Notice To Members 95-102

Overview Of Planned Changes To Disciplinary And Enforcement Procedures

Published Date:

SUGGESTED ROUTING

Senior Management
Legal & Compliance

Executive Summary

The NASD® Select Committee on Structure and Governance (Select Committee), also known as the Rudman Committee, has proposed significant changes to the manner in which the NASD operates. After substantial discussion, the NASD Board of Governors adopted the proposals in substantially the form recommended by the Select Committee. A number of these proposals call for fundamental changes to the procedures followed in the NASD's disciplinary program. Others call for the establishment of new offices within the NASD, or the refocusing of responsibilities or priorities within existing offices.

The NASD conducted a detailed analysis of the Select Committee's recommendations and shortly thereafter developed a plan for implementation which was presented to the Board in mid-November 1995. The principal procedural changes that the NASD expects to implement in 1996 include:

  • the creation of an Office of Professional Hearing Officers and the use of professional Hearing Officers in all disciplinary cases;

  • an amendment to the NASD Code of Procedure to define and prohibit ex parte communications;

  • an amendment to the Code of Procedure providing for an "open file" discovery process intended to assist respondents in preparing their defenses;

  • new rules and possible sanctions against hearing participants who behave improperly during proceedings;

  • the delegation of operational tasks to Office of General Counsel (OGC) staff to refocus the National Business Conduct Committee (NBCC) on national policy issues;

  • a study of personnel resources to determine whether there is sufficient staff to handle the proposed changes;

  • an increase in staff and broadening of scope for the Office of Internal Review, including the creation of a new "ombudsman" position;

  • the centralization of staff responsible for coordinating national, regional, and local initiatives to coordinate regulatory and enforcement matters; and

  • the creation of a new Investor Services Department to coordinate investor programs throughout the Association and act as liaison to investors and investor groups.

Changes To Disciplinary And Enforcement Procedures

Office Of Professional Hearing Officers

The NASD's plan to use professional Hearing Officers in all disciplinary cases, and the resulting creation of the Office of Professional Hearing Officers, together constitute the single most fundamental change that will occur in the NASD disciplinary program. The Office of Professional Hearing Officers will be housed under the newly established NASD Regulation, Inc. (NASDR). The NASD expects to appoint the Chief Hearing Officer in early 1996 and to fully staff the Office of Professional Hearing Officers by the end of that year.

After implementation of the new procedures, Hearing Officers will play a key role in managing cases and handling the many procedural issues that increasingly arise in disciplinary proceedings. They will participate as voting members of all District Business Conduct Committee (DBCC) and Market Surveillance Committee (MSC) hearing panels, and will chair these panels. However, industry volunteers will continue to constitute the majority on disciplinary hearing panels.

Hearing Officers will assume primary responsibility for managing the procedural aspects of disciplinary hearings before, during, and after the hearings. Before hearings, Hearing Officers will be expected to administer a new pre-hearing/motion process, which is discussed in greater detail below. Because Hearing Officers will resolve procedural and evidentiary issues at the pre-hearing stage, the NASD anticipates that hearings will be more orderly and focus on substantive issues. Hearing Officers will also oversee the settlement and discovery process prior to the hearings to ensure that all relevant documents are produced timely and that ex parte communications do not occur. (See discussion of ex parte communications below.)

Hearing Officers will chair the hearing panels, rule on procedural and other legal matters, advise industry volunteers on relevant legal principles, and ensure the creation and maintenance of an appropriate record. As chairperson, the Hearing Officer will participate in hearing panel deliberations and, like the two industry volunteer panelists, he or she will vote on the disposition of cases. Once voting has occurred, the Hearing Officer will be responsible for drafting a decision that represents the views of the hearing panel.

Following hearings, Hearing Officers will conduct necessary legal research, provide legal guidance to the industry panelists, and analyze the hearing transcript and exhibits to prepare a written decision that reflects the view of the Hearing Panel. This augments service to the Hearing Panels as presently there is no legal advisor appointed in most cases.

Additionally, Hearing Officers will be empowered independently to resolve certain categories of disciplinary cases, without the participation of industry volunteers: 1) cases that fall within the NASD's minor violation plan1 but in which respondents wish to challenge the alleged violations; and 2) cases in which the respondent has defaulted by failing to respond to a DBCC or MSC complaint. In the first category of cases, however, respondents would not be compelled to have their cases heard by a Hearing Officer alone; they may request a hearing before the customary three-person hearing panel.

Although cases falling within the above two categories generally do not require the expertise of industry volunteers, they do require a carefully constructed record regarding technical issues (e.g., whether actual or constructive service has been effected). These categories, therefore, appear to be well suited to processing by Hearing Officers alone and should result in more efficient use of the industry volunteers' time.

The NASD anticipates that the use of trained hearing professionals will enhance the NASD's ability to conduct fair and efficient disciplinary proceedings. At the same time, the functional role of professional Hearing Officers will free industry volunteers to focus on their area of expertise: securities industry business practices. As a consequence, the NASD believes that the introduction of professional Hearing Officers will enhance the self-regulatory process.

Although the Office of Professional Hearing Officers will be housed within NASDR, the office will be wholly separate from that corporation's examination, investigatory, and prosecuting departments. The office also will be separate from NASDR appellate and oversight staff. At least initially, the office will be centralized in a single location—likely in the Washington, DC, metropolitan area—to make the most effective use of the substantial staffing and physical resources that will be necessary to support Hearing Officer operations, to promote uniformity and consistency in training and management, and to ensure appropriate separation between the Hearing Officers and regional prosecutorial staff. After the NASD gains experience with the Hearing Officer program, consideration will be given as to whether satellite offices are needed and appropriate.

Motions

Consistent with its initiative on Hearing Officers, the NASD plans to adopt a Code of Procedure provision that authorizes Hearing Officers to engage in a broad range of case-management activities, most significantly, governing the matters of motions—how they are filed and served, and the length and timing of these motions. These provisions likely will be modeled after comparable provisions in federal court and agency rules. Other case-management activities, such as conducting pre-trial conferences and entering scheduling orders, will be modeled after a comparable provision in the SEC's Rules of Practice.

Ex Parte Contacts

Another anticipated change to disciplinary and enforcement procedures is the amendment of the NASD Code of Procedure to define what constitutes ex parte communications and to prohibit such communications in disciplinary proceedings. Generally speaking, an ex parte communication is one that occurs between a party to a proceeding and a decision-maker regarding the merits of the proceeding, without notice to other parties. For example, the term would encompass off-the-record communications between either a disciplinary respondent or NASD prosecutorial staff and a member of a DBCC hearing panel regarding the issues presented in a pending disciplinary proceeding. In drafting these provisions, the NASD will be guided by comparable provisions in the Administrative Procedure Act, and the rules of various of federal agencies, including the Securities and Exchange Commission (SEC).

As recommended by the Select Committee, prosecuting attorneys will cease their traditional involvement in the decision-drafting process, and as discussed above, decision-drafting responsibilities will be shifted to Hearing Officers in an attempt to avoid ex parte contacts. Also, prosecuting attorneys will cease to advise DBCC panels on whether settlement offers conform to NASD Sanction Guidelines or other applicable NASD policies. Once again, this advisory function will be performed by Hearing Officers. However, consistent with long-standing SEC practice, prosecutorial staff will be permitted to present offers of settlement to District Committees on an ex parte basis when staff urges acceptance of offers and the respondent consents to such staff presentation.

The Acceptance, Waiver, and Consent (AWC) process—the widely utilized procedure for settling cases by providing respondents advance notice that they are going to be the subject of a complaint and allowing them to settle the matter quickly— will remain unchanged: AWCs will continue to be negotiated between NASD prosecutorial staff and respondents and be submitted to the DBCC or MSC in the normal course of business.

Beyond implementing the Select Committee's recommendations regarding ex parte communications in the decision-drafting and settlement processes, the NASD will devote substantial effort to identifying other contexts in which ex parte contacts may occur, and devising procedures to prevent inappropriate contacts. The NASD welcomes suggestions regarding additional measures that it might consider in addressing circumstances that have given rise to ex parte concerns in the past.

Discovery

In another Select Committee recommendation approved by the Board for implementation, the NASD will amend its Code of Procedure to provide for the type of "open file" discovery that is available in SEC enforcement proceedings. Materials in the NASD's possession relevant to a specific case will be made available to respondents for inspection and copying at an early stage in disciplinary proceedings, unless that material is subject to certain narrow categories of exceptions. The NASD believes that the new procedures will assist respondents substantially in preparing their defenses. Not only will respondents have access to staff documents beyond those that the NASD staff will introduce as hearing exhibits, but the access will occur much earlier in disciplinary proceedings.

Among other discovery-process initiatives:

  • The NASD will adopt the principles followed by prosecutors (and the prosecutorial staffs of many federal agencies) to determine the extent of the NASD's obligation to disclose exculpatory evidence—evidence that may clear a respondent, for example.

  • NASD discovery obligations will be case-specific. Respondents will be able to obtain non-privileged materials relevant to the specific proceeding in which they are involved; respondents' access will be limited to documents that are relevant to the facts of that case.

  • The NASD staff's document production deadline will fall relatively early in the disciplinary proceeding. The NASD is considering adopting the SEC's requirement that staff documents be made available to respondents no later than 14 days after respondents answer the complaint.

  • In order to be fairer to respondents who are representing themselves, NASD staff documents will be made available as a matter of right; access will not be contingent upon a respondent's making a request. Instead, respondents will be notified that staff documents are available for inspection and copying.

  • The NASD intends to follow the SEC's practice of requiring production of otherwise privileged documents that contain material exculpatory evidence. Staff will be required to produce these documents to respondents.

  • The NASD plans to provide guidance on the limited circumstances in which the NASD will, at the request of a respondent, compel third parties to produce documentary or testimonial evidence.

Sanctions

New procedures resulting from the Select Committee recommendations include less tolerance for inappropriate behavior that occurs during hearings. The NASD plans to adopt variants of the SEC rules that address contemptuous conduct during hearings. Among other things, the NASD will adopt a new Code of Procedure provision to authorize Hearing Officers and hearing panels to exclude persons who engage in contemptuous behavior, or frivolous, dilatory, or other improper practices. This applies to anyone involved in the hearing: respondents, counsel, witnesses, or others. In addition, the NASD will consider whether member firms, associated persons, or NASD staff should be subject to monetary sanctions if they engage in improper behavior during proceedings. Finally, the NASD plans to address whether counsel, who are excluded from hearings for contumacious or otherwise inappropriate behavior, should forfeit the privilege of appearing in future NASD disciplinary proceedings.

NBCC Refocused On Policy

To enable the NBCC to devote more time to issues of national policy, many time-consuming operational tasks will be delegated to NASD OGC staff to perform them under the NBCC's oversight and direction. The OGC staff's role will be expanded to include reviewing settlement offers and non-appealed disciplinary cases and OGC staff will provide extensive additional services to the NBCC, including substantially expanded assistance in preparing for NBCC hearings, to free the NBCC to focus on "big picture" issues.

In the membership area, the NASD also contemplates that the roles of the District staff, the District Committees, and the NBCC will be refined and clarified. For instance, to increase NBCC involvement in policy and membership applications, the NBCC will devote considerable effort to amending the membership criteria set forth in Schedule C of the NASD By-Laws, and formulating uniform policy guidance for the NASD District Offices in applying those criteria. The NASD expects that, in the future, both the District Committees and the NBCC will act in purely appellate capacities with regard to membership applications and restriction agreements. Authority to act with respect to these matters will be delegated to District staff, whose function will be limited to administering membership policies that have been established by the NBCC. In the future, District Committees and the NBCC will focus on ensuring that NBCC-established policies are administered by the staff, fairly and uniformly.

Diversity In DBCC Composition And Selection

Answering the Select Committee's recommendation to foster diversity in DBCC membership, nominating committees now will be provided with more information regarding the relevant criteria such as the need for diversity in size and type of firms represented, and in product knowledge and functional expertise. Nominating committees also may be provided with profiles that summarize relevant membership information including categorization of District Committee members by revenue, number of registered representatives, and primary income sources. The NASD will also consider developing candidate outreach programs, more clearly delineating the responsibilities of District Directors in the nomination process, and providing nominating committees with more candidate background information.

Resources And Staffing

To abate any concerns that existing staff will be insufficient to manage all of the approved changes, the NASD intends to perform immediate analysis of disciplinary and enforcement personnel needs. This analysis will include a determination of resources necessary to establish an Office of Professional Hearing Officers, and a significant expansion of OGC duties associated with the NBCC's appellate functions.

NASDR will construct, implement, and use, on an ongoing basis, a resource needs model that objectively determines resources required to perform current tasks, and projects resources required to perform additional tasks planned for upcoming years. Further, the NASD plans to adopt a policy that will require all future proposals that may affect staffing and resource needs (e.g., rulemaking, or shifts in priorities) to include an estimate of the anticipated resource requirements.

New Offices And Functions Planned

Office Of Internal Review

To broaden the scope and focus of its operational reviews, the NASD will increase the staff of the Office of Internal Review. This step will also permit Internal Review to focus on District reviews, and an aggressive plan to review all Districts will be adopted and implemented as soon as possible.

The Office of Internal Review will be located within the parent corporation and will report to the CEO as well as to the NASD Audit Committee. Internal Review will be housed within the parent corporation to insulate the office and its staff from possible retribution by the operating business lines. The Vice President for Internal Review will be empowered to conduct special investigations on his or her own initiative.

Ombudsman Function Established

A new position and function recommended by the Select Committee— the "ombudsman"— will also be sited within the NASD's existing Office of Internal Review. The ombudsman will receive, consider, and investigate "out of channel" concerns and complaints, that is, those remaining after normal complaint mechanisms are exhausted, from internal and external sources, and act as a liaison with operating departments to resolve complaints.

Centralized Coordination With Other Regulators

The NASD plans to centralize in a single unit staff responsible for coordinating national, regional, and local initiatives designed to further coordination of regulatory and enforcement matters with state regulators, the SEC, other federal regulators, and the other SROs. This action would formalize efforts presently carried out by the Office of Regulatory Policy and others. This central unit will, among other things, sponsor annual meetings with other securities regulators to address regulatory and enforcement matters and coordinate national initiatives. The central unit will also serve as the point of contact for state and other regulators seeking information or assistance from NASDR.

Investor Services

A new Investor Services Department will be charged with promoting individual investor education, functioning as a central point of entry for written inquiries from investors, coordinating investor programs throughout the Association, administering a formal investor outreach program, acting as liaison with investor organizations and governmental consumer affairs offices, and identifying technology services that might be provided to investors.

Because investor concerns may emanate from the rules of either Nasdaq® or NASDR, and because the office's educational efforts should be targeted at both securities market issues and the regulatory process, the Investor Services Department will be housed in the corporate parent. This newly created department will be headed by an officer who reports to the CEO of the parent corporation. The head of this Office will be authorized to raise issues and have open access to the chairs of the NASD's Quality of Markets Committee and/or non-industry directors of the Nasdaq or NASDR Boards.

Questions regarding this Notice should be directed to Daniel M. Sibears, Director, Office of Regulatory Policy at (202) 782-6911 or Anne H. Wright, Assistant General Counsel, Office of General Counsel, at (202) 728-8815.

1 The minor violation plan allows simplified handling of misconduct for which the recommended sanctions are limited to censures, or fines that do not exceed $2,500. Persons who are believed to have engaged in misconduct falling within the plan are given notice of that fact before a disciplinary complaint is issued, and may consent to the entry of specified sanctions. The proposal outlined in text would permit Hearing Officers to act as single-person hearing panels in cases in which disciplinary respondents elected against having allegations of misconduct resolved pursuant to the minor violation plan. Details regarding the minor violation plan may be found in Article II, Section 10(b) of the NASD Code of Procedure, and in NASD Notice to Members 93-42.

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