Legal & Compliance
*These are suggested departments only. Others may be appropriate for your firm.
On April 13, 1989, significant amendments to Article III, Section 27 of the NASD Rules of Fair Practice will take effect. This notice sets forth, in question and answer format, certain guidelines for compliance with the new provision.
As announced in Notice to Members 88-84 (November 1, 1988), significant amendments to Article III, Section 27 of the Rules of Fair Practice, pertaining to supervision, will take effect April 13, 1989. The amendments (1) prescribe specific supervisory practices and procedures for all member firms and (2) revise the definitions of office of supervisory jurisdiction and branch office. Since the publication of Notice to Members 88-84, several NASD members have raised questions concerning the new provisions. The NASD is publishing the answers to certain of these questions for the benefit of all members.
QUESTIONS AND ANSWERS
Supervisory Practices and Procedures
Q: Must the supervisory system established in compliance with Article III, Section 27 cover all operations of the firm or only retail sales?
A: The supervisory system must cover all aspects of the firm's investment banking and securities business, including back office; corporate financing; trading activity; market services such as SOES, OCT, and NASDAQ/NMS trade reporting; and so forth. The degree of detail in the plan for a given aspect of business will vary, depending on, for example, the extent to which detailed regulatory requirements apply to that aspect. Thus, the supervisory procedures for retail activity are likely to be more extensive than for other areas.
Q: Section 27(a)(2) requires the designation, where applicable, of an appropriately registered principal with authority to carry out the supervisory responsibilities of the member for each type of business in which it engages for which registration as a broker-dealer is required. Has the NASD established any specific requirements for these individuals?
A: No specific requirements have been established for purposes of Article III, Schedule 27. The applicable standards are contained in Part II of Schedule C, which sets forth the qualifications for functioning in the various principal capacities. Thus, for example, the principal designated as responsible for the review of the firm's options business must be qualified under Schedule C to function in a principal capacity with respect to options transactions. Similarly, the principals and representatives who are assigned to carry out supervisory functions in the members' offices pursuant to Section 27(a)(4) must be qualified to function as principals or representatives as to the products sold in the offices they supervise.
Q: Section 27(a)(6) requires members to make reasonable efforts to determine that all supervisory personnel are properly qualified. What constitutes reasonable efforts?
A: It would be impossible for the NASD to prescribe specific steps to be taken to determine the proper qualification of supervisory personnel. Generally speaking, such persons should be knowledgeable with respect to both regulatory requirements and the firm's product line, experienced in the activities that take place in the office they are supervising, and capable of exercising authority over their subordinates. In addition, factors such as relevant industry experience, previous employment, and disciplinary history should be taken into account.
Q: Section 27(a)(7) requires that each representative participate in an annual compliance interview.
(a) Is a telephone interview adequate?
A: Neither a telephone interview nor a video conference complies with the rule. The interview or meeting must be "in person," although, as the rule states, it may be individual or collective, and the compliance discussions may take place in conjunction with discussions or presentations on other topics. It would, however, be permissible to include the showing of a videotape prior to or as a part of the presentation.
(b) Must the interview be conducted by a principal? By an employee from the compliance department or main office?
A: The interview or meeting is not required to be conducted by a registered principal or by an employee from the main office or compliance department. A qualified branch manager may conduct the interview or meeting, as may a qualified registered representative. A member may also engage a third party to conduct the interview or meeting; however, the firm cannot avoid ultimate responsibility for any inaccuracies or other problems in the contents presented or procedures employed.
(c) What should be discussed and what type of records should the firm maintain to establish compliance?
A: It would be impossible for the NASD to provide an exhaustive list of the topics that should be addressed at the compliance interview or meeting. Generally speaking, the purpose of the requirement is threefold: (1) to provide the member an opportunity to review the product mix and method of operation of each representative and emphasize compliance issues related thereto; (2) to provide the representative an opportunity to ask any questions he or she may have and receive authoritative guidance; and (3) to communicate regulatory developments, firm policies, and similar information to the representatives. As to evidencing compliance, members may wish to maintain records that reflect the date and location of the interview or meeting, the attendees, and the subjects discussed.
(d) Is the requirement limited to those representatives who engage in retail sales?
A: The rule requires that all registered representatives must attend an interview or meeting; it is not intended to be restricted to those representatives engaged in retail sales.
Q: Section 27(a)(8) requires members to designate and "specifically identify" to the NASD one or more principals to review the member's supervisory system and take or recommend appropriate action. How should members identify such individuals to the NASD?
A: Members should maintain a record of the individual(s) so designated so that it may be provided to the NASD on request. Sometime in the future, the identification will be made by means of the Form BD. Members will be advised of any changes in this regard.
Q: Section 27(c) continues the existing requirement that each member review the activities of each office, including the periodic examination of customer accounts to detect and prevent irregularities or abuses. By the phrase "each office,"does the NASD mean to include nonbranch offices?
A: This review requirement (as contrasted to the inspection requirements applicable to offices of supervisory jurisdiction and branch offices) encompasses all offices of the member, regardless of whether they are OSJs or branch offices. The NASD believes that it is essential for a member to be aware, on an ongoing basis, of the individuals located in and activities of each office at which the member's business is conducted, and to be able to monitor all customer accounts, wherever they are handled, for irregularities and abuses.
Q: May a member employ outside entities to perform the branch office inspections required by Section 27(c)?
A: Yes. As with the compliance interview, however, the member cannot avoid regulatory responsibility for the conduct of the inspections.
Definition of Office of Supervisory Jurisdiction
Q: If an individual located away from an office of the firm telephones an order to the firm's clearing broker, does that person's location become an Office of Supervisory Jurisdiction (OSJ) under Section 27(f)(l)(i), "order execution and/or market making"?
A: The individual's location would not be an OSJ because the order is executed by the clearing broker, not the introducing broker. Such a practice, however, does raise concerns about the introducing broker/employer's ability to supervise the transaction.
Definition of Branch Office
Q: If, prior to April 13, 1989, a member has contracted for a telephone directory listing that does not comply with the exception to the branch office definition, must the office be designated as a branch office until a complying listing is published?
A: No, provided that the listing is modified to comply in the next-published directory and that the contract was entered into prior to November 1, 1988, the date when the membership was notified of the effective date of the amendments.
Q: Must a "white pages" listing also contain the address and telephone number of the supervising office in light of the exclusion of a routine listing from the definition of advertisement in Section 35(a)(l) of the Rules of Fair Practice?
A: Yes, a "white pages" or routine listing must contain the address and telephone number of the supervising office if the member wishes to avail itself of the exception from the definition of branch office. The definition of advertisement does not affect this requirement.
Q: The NASD has proposed amendments to Article III, Section 35 that would affect the form of business cards and letterhead (see Notice to Members 89-22). Is it possible to delay compliance with Article III, Section 27(f)(2) until those provisions go into effect?
A: No. The NASD has already provided a six-month phase-in period for the new branch office definition and does not believe it is appropriate to delay further the effectiveness of this key aspect of the new rules. In order to reduce the financial burden of compliance with both changes, it may be possible to affix the supervising office identification to existing cards and letterhead until the new advertising rules take effect. As an alternative, a member may wish to prepare new business cards that comply with both rules even though the advertising rules are not yet effective.
Q: Under Section 27(f)(2), would the branch office definition include:
(a) An exhibit booth in a shopping mall?
A: If an "exhibit booth" is permanent or regularly used, it would be covered by the definition.
(b) An office listed on a building lobby directory?
A: Such an office would be subject to the definition because it is being identified to the general public as an office of the member.
(c) An office identified by a sign on the door?
A: The NASD believes that, if a door sign is visible to the general public, it would cause the location to be a branch office. In response to member inquiries concerning certain state law requirements regarding door signs, the NASD is considering whether a sign that appears only on a door inside a building on an interior hallway and is not placed in an area of general public access would cause the location to be a branch office.
(d) A sign at a desk in a savings and loan office?
A: If the member does business at that location, it must be designated as a branch office; however, a sign that merely advertises the member's business and directs interested parties to a telephone number or an office of the firm would not give rise to the branch office designation.
(e) An office where only the local telephone number (not an address) is printed in a newspaper advertisement?
A: A nonbranch location may not advertise. If a newspaper advertisement lists a local telephone number, the location at which that telephone is answered would be a branch office regardless of whether the address is given. Such an advertisement identifies that location as a place where the public, via telephone, can do business with the member.
(f) A location to which individuals are referred when they respond to a newspaper or magazine advertisement listing the main office telephone number?
A: The identification of a location otherwise excepted from the definition of a branch office under such circumstances is unlikely to cause that location to become a branch office. It is the main office that is being identified to the public; the local office is identified only after the prospective customer has initiated the contact.
Questions concerning this notice can be directed to Jacqueline D. Whelan, Assistant General Counsel, Office of the General Counsel, at (202) 728-8270.