Notice To Members 83-72

Request for Comments on Proposed Amendment to Schedule C to the By-Laws

Published Date:

I M P O R T A N T

Officers * Partners * Proprietors

TO: Members of the National Association of Securities Dealers, Inc. and Other Interested Persons

COMMENT PERIOD CLOSES ON: January 20, 1984

The National Association of Securities Dealers, Inc. ("Association") is publishing for comment a proposed amendment to Schedule C to the By-Laws. The amendment was approved by the Board of Governors at its November 1983 meeting. After the comment period has expired, the Board of Governors will review the proposal taking into consideration the comments received. If adopted by the Board of Governors the proposal will thereafter be filed with the Securities and Exchange Commission for approval.

A discussion of the background and purpose of the amendment, an explanation of the changes and the text of the amendment appear below.

BACKGROUND AND PURPOSE

The proposal would amend the definition of "representative" in Schedule C to the By-Laws to cover a class of persons including persons who are employed by certain non-broker/dealer organizations and who perform activities on behalf of members similar to those performed by registered representatives. The effect of the amendment will be to require members to register such persons as representatives and bring them under regulation comparable to the regulation to which registered representatives of members presently are subject.

In the mid-1940s the Association instituted its existing program for regulation of personnel of members by adopting amendments to its By-Laws and Rules of Fair Practice requiring members to register certain persons associated with members as registered representatives. The amendments also made registered representatives subject to the same obligations as members under the Association's rules and allowed disciplinary action to be brought against registered representatives for violations of Association rules. The regulation of registered representatives was extended in 1956 by the introduction of a requirement that persons becoming registered as representatives take and pass a written qualification examination before they could function as registered representatives of members.

At the present time the registration and qualification requirements are contained in Schedule C to the By-Laws adopted by the Board of Governors pursuant to the authority granted by Article I, Section 2(d) of the By-Laws. The provisions of Schedule C have been refined in the intervening years so that today there are separate registration categories for principals and representatives and separate examinations for principals and representatives. In addition, there are specialized qualification examinations within the two broad categories for principals and representatives who engage in specialized areas such as the sale of investment company securities and variable annuities, direct participation program securities, options and municipal securities.

Under existing Schedule C all persons who are compensated by members for solicitation, accepting orders, or recommending securities to customers or providing investment advice resulting in securities transactions must be registered before being permitted by a member to engage in such activities. The definition of "representative" in Schedule C covers persons who are engaged in the investment banking and securities business "for the member" including the functions of "solicitation or conduct of business in securities". The definition, however, has been traditionally applied only to employees, independent contractors and other natural persons who are directly compensated by the member for such activities.

The Board is proposing to extend the coverage of Schedule C to apply to certain persons who, if they were employees of a member, would clearly fall within the definition of representative. The securities activities of banks, savings and loan associations and certain other organizations such as real estate brokers have expanded over the past few years. In addition, the relationship between members and these institutions has assumed a different direction. There have traditionally been personnel within these institutions engaged in securities activities such as trust officers, traders, portfolio managers and investment consultants and financial consultants and investment officers. In the past, however, these institutions simply referred securities business to members which charged the institutions a commission or fee. The commissions or fees earned by members from this referred business was not shared by the members with the institutions. A number of banks and savings and loan associations and other business organizations have recently entered into contractual or other arrangements with members to refer the institution's customers to members for execution of transactions and in return for such business the members have agreed to compensate the institutions by sharing commissions or in other ways. 1/ This appears to be an increasing trend in the securities industry. In many cases the ability of institutions to provide brokerage services to its customers through these arrangements with members is actively promoted through advertising and publications. Although some personnel at the institutions appear to perform only clerical and ministerial functions, there do not appear to be any requirements to limit the ability of personnel to make recommendations or engage in other functions specified in the definition of representative in Schedule C to the By-Laws. If such persons do make recommendations to customers, however, it does not appear that the registration requirements of Schedule C would apply since they often receive no direct compensation from members even though the employer institution does.

The Board believes the public interest is not served by exempting from the registration requirements employees of organizations who are dealing with public customers in the same way in which registered representatives of members deal with the public. At the present time these persons are not required to take qualification examinations and function outside the supervisory responsibilities which members are required to exercise over their other representatives. It is also not entirely clear, absent registration, whether the Association could hold them individually accountable for misconduct by imposing disciplinary sanctions against them. The Association is concerned that the lack of any formal qualification standards, supervision and individual accountability for misconduct may create conditions which unnecessarily may expose public customers to the risk of harm. The Board believes that unless registration is a requirement it cannot fully carry out its statutory responsibility to prevent fraudulent acts and practices, to promote just and equitble principles of trade and to protect investors and the public interest.

The proposal is intended to cover non-broker/dealer personnel who perform securities activities on behalf of members. It is thus limited to employees of organizations which have entered into arrangements with members by which the activities of the employees actively further the securities business of the members. Further, the only non-broker/dealer employees who would come under the new definition of "representative" in proposed section (b)(ii) would be employees who receive compensation from members or whose employers receive compensation from members. The Board believes that its statutory duty to regulate its members is not fully implemented by allowing a situation where persons soliciting or receiving business for members are not required to take and pass qualification examinations and to be subject to disciplinary action for violations of applicable requirements. The Board believes that if a person is soliciting or receiving business for a member and the member compensates the employer the impact on the public interest is no less great than if the person is compensated directly by the member. The need for protection against unqualified persons achieved by examinations and accountability through disciplinary proceedings and member supervisory responsibility is no less important. Accordingly, the effect of the proposal is to require members to register such persons so that investors will receive equal protection under the Association's rules and the federal securities laws.

SCOPE OF PROPOSAL

The following is a brief discussion of the intended scope of the proposal.

1. It does not appear that the public interest requires registration of all persons employed by banks or other organizations which assist the organization and the member in furthering the member's securities business. Those employees who perform clerical and ministerial functions such as distributing literature describing the securities service being offered through a member or handing out necessary forms and providing routine procedural directions and instructions are not intended to be covered by the proposal. Such clerical activities do not require registration under present Schedule C for persons directly compensated by members where their employment is solely and exclusively limited to such activities.
The only persons who would be deemed representatives under the proposed amendment are those employees of non-broker/dealer organizations whose activities fall into two categories: (1) solicit or receive orders from public customers for the purchase or sale of securities, or (2) give investment advice or make recommendations to public customers with respect to securities transactions. The language used is intended to limit the definition to employees of non-broker/dealers who receive orders directly from members of the public, whether or not solicited, or who make recommendations or give advice directly to public customers with respect to securities even though any resulting order may be directly transmitted by the customer to the member for execution.
2. It is not intended that the proposal would apply to employees of banks or other organizations who engage in securities activities in areas of an organization where dealings with members do not result in payment of compensation by the member to the organization. The Board believes that its statutory responsibility to regulate its members makes it necessary and appropriate to assure the qualfications and integrity of employees of organizations who are employed in an area of the organization's operations where customers are introduced or referred to a member and compensation is paid to the employee or organization. Thus, the language of proposed Subsection (1)(b)(ii) of Part II of Schedule C would require registration only with respect to employees of organizations where the organization has entered into an arrangement with a member to receive compensation from transactions executed by the member. It also makes clear that only certain employees whose activities with the organization are in furtherance of the arrangement with the member are covered.
The proposal is not intended to interfere with conventional securities activities of banks or other organizations. Where no compensation is received from members, the personnel in bank trust departments, traders, money managers, portfolio managers could continue to engage in such securities activities as making recommendations covering securities and executing or transmitting orders to broker/dealers for execution without any requirement to register.
3. The proposal does not cover arrangements between members and organizations which are registered broker/dealers because under such arrangements the organization's personnel have satisfied applicable qualification requirements and are already subject to regulatory jurisdiction by one or more regulatory organizations. For the same reason employees of non-broker/dealer organizations who are themselves registered broker/dealers are excluded from coverage. The proposal is also intended to cover natural persons who, although not employees, are affiliated with the organization such as consultants or other independent contractors. The definition of "compensation paid by the member" to include commission sharing is intended to prevent circumvention through arrangements structured to make it appear that the compensation is being paid by the organization to the member. If the nature of the arrangement contemplates referral of customer business to the member with an agreement to share resulting commissions, the mechanics of sharing the commissions would be irrelevant for purposes of the new definition.
4. The changes proposed in Subsections (1)(a), (2)(a)(i), (2)(b)(i), (2)(c)(i) and (2)(d) of Part II of Schedule C are technical amendments to avoid misunderstanding concerning the intended scope of new Subsection (1)(b)(ii). The Association believes that in the vast majority of eases such individuals would clearly come within the definition of associated persons under the By-Laws. The Association recognizes, however, that there may be some situations where the definition of associated persons would apply but in an indirect way. The approach the Association has taken therefore is to make the registration requirements clear by defining the term registered representative to specifically include such persons as registered representatives.
All comments pertaining to this proposal should be in writing and sent to S. William Broka, Secretary, National Association of Securities Dealers, Inc., 1735 K Street, N.W., Washington, D.C. 20006, and be received on or before January 13, 1984, in order to receive consideration. Questions concerning the proposal may be directed to John F. Mylod, Jr., Assistant General Counsel, at (202) 728-8288.

Sincerely

Frank J. Wilson
Executive Vice President
Legal and Compliance

TEXT OF PROPOSED AMENDMENTS

Schedule C to the By-Laws

II.

REGISTRATION OF REPRESENTATIVES

(1) Registration Requirements
(a) All Representatives Must be Registered — All persons included within the definition of Representative associated with a member who are to function as representatives shall be registered as such with the Corporation in the category of registration appropriate to the function to be performed as specified in Part II, Section (2) hereof. Before their registrations can become effective, they shall pass a Qualification Examination for Representatives appropriate to the category of registration as specified by the Board of Governors.
(b) Definition of Representative:
(i) Persons associated with a member, including assistant officers other than principals, who are engaged in the investment banking or securities business for the member including the functions of supervision, solicitation or conduct of business in securities or who are engaged in the training of persons associated with a member for any of these functions are designated as representatives; and
(ii) Any other natural person, other than a registered broker or dealer, who solicits or receives orders from customers for the purchase or sale of securities for execution by a member, or gives investment advice or makes recommendations to customers with respect to securities transactions for execution by a member in furtherance of any arrangement by which compensation is paid by the member for such activities to such person or to an entity, other than a registered broker or dealer, with which such person is employed or otherwise affiliated. For purposes of this subsection, "compensation paid by the member" shall include any sharing of compensation paid by customers.

[In addition, Subsections (2)(a)(i), (2)(b)(i), (2)(c)(i) and (2)(d) of Part II of Schedule C would be amended to eliminate the phrase "associated with a member".]

1/ Banks are exempt from the broker /dealers definitions in the 1934 Act and a number of savings and loans have received "no-action" letters to permit such arrangements without broker/dealer registration.