further action is required to establish uniform and consistent standards to govern this activity.
Most significantly, the Chubb Letter focuses on broker/dealer networking arrangements and, in this regard, presents some uncertainties as to the regulatory obligations of bank-affiliated broker/dealers. Accordingly, action is needed to ensure the existence of a level playing field for bank-affiliated members and members operating on the premises of banks pursuant to networking agreements. Further, because the Chubb Letter is a "no-action" position, it may be viewed as a guideline or an interpretive position rather than a required rule or regulation designed to protect investors.
Description Of The Proposed Rules
The proposed rules apply exclusively to the activities of NASD members that are conducting broker/dealer services on the premises of a financial institution where retail deposits are taken. Although applicable to all customers of such members, the main focus of the proposed rules is to minimize confusion by retail customers. Broker/dealer services are defined as services that include, but are not limited to, conducting an investment banking business, recommending any security, giving investment advice, describing investment vehicles, discussing the merits of any security or type of security with a customer, exercising judgment regarding securities and investment alternatives, accepting customer orders, transmitting orders, or handling customer funds or securities.
The proposed new rules also require that a member operating on the premises of a financial institution enter into a written agreement with the financial institution that describes the responsibilities of the parties to the agreement and the conditions to the agreement. Conditions for conducting broker/dealer services on the premises of a financial institution include the member's physical location, customer disclosure, compensation, supervisory responsibilities, solicitation of customers, and communications with the public.
This written "Networking and Brokerage Affiliate Agreement" required by the proposed rules must stipulate that the broker/dealer will have exclusive responsibility for securities activities conducted through the broker/dealer at its location at the financial institution. Significantly, the agreement must contain provisions whereby the member agrees to notify the financial institution if any associated person of the member who is also an employee of the financial institution (dual employee) is terminated for cause by the member.
In turn, pursuant to the terms and conditions of the written agreement, the financial institution must agree to allow supervisory personnel of the member, and representatives of the SEC and the NASD, to have access to the financial institution's premises where the member conducts broker/dealer activities in order to conduct examinations and carry out any other regulatory responsibilities with regard to the member. Further, the financial institution must agree to monitor the unregistered employees of the financial institution to ensure that they perform only clerical- and ministerial-related functions with regard to investment-related services.
The written agreement also must stipulate that the financial institution agrees that unregistered employees of the financial institution will not receive any compensation, cash or non-cash, that is based on the effectiveness or the success of referrals of financial institution customers to the member. Importantly, the written agreement must contain provisions whereby the financial institution agrees that any dual employee whom the member suspends from association with the member, or whom the SEC, the NASD, or any other regulatory or serf-regulatory organization bars or suspends from association with the member or any other broker/dealer, will be terminated or suspended, respectively, from any securities activities conducted directly by the financial institution.
To minimize customer confusion, the proposed rules require that the member's broker/dealer services be conducted in a physical location distinct from the area where retail deposits of the financial institution are taken. Member's disclosure obligations require that, when an account is opened, the member obtain a written acknowledgement from each customer that products purchased or sold by the member:
- are not insured by the Federal Deposit Insurance Corporation;
- are not deposits or obligations of the financial institution;
- are subject to investment risks, including possible loss of principal invested; and
- are not protected by the Securities Investor Protection Corporation (SIPC) as to loss of principal.
The compensation conditions of the proposed rules prohibit the member from making any payments, including referral fees, to individuals employed with the financial institution who are not registered with the member. Broker/dealer services offered by the member are required to be provided only by persons associated with the member. To comply with the supervisory requirements of Article III, Section 27 of the NASD Rules of Fair Practice, associated persons must be properly supervised by the member in light of the member's particular activities conducted at the financial institution. To that end, the rules require that the member designate a registered principal to supervise its associated persons at its location at the financial institution, and the member is further required to register its location at the financial institution as a branch office.
With regard to the member's communications with the public and the solicitation of customers, the rules stipulate that materials used to promote the member's broker/dealer services will be deemed to be materials of the member, and, as such, must be in compliance with Article III, Section 35 of the NASD Rules of Fair Practice. Additionally, the rules address the manner in which the financial institution may be referenced in advertising and promotional materials so as to ensure that it is clear that the broker/dealer services are provided by the member and not the financial institution. Finally, the rules prohibit the member from using confidential financial information maintained by the financial institution to solicit customers for its broker/ dealer services.
Request For Comment
The NASD asks members and other interested persons to comment on the proposed amendments to the NASD Rules of Fair Practice. Comments should be directed to:
Ms. Joan Conley
Corporate Secretary
National Association of Securities Dealers, Inc.
1735 K Street, NW
Washington, DC 20006-1500.
Comments must be received no later than February 15, 1995. Comments received by this date will be considered by the Board. Before becoming effective, the rule amendments must be adopted by the Board and the membership and then filed with the SEC for its approval.
Text Of Proposed Rule
(Note: New language is underlined.)
Broker-Dealer Conduct on Premises of Financial Institution
(a) Applicability
This section shall apply exclusively to the activities of NASD members that are conducting broker-dealer services on the premises of a financial institution where retail deposits are taken. This section does not alter or abrogate members' obligations to comply with other applicable NASD rules, regulations, and requirements, nor those of bank regulatory authorities which may govern members operating on the premises of financial institutions.
(b) Definitions
(1) "Financial institution" shall mean federal and state chartered banks, savings and loan associations, savings banks, credit unions, and the service corporations of such institutions.
(2) "Networking arrangement" shall mean a contractual arrangement between a member and a financial institution pursuant to which agreement the member conducts broker-dealer services for customers of the financial institution and the general public on the premises of such financial institution, without the financial institution, any required service corporation, or their respective non-registered employees registering as broker-dealers under the Securities Exchange Act of 1934 ("Exchange Act").
(3) "Brokerage affiliate of a financial institution" shall mean a member which is controlled by. or under common control with a non-member financial institution as defined in Schedule E of the NASD By-Laws.
(4) "Dual employees" shall mean associated persons of the member who are also employees of the financial institution.
(5) "Broker-dealer services" offered through an NASD member include, but are not limited to. conducting an investment banking business, recommending any security, giving investment advice, describing investment vehicles, discussing the merits of any security or type of security with a customer, exercising judgment regarding securities and investment alternatives, accepting customer orders, transmitting orders, or handling customer funds or securities.
(c) Conducting broker-dealer services on the premises of a financial institution shall be conditioned upon the initial and continuing compliance with the following requirements:
Physical Location
(1) The member's broker-dealer services shall be conducted in a physical location distinct from the area where the financial institution's retail deposits are taken and identified in a manner that clearly segregates and distinguishes the broker-dealer services from the activities of the financial institution. In all settings, it is incumbent upon the member to distinguish the broker-dealer services from the activities of the financial institution.
Signage
(2) The member's name shall be clearly displayed in the area in which the member conducts its broker-dealer services. In no event shall signs regarding the broker-dealer services appear in the financial institution's deposit-taking area.
Branch Office Registration
(3) The member must register as a branch office any of its offices which operates on the premises of a financial institution. As interpreted by the NASD Board of Governors. Article III. Section 27 of the NASD Rules of Fair Practice defines branch office to include any office location that:
(A) operates from public areas of buildings, such as bank branches, even when such locations are temporarily staffed:
(B) advertises an address in any public media;
(C) publicly displays signage; or
(D) performs any function of an office of supervisory jurisdiction as defined by Article III, Section 27.
Networking and Brokerage Affiliate Agreements
(4) Networking and brokerage affiliate arrangements between a member and a financial institution must be governed by a written agreement that sets forth the responsibilities of the parties, the conditions of the arrangement, and the compensation to be received by the financial institution. The agreement must contain provisions whereby the financial institution agrees:
(A) to allow supervisory personnel of the member, representatives of the Securities and Exchange Commission ("SEC"), and the NASD to have access to the financial institution's premises where the member conducts broker-dealer services in order to inspect the books and records and other relevant information maintained by the member with respect to broker-dealer services:
(B) to monitor the activities of the employees of the financial institution who are not registered with the broker-dealer, and ensure their compliance with the limits on their permissible activities with respect to securities transactions and non-deposit broker-dealer services:
(C) to permit the member to conduct periodic reviews to assure that the financial institution and its unregistered employees comply with the limits on their activities with respect to securities transactions and non-deposit broker-dealer services:
(D) that any dual employee whom the member suspends from association with the member, or the SEC, the NASD, or any other regulatory or self-regulatory organization bars or suspends from association with the member or any other broker or dealer will be terminated or suspended, respectively, from all securities activities conducted directly by the financial institution: and
(E) that unregistered employees of the financial institution will not receive any compensation, cash or non-cash, that is based on the effectiveness or the success of referrals of customers of the financial institution to the member.
(5) The written agreement must contain provisions whereby the member agrees to notify the financial institution if any dual employee who is associated with the member is terminated for cause by the member.
Personnel Registration/Associated Persons
(6) Broker-dealer services offered by the member may be provided only by persons associated with the member, including dual employees who are registered and qualified as necessary with the NASD, and any appropriate state, or other self-regulatory authorities, provided however, that unregistered employees may provide clerical and ministerial assistance.
Compensation of Registered/Unregistered Persons
(7)
(A) The amount of any transaction-related compensation paid to the member's registered representatives-including dual employees, acting under a networking arrangement or as associated persons of a brokerage affiliate of a financial institution, shall be determined solely by the member. Transaction-related compensation may be paid to dual employees by the employer financial institution with a clear designation that such payments are made on behalf of the member.
(B) Employees of the financial institution who are not registered with the NASD member may not engage in any broker-dealer services on behalf of the member, nor receive any compensation from the member, cash or non-cash, in connection with but not limited to the referral of customers of the financial institution to the member, or locating or introducing customers of the financial institution to the member.
Supervision and Responsibility
(8)
(A) The member shall establish, maintain, and enforce written procedures to supervise all broker-dealer services conducted by the member and its associated persons at its location at the financial institution. A designated principal of the member shall supervise registered personnel at the member's location at the financial institution. Pursuant to its responsibilities as a designated principal as set forth in Article III, Section 27 of the NASD Rules of Fair Practice, the designated principal shall review the member's supervisory system and written procedures and, where appropriate, recommend action by the member designed to achieve compliance with the applicable securities laws, regulations, and rules of the NASD.
(B) The member shall notify and make available to all of its associated persons the written procedures that govern the broker-dealer services conducted at the financial institution to its associated persons. The supervisory procedures governing the broker-dealer services conducted at the financial institution shall be amended by the member as appropriate within a reasonable time after changes occur in applicable securities laws and regulations, including the rules of the NASD, and the member shall be responsible for communicating amendments to all associated persons engaged in broker-dealer services at its location at the financial institution.
(C) The member shall make available to the financial institution, for distribution to its employees, written procedures that specify the limits of the permissible activities of unregistered persons.
Customer Disclosure and Written Acknowledgment
(9) At the time an account is opened, the member must obtain from each customer a separate written acknowledgment that the securities products purchased or sold by the member through offices located on the premises of the financial institution:
(A) are not insured by the Federal Deposit Insurance Corporation ("FDIC"):
(B) are not deposits or other obligations of the financial institution and are not guaranteed by the financial institution:
(C) are subject to investment risks, including possible loss of the principal invested: and
(D) are not insured by the Securities Investors Protection Corporation ("SIPC") as to the loss of principal amounts invested.
Solicitation
(10) The member shall not use confidential financial information maintained by the financial institution to solicit customers for its broker-dealer services.
Communications with the Public
(11)
(A) All member communications with the public must be in compliance with Article III. Section 35 of the NASD Rules of Fair Practice and the guidelines set forth thereunder.
(B) All communications regarding securities transactions and long and short positions, including confirmations and account statements, must be sent directly to the customer by the member, or by the issuer, transfer agent, or principal underwriter of the security. All communications sent by the member to a customer must clearly indicate that the broker-dealer services are provided by the member and not by the financial institution. The member shall be responsible for ensuring that any documentation regarding securities transactions sent directly to a member's customer by an issuer, transfer agent, or principal underwriter is in compliance with the federal securities laws and NASD rules.
(C) Any advertisement or sales literature, as defined in Article III. Section 35. of the NASD Rules of Fair Practice, used to describe or promote the availability of broker-dealer services of the member on the premises of a financial institution must be approved by the member prior to distribution, in compliance with Article III. Section 35(b)(1) of the NASD Rules of Fair Practice and, where required, filed with the NASD Advertising Regulation Department.
(D) All advertisements, sales literature and other similar materials issued by the member which relate exclusively to its broker-dealer services will be deemed to be the materials of the member and must indicate prominently that the broker-dealer services are being provided by the member and not the financial institution: that the financial institution is not a registered broker or dealer: and whether the member is or is not affiliated with the financial institution. The financial institution may be referenced in a non-prominent manner in advertising or promotional materials solely for the purpose of identifying the location where broker-dealer services are available.
(E) Notwithstanding the provisions of Subparagraph (11)(D), advertisements, sales literature, and other similar materials jointly issued by the member and a financial institution that discuss services or products offered by both entities must clearly separate the products and services offered by the financial institution from those offered by the NASD member. The name of the member must be displayed prominently in the section of the materials that describes the broker-dealer services offered by the member, which section will be deemed materials of the member, and, as such, the section must comply with the provisions of Subparagraph (11) (C).
(12) The member must be in compliance with rules of the SIPC, which require, among other things, that a member identify its SIPC membership in its principal place of business, branch offices, and in advertising material. If the member's sales activities include any written or oral representations concerning protection provided by SIPC. clear explanations of the protection must be provided to customers, including material distinctions between SIPC and FDIC insurance.
