[Federal Register Volume 62, Number 156 (Wednesday, August 13, 1997)]
[Notices]
[Pages 43385-43408]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-21330]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-38908; File No. SR-NASD-97-28]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Approving Proposed Rule Change and Amendment No. 1 
to the Proposed Rule Change, Order Granting Accelerated Approval of 
Amendment No. 2 to the Proposed Rule Change, and Notice of Filing and 
Order Granting Accelerated Approval of Amendment Nos. 3, 4, and 5 to 
Proposed Rule Change Regarding Membership Application Procedures, 
Disciplinary Proceedings, Investigations and Sanctions Procedures, and 
Other Conforming Changes

August 7, 1997.
    On April 18, 1997, the National Association of Securities Dealers, 
Inc. (``NASD'' or ``Association'') filed with the Securities and 
Exchange Commission (``Commission'' or ``SEC'') a proposed rule change 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') <SUP>1</SUP>, and Rule 19b-4 thereunder.<SUP>2</SUP> The 
Association originally proposed to amend: (1) The By-Laws of the NASD; 
(2) the By-Laws of NASD Regulation, Inc. (``NASD Regulation'' or 
``NASDR''); (3) the By-Laws of The Nasdaq Stock Market, Inc. 
(``Nasdaq''); (4) the Plan of Allocation and Delegation of Functions By 
NASD to Subsidiaries (``Delegation Plan''); (5) Rule 0120; (6) Rule IM-
2210-4; (7) the Rule 1010 Series; (8) the Rule 8000 Series; and (9) the 
Rule 9000 Series.
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    \1\ 15 U.S.C. Sec. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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    On April 23, 1997, the NASD filed a technical amendment to the 
proposed rule change.<SUP>3</SUP> Notice of the proposed rule change, 
including Amendment No. 1, was provided by issuance of a Commission 
release on April 24, 1997 and by publication in the Federal Register on 
May 8, 1997.<SUP>4</SUP> On July 10, 1997, the NASD filed Amendment No. 
2, pertaining to changes to the 9400 Series (Members Experiencing 
Financial or Operational Difficulties), the 9500 Series (Summary and 
Non-Summary Suspensions, Cancellation, Bar, and Limitation or 
Prohibition on Access to NASD Services), and the 9600 Series 
(Procedures for Exemptions from Certain NASD Rules). Notice of 
Amendment No. 2 to the proposed rule change was provided by issuance of 
a Commission release on July 11, 1997 and by publication in the Federal 
Register on July 16, 1997.<SUP>5</SUP> On July 11, 1997, the NASD filed 
Amendment No. 3 to the proposed rule change, making several clarifying 
changes to the investigations and sanctions, disciplinary, and member 
admission procedures.<SUP>6</SUP> Amendment No. 3 also withdrew the 
proposed amendments to the by-laws of the NASD, NASD Regulation, and 
Nasdaq, as well as proposed amendments to these entities' restated 
Certificates of Incorporation and the Delegation Plan. These documents 
will be amended to reflect the corporate restructuring recently 
approved by the NASD Board of Governors and will be submitted in a 
separate rule filing at a later date. On July 21, 1997, the NASD filed 
Amendment No. 4 to the proposed rule change making several technical, 
nonsubstantive amendments.<SUP>7</SUP> On August 4, 1997, the NASD 
filed Amendment No. 5 to the proposed rule change, which modified the 
timing of the effectiveness of the proposed rule change and included 
several technical amendments.<SUP>8</SUP> The Commission received two 
comment letters on the proposal.<SUP>9</SUP>
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    \3\ Letter from Alden S. Adkins, General Counsel, NASD 
Regulation, Inc. to Katherine A. England, Assistant Director, 
Division of Market Regulation, Commission, dated April 23, 1997 
(``Amendment No. 1'').
    \4\ Securities Exchange Act Release No. 38545 (Apr. 24, 1997), 
62 FR 25226 (May 8, 1997) (publishing notice of SR-NASD-97-28) 
(``Original Proposal'').
    \5\ Securities Exchange Act Release No. 38831 (July 11, 1997), 
62 FR 38156 (July 16, 1997) (``Amendment No. 2'').
    \6\ Letter from Alden S. Adkins, General Counsel, NASD 
Regulation, to Katherine A. England, Assistant Director, Division of 
Market Regulation, Commission, dated July 11, 1997 (``Amendment No. 
3''). Except for technical, clarifying changes, a description of the 
proposed changes set forth in Amendment No. 3 regarding the 
investigations and sanctions, disciplinary, and member admission 
procedures is provided below. In addition to the NASD's proposed 
changes to the Original Proposal, the NASD included in Amendment No. 
3 its response to the two submitted comment letters (``NASD 
Response''). See also Colish Letter and ABA Letter, infra note 9.
    \7\ Letter from Alden S. Adkins, General Counsel, NASD 
Regulation, Inc. to Katherine A. England, Assistant Director, 
Division of Market Regulation, Commission, dated July 21, 1997 
(``Amendment No. 4'').
    \8\ Letter from Alden S. Adkins, General Counsel, NASD 
Regulation, Inc. to Katherine A. England, Assistant Director, 
Division of Market Regulation, Commission, dated August 4, 1997 
(``Amendment No. 5''). Certain minor modifications to the Delegation 
Plan needed to ensure conformity to the changes in the rules of the 
NASD contained in this rule filing are set forth in Amendment No. 5 
to SR-NASD-96-29, which is being temporarily approved concurrently 
with this filing. Securities Exchange Act Release No. 38909 (Aug. 7, 
1997).
    \9\ Letter from Faith Colish, Attorney, Faith Colish P.C., to 
Jonathan G. Katz, Secretary, Commission, dated June 9, 1997 
(``Colish Letter''); letter from George S. Frazza, Chair, Section of 
Business Law and Barry F. McNeil, Chair, Section of Litigation, 
American Bar Association, to Jonathan G. Katz, Secretary, 
Commission, dated June 17, 1997 (``ABA Letter'').
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I. Introduction and Background

    On August 8, 1996, the Commission issued an order (``SEC Order'') 
pursuant to Section 19(h)(1) of the Act. This order made certain 
findings about the NASD and conduct on Nasdaq and imposed remedial 
sanctions, including ordering the NASD to comply with certain 
undertakings (``Undertakings'').<SUP>10</SUP> The Commission determined 
that the NASD had not complied with the NASD's rules or satisfied its 
obligations under the Act to enforce its rules and the federal 
securities laws. In particular, the Commission determined that the NASD 
failed to thoroughly investigate certain misconduct by dealers and to 
take effective regulatory action. Moreover, the Commission determined 
that the NASD failed to enforce market makers' obligations to trade at 
their quotations, and report transactions on a timely and accurate 
basis. The Commission also determined that the NASD processed 
applications for membership of certain firms in a manner inconsistent 
with its rules.
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    \10\ Securities Exchange Act Release No. 37538 (Aug. 8, 1996), 
SEC's Order Instituting Public Proceedings Pursuant to Section 
19(h)(1) of the Securities Exchange Act of 1934, Making Findings and 
Imposing Remedial Sanctions, In the Matter of National Association 
of Securities Dealers, Inc., Administrative Proceeding File No. 3-
9056. SEC, Report and Appendix to Report Pursuant to Section 21(a) 
of the Securities Exchange Act of 1934 Regarding the NASD and The 
Nasdaq Stock Market (Aug. 8, 1996) (``21(a) Report'').
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    In addition, the Commission found in its 21(a) Report, among other 
things, that market making firms were afforded a disproportionate 
representation on the boards and committees that govern the NASD, 
administer its disciplinary process, and operate the Nasdaq market. The 
Commission concluded in the 21(a) Report that market makers had unduly 
exerted their influence over the disciplinary process through their 
participation in the District Business Conduct Committees 
(``DBCCs'').<SUP>11</SUP> In

[[Page 43386]]

addition, the Commission noted that ``undue influence of market makers 
and a lack of vigor and balance in the NASD's enforcement activities 
with respect to market maker firms'' was inconsistent with the NASD's 
statutory obligation <SUP>12</SUP> to oversee the Nasdaq market and to 
enforce its rules and regulations fairly as to all member 
firms.<SUP>13</SUP>
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    \11\ The Commission found that the DBCCs performed a ``grand 
jury'' function, in which the NASD staff were required to seek DBCC 
authorization to initiate a disciplinary proceeding. In addition, 
the DBCCs served as adjudicative bodies, ruling on disciplinary 
proceedings and approving settlements. 21(a) Report, supra note 10, 
at 35 n.91. As examples of the DBCCs' undue influence over the 
disciplinary process, the Commission pointed to heightened 
enforcement efforts regarding Small Order Execution System 
violations and the NASD's laxity in enforcing firm quote 
obligations, trade reporting rules, and excused withdrawal rules. 
Id. at 36-39.
    \12\ Section 19(g)(1)(B) of the Act, 15 U.S.C. 
Sec. 78s(g)(1)(B).
    \13\ 21(a) Report, supra note 10, at 39.
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    Further, the Commission found that the NASD processed applications 
for membership of certain firms in a manner inconsistent with its 
rules.<SUP>14</SUP> Specifically, the Commission found that the NASD 
failed to process certain applications within a reasonable time, 
required some applicants to satisfy criteria not enumerated in its 
rules, placed improper restrictions on those firms' activities as a 
condition to membership, and prevented such members, once admitted, 
from seeking modifications to their restriction agreements as permitted 
by the NASD's rules.
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    \14\ SEC Order, supra note 10.
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    Based on the Commission's specific findings, the NASD agreed to 
certain undertakings, including, among other things, undertakings to 
improve public representation on its Boards and committees, to 
institute professional hearing officers, to confer sole discretion in 
the regulatory staff of the NASD as to prosecutorial and regulatory 
matters, and to promulgate and apply uniform standards for regulatory 
and other access issues.<SUP>15</SUP> Under the general terms of 
certain of the Undertakings in the SEC Order, and in response to the 
Commission's conclusions in the 21(a) Report, the NASD is proposing to 
amend its Code of Procedure and Membership Application and Registration 
Procedures.
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    \15\ Undertakings one through six of the SEC Order require the 
Association:
    1. To implement and maintain at least fifty percent independent 
public and non-industry membership in its Board of Governors, the 
Board(s) of Governors or Directors of all of its subsidiaries and 
affiliates that exercise or have delegated self-regulatory 
functions, and the following committees: the National Nominating 
Committee, the Trading/Quality of Markets Committee, the Arbitration 
Committee, the Market Surveillance Committee (now the Market 
Regulation Committee), the National Business Conduct Committee, the 
Management Compensation Committee, and all successors thereto.
    2. To provide that NASDR and any successor thereto has, 
consistent with the NASD's By-Laws and Plan of Delegation, as 
amended from time to time and as approved by the Commission, primary 
day-to-day responsibility for the regulation, surveillance, 
examination, and disciplining of NASD member firms and registered 
persons, with respect to market activities as well as other self-
regulatory matters, with full access to the records of the Nasdaq 
market.
    3. To institute the participation of professional Hearing 
Officers (who shall be attorneys with appropriate experience and 
training) to preside over disciplinary proceedings.
    4. To provide for the autonomy and independence of the 
regulatory staff of the NASD and its subsidiaries such that the 
staff, subject only to the supervision of the Board of Governors of 
the NASD and the Boards of Directors of NASDR and Nasdaq, and any 
successor thereto, (a) has sole discretion as to what matters to 
investigate and prosecute, (b) has sole discretion to handle 
regulatory matters such as approval of applications for membership 
and the conditions and limitations that may be placed thereon, (c) 
prepares rule proposals, rule interpretations and other policy 
matters with any consultations with interested NASD constituencies 
made in fair and evenhanded manner, and (d) is generally insulated 
from the commercial interests of its members and the Nasdaq market. 
Among other things, the District Business Conduct Committees and the 
Market Surveillance Committee shall not have any involvement in 
deciding whether or not to institute disciplinary proceedings, nor 
shall the District Committees, or any subcommittee thereof, have any 
involvement in the review or approval of applications for membership 
in the NASD. Subject to the foregoing, the regulatory staff of the 
NASDR engaged in the disciplinary process may, solely on their own 
initiative, inform themselves on matters of market or other 
securities industry expertise by consulting with representatives of 
member firms or committees of the NASD or its subsidiaries.
    5. To promulgate and apply on a consistent basis uniform 
standards for regulatory and other access issues, such as admission 
to the NASD as a member firm, and conditions to becoming a market 
maker; and institute safeguards to ensure fair and evenhanded access 
to all services and facilities of the NASD.
    6. To ensure the existence of a substantial, independent 
internal audit staff which reviews all aspects of the NASD 
(including the regulatory function, the disciplinary process and the 
Nasdaq stock market and its systems) and reports directly to an 
audit committee of the NASD Board of Governors which includes a 
majority of public and non-industry Governors and is chaired by a 
public Governor.
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II. Description of the Proposal

    The proposed changes to the NASD's membership and registration 
rules, investigations and sanctions rules, and the code of procedure 
are summarized below in the order that they appear in the 
rules.<SUP>16</SUP>
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    \16\ For a more detailed description of the NASD's proposed rule 
change, see Original Proposal, supra note 4; Amendment No. 2, supra 
note 5; Amendment No. 3, supra note 6; Amendment No. 4, supra note 
7; and Amendment No. 5, supra note 8.
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A. Changes to the Membership and Registration Rules

    The Rule 1010 Series governs the procedures for becoming a member 
of the NASD. The proposed changes to the Rule 1010 Series will 
substantially alter the current procedures for membership application. 
The proposed Rule 1010 Series provides that NASD Regulation staff, 
rather than a District Committee, will make an initial decision on an 
application for membership. An applicant may appeal a staff decision to 
the National Business Conduct Committee (``NBCC''). The NBCC's decision 
is subject to discretionary review by both the NASD Regulation Board 
and the NASD Board. The proposed rule change also sets forth a more 
detailed and comprehensive list of the documents and information that 
must be submitted with a membership application and sets forth more 
detailed, comprehensive, and objective standards to be used to 
determine whether an applicant should be admitted to membership. The 
proposed rule change provides more procedural rights to applicants to 
ensure that applications are processed fairly and expeditiously, 
including limitations on the time within which the NASD must issue 
membership decisions.

B. Changes to the Investigations and Sanctions Rules

    The Rule 8100 Series currently governs complaints against NASD 
members. The Rule 8200 Series permits the NASD to investigate members' 
books, and requires members or associated persons to provide 
information in connection with investigations or proceedings conducted 
by the NASD. The Rule 8200 Series also currently provides the NASD with 
authority to suspend members or associated persons who do not comply 
with the Rule 8200 Series. The Rule 8300 Series currently provides for 
sanctions against members and persons associated with members for 
violations of NASD rules.
    The NASD proposes to amend the Rule 8000 Series to reflect the 
proposed changes to the disciplinary procedures in the proposed Rule 
9000 Series, discussed below, and to clarify and reorganize certain 
rule provisions in order to make them easier to read and understand. 
Currently, the decision to serve a complaint on a member pursuant to 
Rule 8130 is made by the NBCC. In addition, current Rule 8120 allows 
any person who believes he or she has been aggrieved by any act of any 
member or associated person to institute a formal disciplinary 
proceeding.
    The NASD proposes to rescind current Rule 8120. The NASD believes 
it is no longer necessary to give ``aggrieved persons'' the right to 
invoke NASD processes to institute formal

[[Page 43387]]

disciplinary actions in view of the enhancements to the disciplinary 
process, including the change to staff-initiated disciplinary 
proceedings, enhancements to the arbitration process, and the 
institution of an expanded and independent NASD internal review 
function (including an Ombudsman Office). The NASD also proposes to 
delete current Rule 8130, which authorizes the DBCCs to file 
complaints, to comply with Undertaking 4, which prohibits DBCCs from 
having any involvement in the decision whether or not to institute 
disciplinary proceedings.
    The NASD proposes significant changes to current Rule 8220, which 
authorizes the suspension of a member for failure to furnish the NASD 
with duly requested information or for failure to keep a membership 
application and supporting documents current. The proposed changes 
retain the NASD's summary suspension powers, but provide members and 
persons associated with members with enhanced procedural protections in 
connection with the suspension process. Under the proposed revisions to 
Rule 8221, the NBCC must provide written notice of the suspension to 
the member or associated person. The notice specifies the information 
that must be provided or the action that must be taken, and states that 
the failure to provide information or take the required action within 
20 days after service of the notice constitutes grounds for suspension. 
The NBCC must serve notice of the suspension through personal service 
or commercial courier.
    Proposed Rule 8222 makes explicit the right of a member or 
associated person to request a hearing before a subcommittee of the 
NBCC concerning the notice of suspension. Any subcommittee decision to 
impose a suspension must state the grounds for the suspension and the 
conditions for terminating it. Proposed Rule 8224 requires the NASD to 
provide to the entire NASD membership notice of any suspension imposed 
pursuant to Rule 8223, and proposed Rule 8226 requires that the NASD 
also serve the suspended member with a copy of a notice or decision 
served on the associated person.
    Proposed Rule 8225 adds a new provision for termination of the 
suspension. Upon request by the suspended member or associated person, 
the head of the appropriate NASD Regulation department or office may 
terminate a suspension if the member or associated person has fully 
complied with a notice or decision issued under the Rule 8220 Series. 
If the request is denied, the proposed rule provides the member or 
associated person with the right to apply to the NBCC for relief from 
the suspension on the grounds of full compliance with the notice issued 
under proposed Rule 8221 or the conditions specified in a decision 
issued under proposed Rule 8223.
    Proposed Rule 8227 clarifies that any action taken under the Rule 
8220 Series does not foreclose the NASD from taking action against the 
member or associated person under any other rule. Finally, the NASD 
also proposes to amend the Rule 8300 Series to make it conform with the 
proposed Rule 9000 Series and to make it shorter, clearer, and easier 
to understand.

C. Changes to the Code of Procedure

    The NASD proposes numerous changes to the Code of Procedure. In 
particular, the Rule 9100 Series sets forth rules of general 
applicability to disciplinary proceedings and other proceedings brought 
against a member or a person associated with a member. The Rule 9200 
Series sets forth the specific procedures for disciplinary proceedings, 
including settlements, letters of acceptance, waiver, and consent and 
minor rule plan violation letters, and the Rule 9300 Series sets forth 
the appeal or review procedures for a disciplinary proceeding. The Rule 
9400 and 9500 Series set forth the procedures regarding members 
experiencing financial or operating difficulties; summary and 
nonsummary suspensions, cancellation, bar, and limitation or 
prohibition on access to NASD services; and eligibility proceedings. 
The Rule 9600 Series delineates the procedures for exemptions from 
certain NASD Rules.
1. Application and Purpose
    The proposed Rule 9100 Series contains twenty proposed rules, 
setting forth a variety of important procedural modifications, 
including a detailed list of defined terms used throughout the Code of 
Procedure (proposed Rule 9120);<SUP>17</SUP> a series of rules 
regarding service <SUP>18</SUP> and notice of various papers and filing 
requirements (proposed Rule 9130 Series); rules relating to the 
appearance of counsel (or other person authorized to act in a 
representative capacity) (proposed Rules 9141, 9142, 9150); a detailed 
provision prohibiting ex parte communications generally (proposed Rule 
9143) and a related provision regarding separation of functions 
(proposed Rule 9144); a rule providing for a motions practice (proposed 
Rule 9146); a provision for disqualification of an adjudicator 
(proposed Rule 9160);<SUP>19</SUP> and a provision prohibiting 
interlocutory review (proposed Rule 9148).
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    \17\ In Amendment No. 3, the NASD proposes to amend, add, and 
delete several terms set forth in proposed Rule 9120. First, 
unnecessary terms such as ``Practicing before the NASD'' and 
``Complainant'' (because the only possible complainant is the 
Department of Enforcement) were deleted. A related change was made 
to the definition of ``Party'' now in proposed Rule 9120(v). Two new 
definitions were added. In proposed Rule 9120(d), ``Counsel to the 
National Business Conduct Committee'' was added to provide greater 
clarity with respect to the other proposed changes to the Rule 9300 
Series described below. In proposed Rule 9120(l), ``General 
Counsel'' was defined in order to shorten several references in the 
text to ``the General Counsel of NASD Regulation, or his or her 
delegatee,'' and to make explicit that the delegation by the General 
Counsel would extend only to certain persons directly reporting to 
the General Counsel with certain titles and/or responsibilities 
(e.g., an Associate General Counsel or an Assistant General 
Counsel). In addition, minor changes were also made to the 
definitions of ``Adjudicator,'' ``District Committee,'' ``Extended 
Hearing Panel,'' ``Extended Proceeding Committee,'' ``Hearing 
Panel,'' ``Interested Association Staff,'' ``Statutory 
Disqualification Committee,'' and ``Subcommittee,'' found, 
respectively, in proposed Rule 9120 (a), (f), (i), (k), (p), (q), 
(y), and (z). Some of these changes were made to conform the 
definitions to the proposed Rule 9400 Series and the proposed Rule 
9500 Series. Amendment No. 3, supra note 6.
    \18\ In Amendment No. 3, the NASD proposes to amend proposed 
Rule 9134(b)(2) so that service on an entity may be made by service 
on the contact person listed on the member's Form BD in addition to 
those persons already listed in the rule.
    \19\ The term ``Adjudicator'' means: (1) A body, board, 
committee, group, or natural person that presides over a proceeding 
and renders a decision; (2) a body, board, committee, group, or 
natural person that presides over a proceeding and renders a 
recommended or proposed decision which is acted upon by an 
adjudicator described in (1); or, (3) a natural person who serves on 
a body, board, committee, or group described in (1) or (2). The term 
includes a ``Subcommittee'' as defined in paragraph (z), an 
``Extended Proceeding Committee'' as defined in paragraph (k), and a 
``Statutory Disqualification Committee'' as defined in paragraph (y) 
(proposed Rule 9120(a)).
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2. Disciplinary Proceedings
    The proposed Rule 9200 Series contains thirty proposed rules. Under 
these rules, the roles of the District Committee and Market Regulation 
Committee are greatly reduced. Neither may initiate a complaint; 
instead, the Department of Enforcement may investigate a case and file 
a complaint to initiate a disciplinary proceeding (proposed Rule 
9211(a)). Further, NASD Regulation has established an Office of Hearing 
Officers as an independent office within NASD Regulation. The Office of 
Hearing Officers is headed by the chief hearing officer, who is an 
executive vice president and reports directly to the president of NASD 
Regulation. The purpose of the Office of Hearing Officers is to provide 
a group of independent and professional hearing officers (comprised of 
attorneys with

[[Page 43388]]

appropriate experience and training) to preside over all formal NASD 
disciplinary proceedings.
    Hearing panels or, if applicable, extended hearing 
panels,<SUP>20</SUP> are selected by a chief hearing officer, and are 
composed of a hearing officer (a professional NASD Regulation staff 
member) and two panelists, each selected from the securities industry 
and drawn from a pool of persons associated with a member or retired 
therefrom and who: (1) Currently serve or previously served on a 
District Committee; (2) previously served on the National Business 
Conduct Committee; (3) previously served on a disciplinary subcommittee 
of the National Business Conduct Committee, including a subcommittee, 
an extended proceeding committee, or their predecessor subcommittees; 
or (4) previously served as a director of NASD Regulation, a director 
of the Nasdaq Board of Directors, or a Governor of the NASD, but who do 
not serve currently in any of these positions.<SUP>21</SUP> In 
addition, a person who currently serves on the Market Regulation 
Committee (or who previously served on the Market Regulation Committee 
not earlier than four years before the date the complaint was served 
upon the respondent) <SUP>22</SUP> and who is associated with an NASD 
member or retired therefrom may be chosen by the chief hearing officer 
to serve as one of the panelists on a hearing panel or an extended 
hearing panel when the chief hearing officer determines that the 
complaint alleges at least one cause of action involving a violation of 
a statute or a rule within the scope of proposed Rule 
9120(r).<SUP>23</SUP> The hearing panel, or, if applicable, the 
extended hearing panel, issues the ``trial level'' decision in a 
disciplinary proceeding (proposed Rule 9268).
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    \20\ The chief hearing officer appoints an extended hearing 
panel if upon consideration of the complexity of the issues 
involved, the probable length of the hearing, or other factors, the 
chief hearing officer determines that a matter shall be an extended 
hearing (proposed Rule 9120(i) and proposed Rule 9120(h)). 
Designation of a matter as an extended hearing provides the chief 
hearing officer the ability to select, among other potential 
panelists, persons who are retired and may have both time and 
relevant experience to bring to an extended hearing (proposed Rule 
9231(c)).
    \21\ Amendment No. 3, supra note 6. In previously proposed Rule 
9231, most but not all former members of a District Committee were 
eligible to serve as a panelist on either a hearing panel or an 
extended hearing panel; now all former District Committee members 
are eligible. In addition, recently retired persons who were 
previously associated with the securities industry were not eligible 
to serve on hearing panels but were eligible to serve on extended 
hearing panels. In Amendment No. 3, among other things, retired 
persons may serve on both types of panels, and persons who have been 
retired for more than four years remain eligible to serve as 
panelists. Id.
    \22\ The NASD states that the period of four years was 
incorporated to define more clearly who is properly classified as a 
Market Regulation Committee panelist. This is important because the 
Code provides that only one Market Regulation Committee panelist may 
be appointed to serve on a hearing panel or an extended hearing 
panel. Amendment No. 3, supra note 6.
    \23\ Proposed Rule 9120(r) (formerly proposed Rule 9120(q)) 
states that the term ``Market Regulation Committee'' means the 
committee of NASD Regulation designated to consider the federal 
securities laws and the rules and regulations adopted thereunder and 
various rules of the NASD and policies relating to:
    (1) the quotations of securities;
    (2) the execution of transactions;
    (3) the reporting of transactions; and
    (4) trading practices, including rules prohibiting manipulation 
and insider trading, and those Rules designated as Trading Rules 
(Rule 3300 Series), the Nasdaq Stock Market Rules (Rule 4000 
Series), other Nasdaq and NASD Market Rules (Rule 5000 Series), NASD 
Systems and Programs Rules (Rule 6000 Series), and Charges for 
Services and Equipment Rules (Rule 7000 Series).
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    The NASD also proposes a number of procedural enhancements to the 
disciplinary procedures. Proposed Rule 9215(c) provides for the filing 
of a motion for a more definite statement (in addition to proposed Rule 
9146, providing for the filing of motions generally), proposed Rule 
9221 allows a hearing officer or a hearing panel to order a hearing if 
the adjudicator determines a hearing is necessary, notwithstanding that 
respondents have waived their rights to a hearing, and proposed Rules 
9233 and 9234 set forth detailed disqualification provisions.
    The proposed Rule 9240 Series and proposed Rule 9250 Series set 
forth requirements that parties participate in pre-hearing conferences, 
and exchange, before a hearing on the merits, documentary evidence, a 
list of witnesses and expert witnesses, and an outline of the case or 
defense. The same proposed rules also provide that the Department of 
Enforcement must provide documents to a respondent, and set forth 
procedures for doing so. Sanctions for not complying with requirements 
regarding the production of documents, other provisions of the Rule 
9200 Series, or an order of an adjudicator in the Rule 9200 Series, or 
for other contemptuous conduct, are set forth in proposed Rule 9280. 
<SUP>24</SUP>
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    \24\ In proposed Rule 9280(b)(2), the NASD added an explicit 
reference to the Rule 9240 Series because the NASD believes that the 
parties' cooperation and timely disclosure of information in the 
proposed Rule 9240 Series is of equal importance to their 
obligations under the proposed Rule 9250 Series. Amendment No. 3, 
supra note 6.
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    Under proposed Rule 9262, a witness subject to the jurisdiction of 
the NASD is required to testify under oath or affirmation. Proposed 
Rule 9264 sets forth the rules allowing a party to file a motion for 
summary disposition.
    In the post-hearing time frame, under proposed Rule 9266, a hearing 
officer may require a party to file proposed findings of fact, 
conclusions of law, and post-hearing briefs. The hearing officer 
prepares a decision representing the majority of the hearing panel or, 
if applicable, the extended hearing panel, under proposed Rule 9268. 
Proposed Rule 9268(c) allows a panelist or a hearing officer to write a 
dissenting opinion. Finally, under proposed Rule 9270, the NASD 
proposes to modify existing settlement procedures to provide specific 
procedures for a respondent to execute an offer of settlement prior to 
a determination on the merits.
3. Appeals and Reviews of Disciplinary Proceedings
    In the current and proposed Rule 9300 Series, procedures are set 
forth for the appeal of a case by a party or the review of a case by 
the National Business Conduct Committee, the NASD Regulation Board and 
the NASD Board. The proposed Rule 9300 Series contains nineteen 
proposed rules. In the proposed Rule 9300 Series, changes include the 
right of the Department of Enforcement to appeal a disciplinary 
proceeding decision issued by a hearing panel or, if applicable, an 
extended hearing panel (proposed Rule 9311(a)); <SUP>25</SUP> the 
requirement that persons subject to the jurisdiction of the NASD 
testify under oath or affirmation (proposed Rule 9346(h)); and the 
requirement that members of the NASD Regulation Board or the NASD Board 
shall have a specific period of time to review a disciplinary 
proceeding decision in order to determine whether to call a case for 
discretionary review by such board (proposed Rules 9351 and 9352). 
Proposed Rule 9360 provides that a sanction imposed in a final 
disciplinary action of the NASD becomes effective not earlier than 
thirty days after the date of service of the decision. In a proposed 
change designed to reflect current practice, proposed Rule 9370 
provides that, in most cases, sanctions, other than a bar or expulsion, 
are stayed when a person files with the Commission a request for review 
of a final disciplinary action of the NASD.
---------------------------------------------------------------------------

    \25\ To provide the parties more time to file an appeal, the 
NASD proposes to amend Rule 9311(a) to extend from 15 days to 25 
days the time for noticing an appeal. The NASD states that this 
conforms to the rules of the New York Stock Exchange and parallels a 
provision in the Rule 1010 Series. The NASD also amended proposed 
Rule 9311 to provide parties with prior notice and an opportunity to 
brief an issue that was previously waived if that issue arises and 
will be considered by the NBCC. Amendment No. 3, supra note 6.

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[[Page 43389]]

    In Amendment No. 3 to the proposed rule change, the NASD added 
proposed Rule 9313, authorizing a counsel to the NBCC to perform 
various ministerial and administrative acts on behalf of the NBCC 
during the course of an appeal or review. Because the role of the 
counsel to the NBCC is purely administrative, counsel may not shorten 
any period, postpone or adjourn a hearing, or otherwise limit a right 
previously held by a party, without the consent of all of the parties 
to the disciplinary proceeding. <SUP>26</SUP>
---------------------------------------------------------------------------

    \26\ Amendment No. 3, supra note 6.
---------------------------------------------------------------------------

4. Members Experiencing Financial or Operating Difficulties; Summary 
and Non-Summary Suspensions Cancellation, Bar, and Limitation or 
Prohibition on Access to NASD Services; and Eligibility Proceedings
    The NASD proposes to renumber, consolidate, reorganize, and clarify 
the procedures proposed for the Rule 9400 and 9500 Series. In the 
Original Proposal, the NASD requested temporary approval for five 
separate procedures for: (1) Regulating the activities of members 
experiencing financial or operating difficulty; (2) approving a change 
in business operations that will result in a change in exemptive status 
under SEC Rule 15c3-3 under the Act; (3) summary suspension as 
authorized by Section 15A(h)(3) of the Act; (4) non-summary suspension, 
cancellation, and bar; and (5) eligibility proceedings. Also in the 
Original Proposal, the NASD proposed eliminating the current expedited 
remedial proceedings. <SUP>27</SUP> The NASD stated that it would 
comprehensively review the proposed Rule 9400 and 9500 Series, as 
submitted in the Original Proposal, and would consider submitting a 
revision to the Original Proposal based on that review.
---------------------------------------------------------------------------

    \27\ The NASD also stated its intent to submit a separate rule 
filing to amend its expedited remedial proceedings. Original 
Proposal, supra note 4.
---------------------------------------------------------------------------

    As a result of its review of the Rule 9400 and 9500 Series, the 
NASD submitted Amendment No. 2 to amend the Original Proposal to reduce 
the number of separate proceedings from five to three, and to seek 
permanent approval of these three procedures.<SUP>28</SUP> First, the 
NASD proposes that the current Rule 9510 Series, setting forth 
procedures for limitations on operations for firms experiencing 
financial or operational difficulties as specified in Rules 3130 and 
3131, remain as a separate rule, and be renumbered as the Rule 9410 
Series.<SUP>29</SUP>
---------------------------------------------------------------------------

    \28\ Amendment No. 2, supra note 5.
    \29\ See current Rule 9510 Series.
---------------------------------------------------------------------------

    Second, the NASD proposes that the current Rule 9350 Series, 
setting forth procedures for a member wishing to change its exemptive 
status under SEC Rule 15c3-3, be eliminated. Under the proposed rules, 
a member wishing to change its exemptive status must apply for a change 
to its membership agreement, if the membership agreement covers the 
member's exemptive status, or file a notice and application for 
approval of a material change in the member's business operations if 
the membership agreement does not specifically address the member's 
exemptive status.<SUP>30</SUP> Procedures for applying for a change to 
a membership agreement or for approval of a material change in business 
operations are now set forth in the proposed Rule 1010 
Series.<SUP>31</SUP>
---------------------------------------------------------------------------

    \30\ See current Rule 9530 Series.
    \31\ The NASD has stated it will inform its membership of this 
change in procedure in a notice to members. Amendment No. 2, supra 
note 5.
---------------------------------------------------------------------------

    Third, the NASD proposes to consolidate into the revised Rule 9510 
Series summary suspension proceedings,<SUP>32</SUP> non-summary 
suspension, cancellation, and bar proceedings,<SUP>33</SUP> and new 
denial of access procedures. The new denial of access procedures permit 
the NASD, after notice and opportunity for hearing, to deny a person 
access to services offered by the NASD or a member of the NASD if the 
NASD determines that the person does not meet the qualification 
requirements or other prerequisites for such access, or the person 
cannot be permitted to continue to have such access with safety to 
investors, creditors, members, or the NASD.
---------------------------------------------------------------------------

    \32\ See current Rule 9610 Series.
    \33\ See current Rule 9620 Series.
---------------------------------------------------------------------------

    Finally, eligibility proceedings will remain in a separate rule 
series, and will be renumbered as the Rule 9520 Series.<SUP>34</SUP> 
The eligibility proceedings will continue to permit a person to become 
or remain associated with a member, notwithstanding the existence of a 
statutory disqualification as defined in Section 3(a)(39) of the Act. 
Further, the eligibility proceedings will continue to permit a current 
member or associated person to obtain relief from the eligibility or 
qualification requirements of the NASD By-Laws and Rules. Further, the 
revisions to the Rule 9520 Series will provide members and associated 
persons with enhanced procedural protections, and will conform these 
proceedings to the current corporate structure.
---------------------------------------------------------------------------

    \34\ See current Rule 9640 Series.
---------------------------------------------------------------------------

    The NASD also proposes to amend the Rule 9400 and Rule 9500 Series 
to provide participants with enhanced procedural protections in the 
conduct of these proceedings and to expedite the hearing and review 
processes, especially under the proposed Rule 9510 Series (which 
governs procedures for summary and non-summary suspension, 
cancellation, bar, and limitation or prohibition on access to the 
NASD's services). Specifically, the proposal, as amended by Amendment 
No. 2, adds a variety of new provisions, including provisions 
governing: the time within which a hearing requested by a member must 
be held; the disclosure of documents by NASD staff to the member prior 
to hearing; the exchange of exhibit and witness lists; the rights of 
parties at a hearing; the components of a written decision (including 
conditions for terminating a limitation, where appropriate); the 
preservation of evidence proffered but not accepted into the record; 
and the contents of the record for each proceeding. In addition, the 
proposal provides for discretionary review of lower decisions by the 
NASD Regulation and NASD Boards that is substantially similar to the 
procedures governing disciplinary proceedings.
5. Procedures for Exemptions From Certain NASD Rules
    The NASD proposes a new Rule 9600 Series that requires members to 
apply to the staff for an exemption under various rules, and provides a 
right of appeal to the NBCC. The NASD also proposes to provide 
additional rights for participants in the proceedings; conform the 
series to the proposed Rule 9000 Series, as well as to the current 
corporate structure; and delete the current Rule 9630 Series, which 
governs expedited remedial proceedings.
    Specifically, the NASD proposes a new Rule 9600 Series that would 
require members to apply to NASD Regulation staff for an exemption 
under various rules, and would provide a right of appeal to the NBCC. 
Under current NASD rules, the authority to grant exemptions has been 
granted to various standing committees. Pursuant to the proposal, a 
member seeking an exemption would be required to file a written 
application with the Office of General Counsel of NASD Regulation. 
Members applying for exemptions could receive confidential treatment of 
applications or decisions after a showing of good cause for 
confidential treatment. The proposed rules provide for a right to 
review before a subcommittee appointed by the NBCC. The NBCC's written 
decision, which would constitute final action of the NASD, would be 
based on the matters on appeal, the subcommittee's

[[Page 43390]]

recommendation, and the NBCC's findings and conclusions.

D. Effectiveness of the New Procedures <SUP>35</SUP>
---------------------------------------------------------------------------

    \35\ See Amendment No. 5, supra note 8.
---------------------------------------------------------------------------

    Because the proposed rule change is effective upon approval by the 
Commission on the date of this release (``effective date''), the NASD 
proposes to establish the following schedule to address the transition 
from the current procedures to the proposed procedures approved in this 
rule filing.
1. Membership Admission Rules; Investigations and Sanctions
    The Rule 1010 Series, the membership admission rules, will take 
effect on the effective date. Thus, if a membership application is 
received by the NASD before the effective date, the application will be 
considered under the current rules and procedures. However, if a 
membership application is received by the NASD on or after the 
effective date of the proposed Rule 1010 Series, the amended Rule 1010 
Series will apply to the application process. In addition, the NASD 
proposes that the Rule 8000 Series will take effect on the effective 
date.
2. Complaints, Offers of Settlement
    The proposed Rule 9100 Series through the Rule 9300 Series will 
generally apply to a respondent when the NASD staff first attempted 
service <SUP>36</SUP> of the complaint on or after the effective date. 
If the complaint is authorized and the first attempted service occurs 
prior to the effective date, a respondent will be subject to the 
current Code of Procedure, <SUP>37</SUP> except that if the decision is 
served on or after the effective date and the disciplinary proceeding 
is subsequently appealed to the NBCC or the NBCC calls the disciplinary 
proceeding for review, as described in greater detail below, the appeal 
or review will proceed under the proposed rules. In addition, if a 
respondent is negotiating an offer of settlement for a complaint 
authorized and attempted to be served before the effective date, and 
executes such offer of settlement after the effective date of this 
proposal, the offer of settlement will be reviewed and accepted or 
rejected under the current rules, rather than under proposed Rule 
9270.<SUP>38</SUP> A respondent subject to the current Code of 
Procedure may not seek consideration of whether the complaint should 
have been authorized under the proposed Code.
---------------------------------------------------------------------------

    \36\ First attempted service means the complaint has been mailed 
by NASD staff or delivered by NASD staff to a courier for 
transmission by the courier.
    \37\ In a multiple respondent disciplinary proceeding, all 
respondents will be subject to the current Code of Procedure if 
service was attempted on any one respondent before the effective 
date.
    \38\ Supra note 37.
---------------------------------------------------------------------------

    Conversely, a respondent is subject to the proposed Code if the 
complaint is authorized before the effective date, but the first 
attempted service occurs on or after the effective date of this 
proposal. In a multiple respondent disciplinary proceeding, all 
respondents will be subject to the proposed Code of Procedure if the 
complaint is authorized before the effective date, but NASD staff does 
not make the first attempted service as to any of the named respondents 
until on or after the effective date. A respondent who is subject to 
the proposed Code because the complaint was authorized before the 
effective date, but the first attempted service occurred on or after 
the effective date, may challenge the case for improper authorization 
based only on the current (or old) Code. Accordingly, in such 
circumstances, a respondent cannot challenge the authorization of the 
complaint based on the fact that it was not authorized under the 
proposed Code. <SUP>39</SUP> In any case in which the complaint is 
authorized on or after the effective date of the proposed Code, the 
respondents will be subject to the provisions of the proposed Code.
---------------------------------------------------------------------------

    \39\ Telephone conversation between John Ayanian, Special 
Counsel, Division of Market Regulation, Commission, and Sharon 
Zackula, Senior Attorney, Office of General Counsel, NASD 
Regulation, on August 5, 1997.
---------------------------------------------------------------------------

3. AWCs and MRVs
    On the effective date of the proposed Rule 9100-9300 Series, the 
Department of Enforcement will have the ability to accept letters 
regarding acceptance, waiver, or consent (``AWCs''), and minor rule 
violations (``MRVs''). The application of the proposed rules to AWCs 
and MRVs is based upon when a member or an associated person executes 
such letters. Thus, if a member or an associated person executes an AWC 
or MRV before the effective date of this proposal, the AWC or MRV will 
be subject to review and acceptance under the current Code of 
Procedure. However, if a member or an associated person is engaged in 
negotiations about the terms of an AWC or MRV and the effective date 
occurs before the AWC or MRV is executed by the member or associated 
person, the AWC or MRV will be subject to review and acceptance under 
the proposed rules.
4. Appeals and Reviews--Application of Proposed Rule 9300 Series
    The NASD also proposes that the proposed Rule 9300 Series, when 
effective, apply to any appeal, call for review, or review of a 
decision rendered under Rule 9268 and Rule 9269 if the decision is: (a) 
served on a respondent on or after the effective date of the proposed 
Code of Procedure and (b) appealed, called for review, or reviewed. By 
doing so, the NASD notes that all of the new appellate and review 
procedural enhancements, with one exception, would apply to a completed 
``trial-level'' proceeding on appeal, subject to a call for review, or 
reviewed on or after the effective date of the proposed Code of 
Procedure. The one exception would be that the right of the Department 
of Enforcement to appeal or cross-appeal a case would not apply. The 
NASD proposes that this provision in the proposed Rule 9300 Series not 
be applied to any disciplinary proceeding unless the disciplinary 
proceeding is based upon a complaint served on or after the effective 
date of the proposed Code because a respondent may believe that any 
retroactive application of this procedure may be unfair. <SUP>40</SUP>
---------------------------------------------------------------------------

    \40\ Amendment No. 5, supra note 8.
---------------------------------------------------------------------------

5. A Fourteen Calendar Day ``Opt-In'' Period
    In the Original Proposal, the NASD proposed that in certain cases a 
respondent to a disciplinary proceeding be allowed to opt in to the 
proposed procedures during a thirty-day period following Commission 
approval of the new procedure.<SUP>41</SUP> At the time the NASD 
proposed the opt in procedure, the NASD expected that the Commission 
would delay the effectiveness of the proposed Rule 9100-9300 Series for 
approximately thirty days. The Commission, however, will make the 
proposed Rule 9100-9300 Series effective on the same day that it 
approves such rules. The NASD continues to believe that it is 
appropriate or desirable to have a time period during which a 
respondent subject to the current Code of Procedure could opt to have 
the proceeding administered under the proposed (or new) Code of 
Procedure.<SUP>42</SUP> The NASD proposes that this time period should 
be fourteen calendar days. Thus, a respondent who is named in a 
complaint that is authorized prior to the effective date may opt to 
have the disciplinary proceeding go forward under the proposed Code if 
the first attempted service upon the respondent occurs not earlier than 
fourteen calendar days before the effective date of this proposal. In a 
disciplinary proceeding involving more than one respondent, all

[[Page 43391]]

respondents must opt to have the proceedings administered under the new 
Code of Procedure for it to apply. NASD staff will specifically notify 
all parties eligible to opt in of the existence of this right and the 
limitations on this right.
---------------------------------------------------------------------------

    \41\ Original Proposal, supra note 4.
    \42\ Amendment No. 5, supra note 8.
---------------------------------------------------------------------------

6. Rule 9400-9500 Series
    If a proceeding is initiated before the effective date, the 
proceeding will be administered under the current provisions relating 
to the proceeding. If a proceeding is initiated on or after the 
effective date, the proceeding will be administered under the new 
rules.
7. Rule 9600 Series
    If a request for an exemption has been made before the effective 
date, the request will be administered under the current provisions 
relating to such proceedings. A request for an exemption initiated on 
or after the effective date will be administered under the new rules.

III. Comments and NASD Responses

    The Commission received two comment letters regarding the Original 
Proposal. The Colish Letter generally addresses issues relating to 
premembership application procedures set forth in the proposed Rule 
1010 Series. The ABA Letter addresses proposed changes to the Rule 8000 
Series and the proposed Rule 9100 Series through the Rule 9300 Series.

A. Rule 1010 Series

    The Commission received one comment letter concerning the 
membership application procedures.\43\ Overall, the commenter agrees 
with the proposed rules, but believes the rules could be improved or 
supplemented in certain respects.
---------------------------------------------------------------------------

    \43\ Colish Letter, supra note 9.
---------------------------------------------------------------------------

1. New Member Review
    The commenter recommends that the new member review process be 
centralized at the NASD's headquarters.\44\ The commenter is concerned 
that the examiners in the various District Offices may lack the 
necessary experience and training to adequately discharge the new 
responsibility of approving, disapproving, or setting conditions or 
limits on membership applications. In addition, the commenter believes 
that centralization would be the best way to ensure uniformity.
---------------------------------------------------------------------------

    \44\ Colish Letter, supra note 9, at 4. The commenter agrees, 
however, that the restriction and change in ownership/control/
operations processes should remain in the District Offices.
---------------------------------------------------------------------------

    The NASD does not believe centralization is necessary.\45\ The NASD 
believes that the District Offices obtain valuable insights into the 
applicants' business through the new member review process. It notes 
that significant initiatives are already underway to train examiners 
for their new responsibilities and that new policies and procedures are 
being established to ensure national uniformity and consistency in the 
treatment of membership applications. For example, training sessions 
focusing on the proposed rules have been conducted for supervisors and 
assistant directors, a comprehensive training program is being 
finalized for District Office examiners, and a staff steering committee 
chaired by an NASD Regulation vice president and staffed by senior 
District Office staff members is finalizing detailed procedures for 
District Offices to follow to help ensure uniformity and consistency.
---------------------------------------------------------------------------

    \45\ NASD Response, supra note 6, at 4.
---------------------------------------------------------------------------

2. Monthly Projections of Income and Expenses
    The commenter asserts that it may be unrealistic for some 
applicants to furnish a monthly projection of income and expenses for 
the first twelve months of operations under proposed Rule 
1013(a)(2)(A)(ii).\46\ She notes that this would be especially 
difficult for firms that intend to engage in a significant amount of 
dealer business.
---------------------------------------------------------------------------

    \46\ Colish Letter, supra note 9, at 5.
---------------------------------------------------------------------------

    The NASD believes this information is reasonable and necessary to 
facilitate the NASD's ability to determine whether an applicant has a 
reasonable expectation of being able to comply with the net capital 
rule once the applicant commences business.\47\ The NASD also believes 
it is not overly burdensome for applicants to prepare this information 
because most new firms already project the revenues necessary to meet 
fixed and other expenses for business reasons.
---------------------------------------------------------------------------

    \47\ NASD Response, supra note 6, at 4.
---------------------------------------------------------------------------

3. Use of Forms BD, U-4, and U-5
    The commenter maintains that the NASD should not require applicants 
to submit Forms BD, U-4, and U-5 because the information contained on 
those forms is available to the NASD through the Central Registration 
Depository (``CRD'').\48\ The commenter does note, however, that it is 
not particularly onerous for applicants to include this information as 
part of their application materials. In any event, the commenter 
suggests that the NASD should request an applicant's current composite 
Form BD because the most recent filing may be a partial amendment.
---------------------------------------------------------------------------

    \48\ Colish Letter, supra note , at 5.
---------------------------------------------------------------------------

    The NASD agrees with the comment concerning the submission of an 
applicant's current composite Form BD. Therefore, as part of Amendment 
No. 3, the NASD has made technical changes to proposed Rule 1013 to 
explicitly state that the original, signed, and notarized Form BD must 
be filed with the Membership Department in Rockville, Maryland.\49\ 
With regard to submission of the forms, however, the NASD believes it 
is appropriate to require applicants to submit them because including 
the forms facilitates the NASD's ability to expeditiously process an 
application.
---------------------------------------------------------------------------

    \49\ Amendment No. 3, supra note 6; NASD Response, supra note 6, 
at 4.
---------------------------------------------------------------------------

4. Capital Risks Posed by Proposed Business Activities
    The commenter states that it is not clear what type of information 
would be required to satisfy the requirement of a description of the 
risk to capital presented by an applicant's proposed business 
activities under proposed Rule 1013(a)(2)(J).\50\ In addition, the 
commenter notes that there currently is considerable variation among 
the District Offices regarding the application of this requirement.\51\ 
Finally, the commenter questions the relevance of this information.
---------------------------------------------------------------------------

    \50\ Colish Letter, supra note 9, at 6.
    \51\ For example, the commenter criticizes the high degree of 
scrutiny given to the source of capital for an applicant she 
recently represented. The NASD maintains that it will continue to 
carefully review the source of each applicant's capital in order to 
properly identify the true owners of an applicant and ensure that 
the owners do not include improper parties (e.g., a person who has 
been barred from the industry).
---------------------------------------------------------------------------

    In responding to these comments, the NASD asserts that this 
information is necessary to establish an appropriate level of net 
capital for a particular applicant that ensures customers are 
adequately protected.\52\ The NASD also notes, as described previously, 
that it has taken steps to ensure an appropriate degree of consistency 
and uniformity. For example, the NASD indicated that it will require 
memoranda or public offering documents containing information 
describing the risk to the applicant's capital.
---------------------------------------------------------------------------

    \52\ NASD Response, supra note 6, at 5.
---------------------------------------------------------------------------

5. Applicant's Best Practices and Supervisory System
    The commenter states that the standards in proposed Rule 
1014(a)(8), regarding the industry's best practices, and proposed Rule 
1014(a)(9), concerning an applicant's supervisory

[[Page 43392]]

system, are somewhat redundant.\53\ In addition, the commenter asserts 
that those standards may be subject to wide differences of opinion and 
subjective judgment.
---------------------------------------------------------------------------

    \53\ Colish Letter, supra note 9, at 7.
---------------------------------------------------------------------------

    The NASD maintains that these standards are distinct.\54\ It 
explains that the standard in proposed Rule 1014(a)(8) is designed to 
focus on whether an applicant is adopting the industry's best practices 
in certain areas, while the standard in proposed Rule 1014(a)(9) 
encompasses an applicant's overall supervisory system. The NASD states 
that it does not anticipate that an applicant's failure to meet the 
requirements of proposed Rule 1014(a)(8) would, by itself, be grounds 
for denying an application. In contrast, the NASD expects that an 
applicant's failure to meet the supervision requirements could be a 
sole basis for denying an application.
---------------------------------------------------------------------------

    \54\ NASD Response, supra note 6, at 5.
---------------------------------------------------------------------------

B. Rule 8000 Series

    The ABA comment letter addresses the Rule 8000 Series.\55\ The 
commenter notes that proposed Rule 8210, which requires the submission 
of information, testimony and books to the NASD, does not differentiate 
between the NASD's right to obtain information or documents prior to 
the filing of a complaint and such requests once a proceeding has been 
initiated.\56\ The commenter also suggests that post-complaint 
discovery under proposed Rule 8210 should be reciprocal, and that 
information and documents submitted to the NASD should be returned upon 
completion of a disciplinary matter. In response, the NASD notes that a 
change to proposed Rule 8210 to limit the NASD's ability to obtain 
information and documents would impede the NASD in its performance of 
its investigatory and enforcement functions.\57\ The NASD also points 
out that pursuant to proposed Rule 9251(a), the Department of 
Enforcement has an obligation to turn over certain documents to a 
respondent. Further, under the Brady doctrine and the Jencks Act, the 
Department of Enforcement has a continuing obligation to produce 
documents to the respondent. The NASD also states it must retain 
information and documents obtained for a disciplinary proceeding for a 
number of reasons, including enabling the NASD to meet its regulatory 
and enforcement obligations, and allowing the NASD to comply with SEC 
Rule 17a-1(b), which requires the NASD to retain such documents for 
five years.
---------------------------------------------------------------------------

    \55\ ABA Letter, supra note 9.
    \56\ ABA Letter, supra note 9, at 8.
    \57\ NASD Response, supra note 6, at 6.
---------------------------------------------------------------------------

    The commenter notes that proposed Rule 8210 does not differentiate 
between parties and non-parties in requests for information or 
documents. Finally, the commenter states that proposed Rule 8210 does 
not address privileges otherwise available at law as a basis for 
objecting to a request for information or documents by the NASD, and 
suggests that the NASD create a mechanism to enable non-parties to 
limit the use of submitted materials. The NASD states that it 
interprets proposed Rules 9235 and 9146, setting forth the powers of a 
hearing officer, to authorize a hearing officer in appropriate 
circumstances to issue a protective order during the course of 
disciplinary proceedings.<SUP>58</SUP> The NASD has added subparagraph 
(k) to proposed Rule 9146 to clarify that the hearing officer has 
authority to issue a protective order upon the motion of a party or 
other person. The NASD points out, however, that this authority would 
not negate the NASD's obligation to respond to a subpoena, or the 
NASD's right or obligation to provide information to federal, state, 
and foreign regulatory authorities, as well as other self-regulatory 
organizations (``SROs'').<SUP>59</SUP>
---------------------------------------------------------------------------

    \58\ NASD Response, supra note 6, at 6-7.
    \59\ Amendment No. 3, supra note 6.
---------------------------------------------------------------------------

    The commenter adds that the comments made regarding proposed Rule 
8210 above also apply to proposed Rules 8220 through 8225.<SUP>60</SUP> 
Further, the commenter states that the proposed rules should explicitly 
provide for less harsh sanctions than suspension in the case of a 
failure to provide requested information under proposed Rule 8210. The 
NASD states that most actions taken by the NASD in response to a 
failure to provide requested information pursuant to a Rule 8210 
request are not brought under proposed Rule 8220, but are instead 
brought as disciplinary proceedings.<SUP>61</SUP> The NASD adds that as 
disciplinary proceedings, the Sanctions Guidelines apply, permitting a 
less severe sanction than a suspension. The NASD also notes that it has 
changed the verb in proposed Rules 8221 (a) and (b) from ``shall'' to 
``may,'' clarifying that the NASD has other avenues, aside from 
proposed Rule 8220, to address the failure to provide requested 
information.
---------------------------------------------------------------------------

    \60\ ABA Letter, supra note 6, at 13-14.
    \61\ NASD Response, supra note 6, at 7.
---------------------------------------------------------------------------

    The commenter also suggests that proposed Rule 8310, relating to 
sanctions for violations of the NASD's rules, should contain a 
reference to the NASD Sanctions Guidelines.<SUP>62</SUP> The commenter 
believes that use of and reference in the rule to the Sanctions 
Guidelines would ensure consistency in the application of sanctions. 
The NASD does not believe that the Sanctions Guidelines should be 
incorporated into the Code of Procedure, noting that the Guidelines by 
their terms are flexible guidelines and not absolute 
rules.<SUP>63</SUP>
---------------------------------------------------------------------------

    \62\ ABA Letter, supra note 9, at 18.
    \63\ NASD Response, supra note 6, at 7.
---------------------------------------------------------------------------

    Further, the commenter suggests that the period for payment of 
fines, pursuant to proposed Rule 8320, should be extended to thirty 
days from the seven days proposed in the rule.<SUP>64</SUP> In its 
response, the NASD points out that the notice to a respondent issued 
pursuant to proposed Rule 8320 is actually the third communication a 
respondent has received regarding a payment of fines, other monetary 
sanctions, or costs. The first letter to the respondent (stating that 
payment is due within ten business days from the date of the letter) is 
prepared after the forty-sixth day after service of a disciplinary 
decision that is not appealed or called for review. A second letter is 
sent when payment has not been received within ten to fifteen business 
days of the first letter. After ten additional business days, the NASD 
prepares the Rule 8320 notice.
---------------------------------------------------------------------------

    \64\ ABA Letter, supra note 9, at 19.
---------------------------------------------------------------------------

    Finally, the commenter requests that the NASD's practice of 
accepting installment payment plans for fines of $5,000 or greater be 
continued and incorporated into the rule.<SUP>65</SUP> The NASD 
confirms in its response to the comment letter that it will inform its 
members of the existence of payment plans through the inclusion of 
information regarding installment plans in the NASD's Sanctions 
Guidelines, which are publicly available.<SUP>66</SUP>
---------------------------------------------------------------------------

    \65\ ABA Letter, supra note 9, at 20.
    \66\ NASD Response, supra note 6, at 8.
---------------------------------------------------------------------------

C. Rule 9100 Through Rule 9300 Series

    The ABA's letter also addresses the proposed Rule 9100 through the 
Rule 9300 Series. The commenter expresses general support for the 
NASD's proposed changes to its disciplinary process, but also sets 
forth specific comments and recommends certain modifications, as 
discussed below.<SUP>67</SUP>
---------------------------------------------------------------------------

    \67\ ABA Letter, supra note 9.
---------------------------------------------------------------------------

    1. Rule 9100 Series
    The commenter makes several specific comments regarding the 
proposed Rule 9100 Series. The commenter believes that the text of 
proposed Rule 9136 regarding the filing of papers should be combined 
with proposed Rule 9266 regarding proposed

[[Page 43393]]

findings of fact, conclusions of law and post-hearing briefs, and 
include a twenty-five page limitation.<SUP>68</SUP> The NASD believes 
that reordering the special pagination requirement that is now set 
forth in proposed Rule 9266 would introduce a level of detail well 
beyond that appropriate for the Code of Procedure.<SUP>69</SUP>
---------------------------------------------------------------------------

    \68\ ABA Letter, supra note 9, at 30-31.
    \69\ NASD Response, supra note 6, at 8.
---------------------------------------------------------------------------

    The commenter recommends that proposed Rule 9142 regarding the 
withdrawal by an attorney or representative should be amended to allow 
an attorney or representative the ability to withdraw from 
representation of a party, upon notice, at any time. Proposed Rule 9142 
requires an attorney or representative of a party to give at least 30 
days notice of withdrawal, and show good cause for the withdrawal. The 
commenter believes that these requirements do not provide sufficient 
flexibility to withdraw in compliance with the Code when such 
withdrawal is required under the Model Rules of Professional Conduct or 
is otherwise necessary. The commenter also recommends that a separate 
motion be required under Proposed Rule 9222(b), in the event that a 
hearing panel becomes concerned that counsel is withdrawing as a 
pretext to postpone or disrupt a hearing.<SUP>70</SUP>
---------------------------------------------------------------------------

    \70\ ABA Letter, supra note 9, at 34.
---------------------------------------------------------------------------

    The NASD agrees that the current version of proposed Rule 9142 does 
not afford an attorney or representative with sufficient flexibility to 
withdraw under the circumstances described above. The NASD therefore 
proposes to amend the provision to allow an attorney to withdraw in 
less than thirty days where circumstances do not permit thirty days 
notice. Further, the NASD agrees with the approach suggested by the 
commenter that a separate motion may be filed under proposed Rule 
9222(b) to determine whether a hearing should be 
postponed.<SUP>71</SUP>
---------------------------------------------------------------------------

    \71\ NASD Response, supra note 6, at 8. See also Amendment No. 
3, supra note 6.
---------------------------------------------------------------------------

    The commenter agrees with the NASD's efforts to separate the 
adjudicatory and prosecutorial functions, and prohibit ex parte 
communication with adjudicators. The commenter recommends, however, 
that proposed Rule 9143 regarding ex parte communications be amended to 
allow participants to a proceeding to respond to allegations or 
contentions contained in a prohibited ex parte 
communication.<SUP>72</SUP> The commenter also expresses concern that 
the Office of Hearing Officers is accountable to the President of NASD 
Regulation. The commenter recommends that, to avoid the perception of 
unfairness and bias regarding the separation of functions provisions 
set forth in proposed Rule 9144, the Office of Hearing Officers should 
report to the President of the NASD, rather than to the ``senior 
enforcer'' of NASD Regulation.<SUP>73</SUP>
---------------------------------------------------------------------------

    \72\ ABA Letter, supra note 9, at 38.
    \73\ ABA Letter, supra note 9, at 39-40.
---------------------------------------------------------------------------

    In response to the commenter, the NASD proposes to incorporate into 
proposed Rule 9143 a provision allowing participants to a proceeding to 
respond to allegations or contentions contained in a prohibited ex 
parte communication.<SUP>74</SUP> The NASD has determined, however, 
that the Office of Hearing Officers should report to the President of 
NASD Regulation. The NASD notes that various measures have been 
implemented to assure the independence of the chief hearing officer and 
the hearing officers. For example, if the President of NASD Regulation 
terminates a hearing officer, the hearing officer has the right to 
appeal to the Audit Committee of the NASD Board of Governors. The NASD 
also notes that measures have been adopted to ensure that if the 
President of NASD Regulation participates in a discussion regarding a 
proposed issuance of a complaint, he or she will recuse him or herself 
and not attempt to influence an adjudicator or participate as an 
adjudicator in that disciplinary action.<SUP>75</SUP>
---------------------------------------------------------------------------

    \74\ NASD Response, supra note 6, at 8-9. See also Amendment No. 
3, supra note 6.
    \75\ NASD Response, supra note 6.
---------------------------------------------------------------------------

    The commenter also recommends that the NASD explicitly provide in 
proposed Rule 9145 (regarding rules of evidence and official notice), 
as well as proposed Rule 9263 (regarding evidence admissibility), and 
Rule 9346(g) (regarding evidence in NBCC proceedings) that the Federal 
Rules of Evidence will serve as a guide to adjudicators in ruling on 
evidentiary matters that arise in disciplinary proceedings. The 
commenter believes that this would promote both fairness and uniformity 
in the disciplinary proceedings, while preserving the adjudicators' 
flexibility in ruling on evidentiary matters. The commenter also 
suggests that the official notice provision in Rule 9145 is vague and 
overbroad and is not consistent with the Federal Rules of Evidence 
provision stating that a judicially noticed fact must be ``not subject 
to reasonable dispute.'' The commenter is concerned that, by allowing 
an adjudicator to take official notice of ``other matters within the 
specialized knowledge of the NASD as an expert body'' (proposed Rule 
9145(b)), certain matters that may be subject to a reasonable dispute 
and potentially the subject of expert testimony might be deemed to be 
true under the standard set forth in the proposed rule.<SUP>76</SUP>
---------------------------------------------------------------------------

    \76\ ABA Letter, supra note 9, at 41.
---------------------------------------------------------------------------

    The NASD does not believe it is appropriate to incorporate a 
reference to the Federal Rules of Evidence into proposed Rule 9145(a), 
Rule 9263, or Rule 9346(g). The NASD notes that formal rules of 
evidence traditionally have not been applied in SRO proceedings--e.g., 
hearsay may be admitted as evidence in SRO proceedings and the use of 
telephone testimony is accepted. The NASD believes that hearsay and 
telephone testimony should continue to be used as appropriate in a 
disciplinary proceeding administered under the Code.
    Further, the NASD does not believe it is appropriate for the NASD 
to adopt the commenter's suggestion for proposed Rule 9145 regarding 
official notice. The NASD notes that the official notice procedure will 
not be a substitute for expert testimony, nor be frequently used. If a 
technical matter is the subject of debate or controversy, the NASD 
notes that it would not be officially noticed under proposed Rule 9145. 
Moreover, the NASD states that a party has the right to oppose or 
otherwise comment if an adjudicator proposes to take official 
notice.<SUP>77</SUP>
---------------------------------------------------------------------------

    \77\ NASD Response, supra note 6, at 9.
---------------------------------------------------------------------------

    The commenter also proposes that the right to an interlocutory 
appeal, as set forth in proposed Rule 9148, should be available to 
contest any ruling denying a claim of attorney-client privilege or 
work-product privilege and any situation in which a panelist refuses to 
recuse him or herself. First, the commenter believes that the right to 
an interlocutory appeal regarding privilege claims will ensure that 
every effort has been taken to carefully examine the claim before 
disclosure is compelled. Second, the commenter believes that the 
interlocutory appeal of a panelist failing to recuse him or herself 
will help to eliminate a possible perception of unfairness in the 
proceeding.<SUP>78</SUP>
---------------------------------------------------------------------------

    \78\ ABA Letter, supra note 9, at 46-48.
---------------------------------------------------------------------------

    In response to the commenter's recommendation, the NASD notes that 
under the proposed Rule 9146 regarding general motions, a party and 
certain non-parties may file a motion seeking relief or guidance with 
regard to privilege issues. Further, the NASD notes that Rule 9251 
authorizes the hearing officer to review relevant documents in camera. 
The NASD

[[Page 43394]]

recognizes that privilege issues are very important, but believes that 
to grant interlocutory review as a right regarding every contested 
privilege issue would ``cripple the SRO's adjudicatory process from the 
beginning.'' <SUP>79</SUP>
---------------------------------------------------------------------------

    \79\ NASD Response, supra note 6, at 10.
---------------------------------------------------------------------------

    The NASD also believes that the failure of a panelist to recuse him 
or herself should not be the subject of an interlocutory appeal because 
if a panelist fails to recuse him or herself, a party may challenge the 
panelist through a disqualification motion. In addition, persons other 
than parties may inform the chief hearing officer or hearing officer of 
disqualifying factors, providing another avenue to remove a panelist 
from a hearing panel. Further, the NASD believes that such appeals 
would ``unduly burden the forum, would impose great costs, and would 
not further the public interest in the fair and speedy resolution of 
all disciplinary matters.'' \80\
---------------------------------------------------------------------------

    \80\ NASD Response, supra note 6, at 10.
---------------------------------------------------------------------------

    The commenter generally supports the provision in proposed Rule 
9150 authorizing hearing panels to exclude persons if they engage in 
contemptuous, unethical or improper professional conduct. \81\ The 
commenter recommends that the NASD clarify that a representative 
excluded under Rule 9150 may seek review as provided under proposed 
rule 9280(c). The NASD has amended proposed Rule 9150 to clarify the 
relationship between Rule 9150 and Rule 9280(c). \82\
---------------------------------------------------------------------------

    \81\ ABA Letter, supra note 9, at 49-50. See infra discussion 
regarding ABA comments on proposed Rule 9280.
    \82\ NASD Response, supra note 6. See also Amendment No. 3, 
supra note 6.
---------------------------------------------------------------------------

    The commenter also recommends that proposed Rule 9160 regarding 
recusal or disqualification set forth procedural steps that must be 
followed in seeking disqualification of Governors, Directors, NBCC 
Committee members, and certain NASD Regulation staff when serving an 
adjudicatory role. \83\ The NASD believes this is unnecessary because 
an adjudicator will recuse him or herself when he or she has a conflict 
of interest or a bias, and other members of a board or committee have 
the ability to suggest recusal or seek disqualification if the member 
does not act promptly to recuse him or herself. Moreover, the NASD 
generally does not believe that it is appropriate to codify internal 
board procedures. With respect to paragraph (g) (now paragraph (h)), 
the NASD also believes that the President of NASD Regulation may 
consider disqualification issues as appropriate. For the same reasons, 
the NASD does not believe specific procedures under which the President 
of NASD Regulation must act are necessary. \84\
---------------------------------------------------------------------------

    \83\ ABA Letter, supra note 9, at 52.
    \84\ NASD Response, supra note 6, at 11.
---------------------------------------------------------------------------

2. Rule 9200 Series
    The commenter also makes several specific comments regarding the 
proposed Rule 9200 Series. The commenter agrees with the proposal to 
transfer the authority to issue complaints to the Department of 
Enforcement, as set forth in proposed Rule 9211. To ensure that the 
process by which the Department of Enforcement authorizes and issues 
complaints is open and fair, the commenter recommends that the NASD 
provide guidance to the industry regarding the mechanics of the process 
through the issuance of a resolution of the Board of Governors or 
publication of a notice to members.
    Further, the commenter suggests that the NASD should consider 
developing a pre-complaint forum for discussions between enforcement 
staff and counsel regarding any proposed charges. The commenter 
believes that both the enforcement staff and the potential respondents 
would benefit from discussions prior to the initiation of a formal 
proceeding. In addition, the commenter recommends that the NASD adopt a 
formal ``Wells-type submission'' process. The commenter also suggests 
that the NASD should adopt procedures for notifying affected persons or 
firms when an investigation has been terminated without the filing of a 
complaint. \85\
---------------------------------------------------------------------------

    \85\ ABA Letter, supra note 9, at 53-57.
---------------------------------------------------------------------------

    The NASD agrees with the commenter's suggestion that the NASD 
should provide guidance regarding the complaint authorization and 
issuance process. The NASD proposes to do so in a notice to members, 
which will describe the roles of the various parties in developing a 
disciplinary proceeding, and authorizing and issuing a complaint. The 
NASD notes that disciplinary proceedings are initiated in NASD district 
offices, the Department of Market Regulation, and the national office 
of the Department of Enforcement. The NASD states that the notice will 
describe each department's role in identifying and organizing the 
evidence that is the foundation of the disciplinary proceeding and 
drafting a complaint, and the role of the national office of the 
Department of Enforcement and the Office of Disciplinary Policy in 
authorizing the complaint. The notice to members will also provide 
guidance on the NASD's use of the ``Wells-type procedure'' by which a 
potential respondent may make a written submission to the Department of 
Enforcement prior to the issuance of a complaint. The NASD, however, 
does not propose to codify the use of the ``Wells-type procedure,'' or 
the use of letters informing affected persons that an investigation has 
been terminated. \86\
---------------------------------------------------------------------------

    \86\ NASD Response, supra note 6, at 11.
---------------------------------------------------------------------------

    The commenter also suggests that proposed Rule 9216 regarding AWCs 
should provide greater clarification concerning the pre-complaint 
settlement process. In addition, the commenter recommends that the 
proposed rule contain a provision explicitly permitting a potential 
respondent to consent to the issuance of an AWC without admitting or 
denying the facts or allegations contained in the AWC. \87\
---------------------------------------------------------------------------

    \87\ ABA Letter, supra note 9, at 64-65.
---------------------------------------------------------------------------

    The NASD agrees that the industry should be informed of how to 
initiate settlement discussions or pre-complaint discussions, and 
states that such guidance will be included in the notice to members 
described above. Further, in response to the recommendation that the 
Code contain a provision ``explicitly permitting a respondent to 
consent to the issuance of an AWC without admitting or denying the 
facts or allegations contained in the AWC'' and a second provision 
``reflecting the fact that the settlement is being offered (and 
accepted) without any prior adjudication or evidentiary hearing, so as 
to minimize any potential collateral consequences,'' the NASD believes 
that the terms of a settlement or an AWC should be based on the 
applicable law and the particular facts and circumstances of each case. 
The NASD notes that the terms of settlement documents or AWCs will 
change as federal and state law evolves. Accordingly, the NASD does not 
believe that it is appropriate to attempt to codify standardized 
settlement language. \88\
---------------------------------------------------------------------------

    \88\ NASD Response, supra note 6, at 11-12.
---------------------------------------------------------------------------

    The commenter recommends that proposed Rule 9221 regarding requests 
for hearing should require that at least one person serving as a 
panelist on a hearing panel or extended hearing panel ``be engaged in 
similar activities within the securities industry as the respondent.'' 
The commenter believes that this requirement will provide a higher 
level of expertise and a better perspective to a hearing panel. In 
addition, the commenter suggests that the minimum notice period prior 
to a hearing as provided in proposed Rule 9221(d) should be expanded 
from twenty-eight to sixty days. The commenter is concerned that

[[Page 43395]]

respondents will not have sufficient time to prepare for the hearing. 
\89\
---------------------------------------------------------------------------

    \89\ ABA Letter, supra note 9, at 67.
---------------------------------------------------------------------------

    The NASD agrees that persons with securities industry expertise 
should be fully represented on the hearing panels, and notes that 
proposed Rules 9231 and 9232 provide that the chief hearing officer 
will consider ``expertise'' and ``the absence of any conflict of 
interest or bias, and any appearance thereof'' as factors in selecting 
panelists. The NASD believes that these provisions ensure that the 
panelist selection process will provide panelists with a sufficient 
level of expertise and perspective. Accordingly, the NASD declines to 
amend proposed Rule 9221(a) (or other related provisions) as 
recommended above.
    The NASD further believes that the commenter's recommendation to 
expand the notice period prior to a hearing is not necessary. The NASD 
notes that in most cases parties will be notified several months in 
advance of the hearing, but that there will be occasions when it will 
be in the public interest to proceed as quickly as possible. In 
addition, very simple cases may be dealt with expeditiously to the 
benefit of both parties.<SUP>90</SUP>
---------------------------------------------------------------------------

    \90\ NASD Response, supra note 6, at 12-13.
---------------------------------------------------------------------------

    In proposed Rule 9222(b)(1), the NASD proposed a list of factors 
for a hearing officer when ruling on a motion for postponement or 
adjournment of a hearing. The commenter suggests that the hearing 
officer should not be required to consider any particular factors, but 
to the extent that the NASD codifies specific factors, it should 
include additional factors, such as ``the amount of time that has 
passed since the commencement of the investigation and the issuance of 
the complaint; whether there is any outstanding discovery; the amount 
of notice the parties had of the hearing; the complexity of the case; 
and prior commitments of counsel.'' <SUP>91</SUP>
---------------------------------------------------------------------------

    \91\ ABA Letter, supra note 9, at 69.
---------------------------------------------------------------------------

    The NASD believes that the standards as originally proposed are 
appropriate, and consistent with Commission standards. The NASD 
believes that there is a bias in favor of denying postponements and 
adjournments because of the need to proceed expeditiously toward a 
resolution in order to further the public interest and benefit the 
parties involved in such proceedings. The NASD also states that the 
proposed rules relating to timing, including postponements, will be 
applied fairly, but postponements will not be granted each time a 
motion is made.<SUP>92</SUP>
---------------------------------------------------------------------------

    \92\ NASD Response, supra note 6, at 13.
---------------------------------------------------------------------------

    The commenter makes several recommendations regarding proposed Rule 
9231 (Appointment by the Chief Hearing Officer of Hearing Panel or 
Extended Hearing Panel) and proposed Rule 9232 (Criteria for Selection 
of Panelists and Replacement Panelists). First, the commenter supports 
the concept of hearing panels, as set forth in the rules, as 
``appropriate to achieve a balance between `peer justice' and more 
uniform and professional rulings.'' <SUP>93</SUP> The commenter 
believes, however, that the criteria used by the chief hearing officer 
to select panelists is ``unclear and open-ended.'' <SUP>94</SUP> In 
particular, the commenter believes that proposed Rule 9232 provides the 
chief hearing officer with too much discretion to choose panelists from 
anywhere in the country, rather than selecting members from the primary 
district committee.<SUP>95</SUP> The commenter also states that it is 
unclear under proposed Rule 9232(d) whether someone who has served 
frequently or infrequently on hearing panels is more likely to be 
selected.<SUP>96</SUP> In addition, the commenter is concerned that the 
Department of Enforcement may be able to ``pre-select'' panelists from 
the Market Regulation Committee (current or former members) by alleging 
at least one violation set forth in proposed Rule 9120(r),<SUP>97</SUP> 
thereby affecting the selection process.<SUP>98</SUP>
---------------------------------------------------------------------------

    \93\ ABA Letter, supra note 9, at 71.
    \94\ ABA Letter, supra note 9, at 73.
    \95\ Proposed Rule 9232 sets forth criteria for the chief 
hearing officer to consider when designating a particular district 
committee as the primary district committee.
    \96\ ABA Letter, supra note 9, at 74-75.
    \97\ Supra note 23.
    \98\ ABA Letter, supra note 9, at 75.
---------------------------------------------------------------------------

    The NASD believes that it is necessary to provide the chief hearing 
officer with flexibility to both appoint panelists with expertise and 
to avoid selecting panelists with perceived or real bias or conflicts 
of interest. In addition, the NASD states that the chief hearing 
officer will attempt to ensure broad-based participation by all 
segments of the securities industry; the NASD desires that more people 
be involved in the adjudicatory process so the perception and the 
reality is that disciplinary proceedings are fair.<SUP>99</SUP> The 
NASD also proposes to amend Rule 9232(d)(4) to clarify that the Office 
of Hearing Officers will be less likely to select a person who has 
served frequently on a disciplinary panel than a person who has 
not.<SUP>100</SUP>
---------------------------------------------------------------------------

    \99\ NASD Response, supra note 6, at 13-14.
    \100\ Amendment No. 3, supra note 6.
---------------------------------------------------------------------------

    Further, the NASD points out that the comment reflects a 
misunderstanding of the scope of proposed Rule 9120(r), the definition 
of the Market Regulation Committee. The NASD notes that proposed Rule 
9120(r) does not intend to place all federal and state securities laws, 
rules, and regulations under the advisory jurisdiction of the Market 
Regulation Committee. A current or former member of the Market 
Regulation Committee will serve on a panel only when the matter relates 
to certain subjects, including: quotations of securities; execution of 
transactions; reporting of transactions; and trading practices. The 
NASD further notes that the chief hearing officer, while provided with 
flexibility to choose panelists nationwide under proposed Rule 9232 
(c), (d), and (e), cannot pre-select panelists and will not allow the 
Department of Enforcement to pre-select panelists.<SUP>101</SUP>
---------------------------------------------------------------------------

    \101\ NASD Response, supra note 6, at 13-14.
---------------------------------------------------------------------------

    Pursuant to proposed Rule 9241, pre-hearing conferences are 
discretionary upon a motion by a party or at the request of the hearing 
officer. The commenter believes that the pre-hearing conference, in 
most cases, should be mandatory. In addition, the commenter recommends 
that the time period from the date of the answer to the pre-hearing 
conference be extended from twenty-one to forty-five days. The 
commenter also suggests that the list of subjects to be covered at the 
pre-hearing conference be expanded to include ``non-party discovery, 
confidentiality, and privilege issues and the issuance of protective 
orders.'' <SUP>102</SUP>
---------------------------------------------------------------------------

    \102\ ABA Letter, supra note 9, at 81.
---------------------------------------------------------------------------

    The NASD does not believe it is appropriate to change proposed Rule 
9241 so that a pre-hearing conference takes place within forty-five 
days after the answer has been filed instead of the twenty-one day 
period, as currently proposed. The NASD must ensure that disciplinary 
proceedings move forward as expeditiously as is possible while 
maintaining a fair forum for the parties. The NASD believes that for 
disciplinary proceedings where simple issues are involved, or with 
multiple pre-hearing conferences, creating a delay beyond twenty-one 
days is not a proper use of NASD or panelist resources and imposes an 
unnecessary cost on a respondent. The NASD also believes that it is 
unnecessary to include additional subjects to be covered at the pre-
hearing conference because proposed Rule 9241(c)(10) encourages the 
parties to request that the hearing officer consider any issue not 
specifically listed in the rule.<SUP>103</SUP>
---------------------------------------------------------------------------

    \103\ NASD Response, supra note 6, at 14.
---------------------------------------------------------------------------

    Proposed Rule 9242 regarding pre-hearing submissions indicates that 
the

[[Page 43396]]

appropriate adjudicator may, at his or her discretion, order the 
exchange and/or furnishing of information prior to a hearing. The 
commenter believes that this should be mandatory. In addition, the 
commenter argues that such an exchange of information should be made at 
least thirty days before the hearing.<SUP>104</SUP> The NASD does not 
believe that it is appropriate in every case to require a hearing 
officer to order the parties to furnish information regarding the case. 
The NASD believes that the hearing officer has been provided 
appropriate discretion to control the proceeding, and determine if a 
pre-hearing exchange of the information is necessary.<SUP>105</SUP>
---------------------------------------------------------------------------

    \104\ ABA Letter, supra note 9, at 82.
    \105\ NASD Response, supra note 6, at 14.
---------------------------------------------------------------------------

    The commenter recommends several changes to the discovery rules set 
forth in proposed Rule 9251. First, the commenter believes that the 
proposed rule should not include a standard regarding materiality and 
relevance in the post-complaint time frame. If a relevance standard is 
required, the enforcement staff should be required to provide a list of 
all documents it obtains to the respondent, and the hearing officer, 
not the enforcement staff, should make determinations of 
relevance.<SUP>106</SUP> The commenter also recommends that if the 
staff fails to make documents available, the staff, rather than the 
respondent, should have the burden to prove that such failure 
constituted harmless error.<SUP>107</SUP>
---------------------------------------------------------------------------

    \106\ ABA Letter, supra note 9, at 85.
    \107\ ABA Letter, supra note 9, at 89.
---------------------------------------------------------------------------

    The commenter also believes that the only documents that the staff 
should be able to withhold pursuant to proposed Rule 9251(b) are 
privileged documents or documents constituting attorney work product. 
The commenter also believes that the proposed rule should contain a 
provision that addresses privilege and work-product immunity for both 
the staff and respondents. Further, the commenter suggests that Federal 
Rule of Evidence 501 (for privilege issues) and Federal Rule of Civil 
Procedure 26(b)(3) (for work-product immunity issues) should be used as 
a model. The commenter suggests that if the staff wants to withhold 
documents on any other basis, a motion for protective order should be 
required. In addition, the commenter recommends that the NASD consider 
the impact of Fifth Amendment claims before the NASD. The commenter 
believes that expulsion from the NASD for asserting the Fifth Amendment 
is too severe and will continue to result in constitutional challenges 
to the self-regulatory system.<SUP>108</SUP>
---------------------------------------------------------------------------

    \108\ ABA Letter, supra note 9, at 89-90.
---------------------------------------------------------------------------

    The NASD believes that a secondary production of documents should 
be subject to a material relevance standard so that the Department of 
Enforcement only has to turn over documents that are relevant to the 
proceeding initiated and not other documents that may relate to a 
potential, but yet-to-be named respondent as part of the same 
investigation file. In addition, in the NASD's view, its enforcement 
efforts would be impaired if all internal memoranda were required to be 
produced. The NASD notes that not all examinations are done by lawyers, 
and therefore the resulting documents and reports may not be 
privileged.<SUP>109</SUP>
---------------------------------------------------------------------------

    \109\ Further, the NASD proposes to expand the category of 
documents that may be withheld by the Department of Enforcement from 
the respondent under proposed Rule 9251(b)(1)(C), to exclude from 
production, among other things, correspondence between the NASD and 
a state, federal, or foreign regulatory authority or an SRO. 
Amendment No. 3, supra note 6.
---------------------------------------------------------------------------

    Further, the NASD believes it would be inappropriate to mandate a 
withheld document list in every case. The NASD notes that a withheld 
document list in certain cases could enable a reader to trace the 
course of an investigation, forcing improper disclosure about the 
investigation and the investigatory process in circumstances that could 
impede a continuing investigation of another member or associated 
person. The NASD notes, however, that the hearing officer may request 
in camera inspection of documents, and may order the production of a 
list of withheld documents, on a case-by-case basis. In the NASD's 
view, requiring a list in every case would be burdensome and 
costly.<SUP>110</SUP> Accordingly, the NASD has added a sentence to 
proposed Rule 9251(c) stating: ``[a] motion to require the Department 
of Enforcement to produce a list of documents withheld pursuant to 
paragraph (b) shall be based upon some reason to believe that a 
document is being withheld in violation of the Code.'' <SUP>111</SUP>
---------------------------------------------------------------------------

    \110\ NASD Response, supra note 6, at 14-15.
    \111\ Amendment No. 3, supra note 6.
---------------------------------------------------------------------------

    The NASD also believes it would be undesirable to adopt Federal 
Rule of Evidence 501 for privilege issues and Federal Rule of Civil 
Procedure 26(b)(3) regarding work-product immunity. The NASD states 
that it must provide a fair process but is not limited by the specific 
evidentiary rules relating to privilege in the Federal Rules of 
Evidence and the Federal Rules of Civil Procedure.
    In addition, the NASD believes that the suggested change to the 
harmless error provision is unnecessary. The NASD notes that the 
provision is based upon the Commission's rule and recognizes that 
proposed Rule 9251 affords the respondent the right to receive the 
documents and information in preparation for his defense in a 
disciplinary matter.
    The NASD further states that it would be inappropriate to change 
its position that there is no Fifth Amendment privilege in an SRO 
disciplinary investigation or proceeding. A respondent therefore may 
not claim the Fifth Amendment without sanction.<SUP>112</SUP>
---------------------------------------------------------------------------

    \112\ NASD Response, supra note 6, at 14-15.
---------------------------------------------------------------------------

    The commenter recommends that the minimum time for pre-hearing 
exchange of proposed exhibits and witness lists, as set forth in 
proposed Rule 9261, should be expanded from ten to thirty days. The 
commenter believes that ten days will not provide parties enough time 
to prepare for a hearing.<SUP>113</SUP>
---------------------------------------------------------------------------

    \113\ ABA Letter, supra note 9, at 93.
---------------------------------------------------------------------------

    The NASD believes it would be inappropriate and unnecessary to 
amend the minimum period for pre-hearing exchange of proposed exhibits 
and witness lists. As noted earlier with respect to the NASD's comments 
regarding the twenty-eight day notice given prior to a hearing in 
proposed Rule 9221(d), there are cases in which a hearing may or should 
proceed expeditiously in order to serve the interest of all the 
parties, to protect the public interest, or to preserve resources. With 
respect to difficult or large cases, the NASD's Office of Hearing 
Officers has indicated that parties will be required to exchange such 
information much earlier than ten days before the 
hearing.<SUP>114</SUP>
---------------------------------------------------------------------------

    \114\ NASD Response, supra note 6, at 15-16.
---------------------------------------------------------------------------

    The commenter notes that proposed Rule 9262 regarding testimony 
does not address whether telephone testimony will be permitted. The 
commenter believes that the use of telephone testimony raises fairness 
issues.<SUP>115</SUP> Accordingly, the commenter recommends that the 
proposed rule should prohibit telephone testimony unless all parties 
agree to such testimony. As an alternative, the commenter recommends 
that for good cause shown, a witness should be able to present a pre-
hearing videotaped testimony.<SUP>116</SUP>
---------------------------------------------------------------------------

    \115\ The commenter believes that it would be difficult to 
cross-examine and to determine the demeanor of a witness during 
telephone testimony. ABA Letter, supra note 9, at 95.
    \116\ ABA Letter, supra note 9, at 95.
---------------------------------------------------------------------------

    The NASD states that to fulfill its SRO enforcement 
responsibilities, it must rely upon the voluntary cooperation of firm 
customers. The NASD needs to

[[Page 43397]]

remain flexible in obtaining the cooperation of customers, including 
obtaining testimony to be used in a disciplinary proceeding. Thus, the 
NASD believes it would be undesirable to ban telephone testimony from 
use in a disciplinary proceeding. The NASD notes that the circumstances 
of each case will be reviewed and considered in determining whether to 
allow telephone testimony and how to weigh the testimony. To address 
credibility issues, the hearing officer may request that the party on 
whose behalf the telephone testimony is sought provide a notary at the 
site of the witness to swear in the witness, or obtain an affidavit or 
declaration from the witness, acknowledging that the testimony will be 
given under oath. The hearing officer may alternatively require that 
the witness review the transcript of his or her telephone testimony, 
attach it to an affidavit or declaration, and swear to the veracity of 
the attached testimony. Finally, in certain cases, unsworn testimony 
will be admitted, but its weight shall be considered in light of the 
circumstances in which it was taken.
    In response to the comment regarding video-taped testimony, the 
NASD interprets the proposed Code in appropriate circumstances to 
authorize a hearing officer to order a party to video-tape the pre-
hearing testimony of a person who will not be physically present at the 
hearing. The NASD notes, however, that extensive use of video-taped 
testimony would be costly and, therefore, will not occur 
routinely.<SUP>117</SUP>
---------------------------------------------------------------------------

    \117\ NASD Response, supra note 6, at 16.
---------------------------------------------------------------------------

    The commenter commends the incorporation of proposed Rule 9264 
regarding motions for summary disposition, but suggests that NASD make 
several modifications. First, the commenter recommends that hearing 
panels be instructed that the option to defer a decision on a proposed 
Rule 9264 motion for summary disposition not be used to avoid 
determining whether the Department of Enforcement staff has a case that 
it can prove. Second, the commenter recommends that the Department of 
Enforcement should not have the ability to move for summary disposition 
after a hearing on the merits has commenced, or after the Department of 
Enforcement has completed its case. Third, the commenter recommends 
that the rules should expressly state that dispositive motions against 
respondents should be granted only in ``completely clear-cut 
circumstances.'' Fourth, the commenter recommends a technical revision 
to proposed Rule 9264(d) which provides that, in ruling on motions for 
summary disposition, the hearing panel shall take as true ``the facts 
alleged in the pleadings against whom the motion is made'' unless those 
facts are contradicted by ``uncontested affidavits'' or ``stipulations 
or admissions made by the non-moving party.'' The commenter suggests 
that the word ``uncontested'' should be deleted and the moving party be 
required to support its motion with affidavits or other materials 
showing that there is no genuine issue for trial.<SUP>118</SUP>
---------------------------------------------------------------------------

    \118\ ABA Letter, supra note 9, at 98-103.
---------------------------------------------------------------------------

    The NASD agrees that hearing panels be instructed that the option 
to defer a decision on a proposed Rule 9264 motion for summary 
disposition should not be used to avoid determining whether the 
Department of Enforcement has a case that it can prove. Dispositive 
motions play a valuable role in cases where the evidentiary basis is 
lacking or where a legal claim is not set forth in the complaint. 
However, the NASD does not believe that it is appropriate to codify 
such instructions.
    In addition, the NASD states that it will amend proposed Rule 
9264(b) to eliminate the ability of the Department of Enforcement to 
move for summary disposition after a hearing on the merits has 
commenced. While the NASD recognizes that in the pre-hearing context of 
proposed Rule 9264(a) such dispositive motions should be granted 
against a respondent only in very clear cases, it does not propose to 
codify this policy. Further, the NASD agrees with the commenter that 
paragraph (d) of proposed Rule 9264 should be amended.<SUP>119</SUP>
---------------------------------------------------------------------------

    \119\ NASD Response, supra note 6, at 16-17. See also Amendment 
No. 3, supra note 6.
---------------------------------------------------------------------------

    The commenter recommends that the NASD adopt changes to proposed 
Rule 9270 to provide guidance as to what constitutes a frivolous offer, 
to apply the Sanctions Guidelines to such offers, and to specify the 
procedures that should govern an offer of settlement once a hearing has 
begun. The commenter also recommends that the NASD consider designating 
hearing officers as a ``Duty Officer'' on a rotating basis to consider 
settlement offers to eliminate any appearance of unfairness from 
hearing officers being allowed to reject offers of settlement and later 
conduct the hearing on the merits.<SUP>120</SUP>
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    \120\ ABA Letter, supra note 9, at 112-114.
---------------------------------------------------------------------------

    The NASD does not believe that it is necessary or appropriate to 
adopt these proposed changes to proposed Rule 9270. First, the NASD 
does not believe it is appropriate to codify ``standardized language'' 
to be used routinely in settlement documents. Second, in the NASD's 
view, the application of the Sanctions Guidelines to a particular 
disciplinary proceeding should not be codified. Third, the NASD does 
not believe it is appropriate to amend proposed Rule 9270(c) based on 
the commenter's concern that a hearing panel or an extended hearing 
panel may view with prejudice some aspect of a respondent's case if the 
respondent previously submitted an offer of settlement that the hearing 
panel or the extended hearing panel rejected. The NASD notes that 
although some jurisdictions provide settlement judges, in most 
jurisdictions, a judge continues to preside over the case throughout 
the disciplinary process, even after approving or disapproving a 
settlement. The NASD notes further that it is the duty of the hearing 
officer sitting on the hearing panel or the extended hearing panel to 
instruct the panelists to disregard the proposed settlement therefore 
allowing the respondent to obtain a fair hearing on the 
merits.<SUP>121</SUP>
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    \121\ NASD Response, supra note 6, at 17-18.
---------------------------------------------------------------------------

    Proposed Rule 9280 sets forth a list of sanctions that may be 
imposed upon a party and/or a party's attorney for conduct in violation 
of an order or ``other contemptuous conduct during a proceeding.'' The 
commenter recommends that the NASD define ``contemptuous conduct'' in 
the proposed rule.<SUP>122</SUP> The commenter does not believe it is 
clear to what extent the hearing panel must consider an attorney's 
ethical obligation to vigorously represent a client in determining the 
limits of acceptable conduct. Further, the commenter suggests that an 
attorney subject to an exclusion order should have the right to an oral 
argument before the NBCC.<SUP>123</SUP>
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    \122\ In a previous comment regarding proposed Rule 9150 
(Exclusion from Rule 9000 Series Proceeding), the commenter also 
recommends that the NASD ensure that an attorney's obligations under 
the Model Rules of Professional Conduct are not compromised by the 
application of this proposed rule.
    \123\ ABA Letter, supra note 9, at 116.
---------------------------------------------------------------------------

    The NASD believes it is unnecessary to define ``contemptuous 
conduct.'' The NASD does not believe that the use of proposed Rule 9280 
against a counsel will compromise zealous advocacy of a client; in any 
case, the NASD will analyze any interpretive questions on a case-by-
case basis. Further, the NASD does not believe it is appropriate to 
codify that an attorney has the right to oral argument before the NBCC 
in every case as a matter of right if the attorney is appealing a 
proposed Rule 9150 exclusion order. The NASD notes that under proposed 
Rule 9150 and

[[Page 43398]]

proposed Rule 9280, attorney exclusion is the only contested order 
following which an interlocutory appeal is granted as a matter of 
right. The NASD states that the Code need only provide that an attorney 
(or a representative) may request oral argument before the NBCC when he 
or she is appealing a proposed Rule 9150 exclusion order, as the 
proposed Rule currently does.<SUP>124</SUP>
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    \124\ NASD Response, supra note 6, at 18.
---------------------------------------------------------------------------

3. Rule 9300 Series
    The rules provide for two levels of discretionary review of 
disciplinary proceedings by the NASD Regulation Board of Directors 
(proposed Rules 9351) and the NASD Board of Governors (proposed Rule 
9352). The commenter recommends that the proposed rules should restrict 
a call for review to either the NASD Regulation Board, or the NASD 
Board, but not both.\125\ The NASD generally agrees with the comment 
regarding the two levels of discretionary review of disciplinary 
proceedings. The NASD states that a central feature of the corporate 
restructuring recently approved by the NASD Board of Governors, and 
shortly to be submitted to the Commission, is to eliminate such 
unnecessary levels of discretionary review.\126\
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    \125\ ABA Letter, supra note 9, at 135-36.
    \126\ NASD Response, supra note 6, at 18-19.
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    The commenter also recommends that a bar or expulsion become 
effective thirty days after service rather than effective upon service 
as set forth in proposed Rule 9360. In addition, the commenter 
recommends that the bar or expulsion be effective only upon personal 
service on the member.\127\
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    \127\ ABA Letter, supra note 9, at 137.
---------------------------------------------------------------------------

    The NASD proposes to amend proposed Rule 9360 to reflect the 
concern of the commenter that a person subject to a sanction of a bar 
or an expulsion be personally served. Because such persons are often 
very difficult to serve, the NASD proposes to amend proposed Rule 9360 
to provide that the NASD shall take reasonable steps to obtain personal 
service of a respondent when the sanction is a bar or an 
expulsion.\128\ A bar or expulsion will continue to be effective upon 
service. The NASD states that a party may seek a stay of the 
effectiveness of the sanction from the Commission or from the 
appropriate federal court.\129\
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    \128\ Amendment No. 3, supra note 6.
    \129\ NASD Response, supra note 6.
---------------------------------------------------------------------------

    The commenter notes that proposed Rule 9370 stays the effectiveness 
of any sanction other than a bar or an expulsion upon application for 
review by the Commission pursuant to Section 19(d)(2) of the Act. The 
commenter recommends that bars and expulsions should also be stayed 
pending appeal under proposed Rule 9370.\130\ The NASD, however, 
believes that a bar or an expulsion should not be stayed automatically 
upon an application for review by the Commission pursuant to Section 
19(d)(2) of the Act.\131\ As noted in the NASD's response to proposed 
changes to proposed Rule 9360, an aggrieved person may seek a stay from 
the Commission or from the appropriate federal court.\132\
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    \130\ ABA Letter, supra note 9, at 138-39.
    \131\ Under proposed Rule 9370, other sanctions are stayed when 
an application for review is filed.
    \132\ NASD Response, supra note 6, at 19.
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IV. Discussion

    As discussed more fully herein, the Commission has determined at 
this time to approve the NASD's proposed rule change. The standard by 
which the Commission must evaluate a proposed rule change is set forth 
in Section 19(b) of the Act. The Commission must approve a proposed 
NASD rule change if it finds that the proposal is consistent with the 
requirements of the Act and the rules and regulations thereunder that 
govern the NASD.\133\ In evaluating a given proposal, the Commission 
examines the record before it and all relevant factors and necessary 
information. In addition, Section 15A of the Act establishes specific 
standards for NASD rules against which the Commission must measure the 
NASD proposal.\134\
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    \133\ 15 U.S.C. Sec. 78s(b).
    \134\ 15 U.S.C. Sec. 78o-3.
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    As discussed below, the Commission has evaluated the NASD's 
proposed change in light of the standards and objectives set forth in 
the Act and, in particular, Sections 15A \135\ and 3(f) \136\ of the 
Act. The Commission believes the NASD's proposed rule change is 
consistent with the Act. The Commission also believes the rule change 
proposed by the NASD is consistent with the NASD's Undertakings in the 
SEC Order and is reasonably taken in furtherance of the Undertakings. 
The Commission expects that the NASD's rule change should strengthen 
the NASD's operational and disciplinary procedures, which are important 
in governing its members in a free, open, and competitive market. 
Further, in the Commission's view, the proposed change should enhance 
the dispassionate application of rules and fairness in the disciplinary 
process and bring greater consistency and fairness to the membership 
application and other regulatory processes.
---------------------------------------------------------------------------

    \135\ For example, Section 15A(b)(8) requires that the rules of 
an association provide a fair procedure for the disciplining of 
members and persons associated with members, the denial of 
membership, the barring of any person becoming associated with a 
member thereof, and for the prohibition or limitation by the 
association of any person with respect to access to services offered 
by the association. Section 15A(h)(2) requires a registered 
securities association when determining whether a person shall be 
denied membership, barred from becoming associated with a member, or 
prohibited or limited with respect to access to services offered by 
the association or member thereof, to notify such person of and give 
him an opportunity to be heard upon, the specific grounds for 
denial, bar, or prohibition or limitation under consideration and 
keep a record. Section 15A(h)(3) governs when a registered 
securities association may summarily suspend a member or a person 
associated with a member.
    \136\ In approving this proposal, the Commission notes that it 
has considered the proposed rule change's impact on efficiency, 
competition, and capital formation. 15 U.S.C. Sec. 78c(f).
---------------------------------------------------------------------------

A. Changes to the Membership and Registration Rules

    For the reasons discussed below, the Commission believes the 
proposed rule change regarding membership decisions is consistent with 
the Act and the rules and regulations thereunder applicable to a 
national securities association. In particular, the proposal is 
consistent with Sections 15A(b)(3), 15A(b)(8), 15A(g)(3), and 15A(h)(2) 
of the Act.<SUP>137</SUP> This change improves the current system by 
implementing safeguards to ensure that decisions regarding membership 
are addressed in a fair and efficient manner. Moreover, the rule change 
is reasonably taken in furtherance of the Undertakings and is 
consistent with the Undertakings.
---------------------------------------------------------------------------

    \137\ 15 U.S.C. Secs. 78o-3(b)(3), 78o-3(b)(8), 78o-3(g)(3), and 
78o-3(h)(2).
---------------------------------------------------------------------------

    That portion of the settlement between the Commission and the NASD 
concerning the admission of member firms to the NASD requires the 
regulatory staff of the NASD, subject only to the supervision of the 
Board of Governors of the NASD and the Board of Directors of NASD 
Regulation, to have sole discretion to handle the approval of 
applications for membership and the conditions and limitations on 
membership.<SUP>138</SUP> The District Committees (including any 
subcommittees) may not be involved in the review or approval of 
applications for membership in the NASD.<SUP>139</SUP> Moreover, the 
NASD agreed to promulgate and apply on a consistent basis uniform 
standards regarding admission to the NASD and to institute safeguards 
to ensure fair and

[[Page 43399]]

evenhanded access to the NASD's services.<SUP>140</SUP>
---------------------------------------------------------------------------

    \138\ SEC Order, supra note 10; see also Undertaking 4, supra 
note 15.
    \139\ SEC Order, supra note 10; see also Undertaking 4, supra 
note 15.
    \140\ SEC Order, supra note 10; see also Undertaking 5, supra 
note 15.
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1. Processing Membership Applications
    The Commission noted in the 21(a) Report that the District 
Committee (or a subcommittee it created called the Pre-Membership 
Interview (``PMI'') Subcommittee) at the New York City District 10 
office of the NASD encouraged the close scrutiny of applicants who 
appeared likely to engage in active SOES trading.<SUP>141</SUP> This 
scrutiny substantially hindered or delayed a number of these 
applications, even though the NASD's rules provided for reasonable 
review periods.
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    \141\ 21(a) Report, supra note 10, at 41, A-74.
---------------------------------------------------------------------------

    The current membership application procedures require an applicant 
to file its application with the District Office where the applicant 
intends to have its principal place of business. The District Office 
will then schedule a premembership interview within a reasonable time 
after it receives the application and supporting documents. Within 
thirty days after the conclusion of the premembership interview, a 
subcommittee will consider the application and notify the applicant in 
writing whether its application has been granted, denied, or granted 
subject to restrictions, and provide the rationale for such 
determination. If an application is denied, the applicant has the right 
to file an appeal with the District Committee within fifteen days. The 
District Committee will consider the record developed before it and 
notify the applicant in writing within a reasonable time after the 
close of the record whether its application has been granted, denied, 
or granted subject to restrictions on its business activities. The 
applicant also has the right to appeal the District Committee's 
decision to the NBCC. The NBCC will consider the record developed 
before it and notify the applicant in writing within a reasonable time 
after the close of the record whether its application has been granted, 
denied, or granted subject to restrictions on its business activities. 
Determinations of the NBCC may be called for review by either the Board 
of NASD Regulation or the Board of the NASD.
    Rather than requiring the NASD to simply act within a ``reasonable 
time frame,'' the proposed rule change sets forth a schedule for the 
membership application process and allows applicants to ensure that 
their applications are being processed expeditiously. The process 
begins with the submission of an application to the NASD. The first 
part of the application must be filed with the Membership 
Department,<SUP>142</SUP> and the second part of the application must 
be filed with the Department of Member Regulation at the District 
Office in the District in which an applicant intends to have its 
principal place of business.<SUP>143</SUP> The Department will notify 
an applicant within thirty days after it receives an application 
whether the application is complete.<SUP>144</SUP> Within ninety days 
after the receipt of the application or within sixty days after the 
receipt of all additional information, whichever is later, the 
Department will schedule a membership interview.<SUP>145</SUP> The 
Department will issue its written decision within thirty days after the 
conclusion of the membership interview or within thirty days after the 
submission of additional information, whichever is later.<SUP>146</SUP>
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    \142\ Specifically, the first part of the application must 
contain an original, signed, and notarized Form BD, with applicable 
schedules; an original, signed Form U-4 for each associated person 
who is required to be registered under the rules of the NASD; an 
original NASD-approved fingerprint card for each associated person 
who will be subject to SEC Rule 17f-2; a new member assessment 
report; a new member firm contact questionnaire; and a check for the 
appropriate fee. Proposed Rule 1013(a)(1).
    \143\ The second part of the application must include, among 
others: a monthly projection of income and expenses, with supporting 
rationale, for the first 12 months of operations; a list of all 
associated persons, the most recent Form U-4 and Form U-5 for each 
associated person, any other document that discloses the 
disciplinary history of each associated person, and a list of any 
other persons or entities that will exercise control with respect to 
the applicant's business; and a description of the nature and source 
of applicant's capital, including a list of all persons or entities 
that have contributed or plan to contribute financing to the 
applicant's business, the terms and conditions of such financing 
arrangements, the risk to net capital presented by the applicant's 
proposed business activities, and any arrangement for additional 
capital should a business need arise. Proposed Rule 1013(a)(2).
    \144\ Proposed Rule 1013(a)(4).
    \145\ Proposed Rule 1013(c)(3).
    \146\ Proposed Rule 1014(d)(1).
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    If the Department fails to issue its decision within 180 days after 
the receipt of an application, or such later date as the Department and 
an applicant have agreed to in writing, an applicant may petition the 
NASD Board in writing to direct the Department to issue a 
decision.<SUP>147</SUP> Within seven days of receiving such a request, 
the NASD Board will instruct the Department to serve its written 
decision immediately or show good cause for an extension of time. If 
the Department establishes good cause for an extension of time, the 
NASD Board may grant the Department an extension of no more than ninety 
days.<SUP>148</SUP>
---------------------------------------------------------------------------

    \147\ Proposed Rule 1014(d)(3).
    \148\ Proposed Rule 1014(d)(3).
---------------------------------------------------------------------------

    If the Department denies an application, the applicant may request 
that the NBCC review the decision.<SUP>149</SUP> If a hearing is 
requested, it shall be conducted by a subcommittee of the NBCC within 
forty-five days after the receipt of the request.<SUP>150</SUP> The 
subcommittee will present its recommended decision to the NBCC within 
sixty days after the date of the hearing.<SUP>151</SUP> The NBCC will 
then provide the NASD Regulation Board with its proposed written 
decision.<SUP>152</SUP> If the decision is not called for review by the 
NASD Regulation Board, the NBCC will transmit its proposed written 
decision to the NASD Board.<SUP>153</SUP> If the NASD Board does not 
call the decision for review, the NBCC will serve the applicant with 
written notice specifying the date on which the call for review period 
expired and stating that the final written decision will be served 
within fifteen days after such date.<SUP>154</SUP>
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    \149\ Proposed Rule 1015(a).
    \150\ Proposed Rule 1015(f).
    \151\ Proposed Rule 1015(h).
    \152\ Proposed Rule 1015(i)(3). The NASD anticipates that the 
NBCC will provide the Boards with its proposed decision at the next 
applicable Board meeting after receiving the subcommittee's 
recommendation.
    \153\ Proposed Rule 1015(i)(3).
    \154\ Proposed Rule 1015(i)(3).
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    If the NBCC fails to issue its decision within fifteen days after 
the expiration of the call for review period, the applicant may 
petition the NASD Board in writing to direct the NBCC to issue its 
decision.<SUP>155</SUP> Within seven days of receiving such a request, 
the NASD Board will instruct the NBCC to serve its written decision 
immediately or show good cause for an extension of time. If the NBCC 
establishes good cause for an extension of time, the NASD Board may 
grant the NBCC an extension of no more than fifteen days.
---------------------------------------------------------------------------

    \155\ Proposed Rule 1015(i)(4).
---------------------------------------------------------------------------

    The Commission believes these detailed procedures will help ensure 
that applications will be processed in a timely manner. Centralizing 
the new member review process at the NASD's headquarters, however, is 
not necessary to facilitate the process. Each step in the application 
process contains a discrete time frame within which the NASD must act. 
In addition, the NASD has represented that significant initiatives are 
already underway to ensure national uniformity and consistency in the 
treatment of membership applications.<SUP>156</SUP>
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    \156\ For example, the NASD noted that training sessions 
focusing on the proposed rules have been conducted for supervisors 
and assistant directors, a comprehensive training program is being 
finalized for District Office examiners, and a staff steering 
committee chaired by an NASD Regulation vice president and staffed 
by senior District Office staff members is finalizing detailed 
procedures for District Offices to follow to help ensure uniformity 
and consistency.

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[[Page 43400]]

    It is also reasonable for the application for membership to require 
applicants to provide the information set forth in proposed Rule 
1013(a). The required information is reasonably necessary to facilitate 
the NASD's ability to review an application and determine if an 
applicant will be able to comply with all of the applicable standards. 
In particular, it is appropriate to require applicants to project 
income and expenses for the first twelve months of operations, to 
describe the nature and source of the applicant's capital, and to 
submit copies of Forms U-4 and U-5 as part of their application.
    Specifically, it is reasonable to require applicants to furnish a 
monthly projection of income and expenses for the first twelve months 
of operations because this information enhances the NASD's ability to 
determine whether an applicant has a reasonable expectation of being 
able to comply with the net capital rule once an applicant commences 
business. It should not be overly burdensome for applicants to provide 
this information because most new firms already project the revenues 
necessary to help meet fixed and other expenses for business reasons.
    Similarly, it is appropriate for applicants to provide a 
description of the nature and source of an applicant's 
capital.<SUP>157</SUP> This information will assist the NASD in 
determining whether the applicant will have difficulty in maintaining 
required net capital. Moreover, it enhances the NASD's ability to 
correctly identify the true owners of a firm and thus ensure that 
improper parties (e.g., parties that are barred from the industry) are 
not involved.
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    \157\ The NASD has represented, as described previously, that it 
has taken steps to ensure an appropriate degree of consistency and 
uniformity will exist. For example, the NASD indicated that it will 
require memoranda or public offering documents as information 
describing the risk to the applicant's capital.
---------------------------------------------------------------------------

    It is also reasonable to require applicants to submit copies of 
Forms BD, U-4, and U-5 as part of their application. Presenting the 
NASD with all of the relevant information in one package, including 
these forms, should help expedite the processing of applications.
    Finally, the proposal adequately addresses a commenter's concern 
that the tolling provisions may prolong the application 
process.<SUP>158</SUP> Although these provisions allow the maximum time 
limits to begin from the date of the Department's last request for 
information, the proposal also allows an applicant to demand that the 
Department issue its written decision within 180 days after it was 
received by the NASD, notwithstanding any of the tolling provisions. 
This should prevent the Department's requests for information from 
unduly delaying the application procedure.<SUP>159</SUP>
---------------------------------------------------------------------------

    \158\ Colish Letter, supra note 9, at 4.
    \159\ Proposed Rule 1014(d)(3).
---------------------------------------------------------------------------

2. Membership Standards
    In the 21(a) Report, the Commission found that the NASD applied 
criteria not enumerated in the NASD's rules to some 
applicants.<SUP>160</SUP> Currently, the NASD's rules do not contain 
explicit standards that an applicant must meet; they only contain 
general topics that the membership interview will cover.<SUP>161</SUP> 
In addition, the current rules only require that the NASD provide the 
general rationale for its decision.
---------------------------------------------------------------------------

    \160\ SEC Order, supra note 10. For example, the NASD considered 
adopting a guideline to deny membership to:
    Owners, control persons, or principal officers who have been 
recently employed by a known SOES activist and who have indicated an 
interest in being a SOES activist themselves. This interest would be 
evidenced by conducting business predominately on a retail agency 
basis and the request to have pieces of equipment with SOES 
capabilities that is close in number to the registered 
representatives that the firm intends to employ.
    Although not adopted as an official policy of the NASD, the 
supervisor of the PMI section of District 10 applied this particular 
SOES-related guideline to new applicants along with other guidelines 
in identifying issues for the PMI Subcommittee to consider. 21(a) 
Report, supra note 10, at A-72.
    \161\ Current Rule 1011(c)(1)-(6).
---------------------------------------------------------------------------

    In contrast, the proposed rule change sets forth thirteen standards 
that the NASD must consider.<SUP>162</SUP> Moreover, if the NASD denies 
an application, the proposed rules explicitly require that the 
Department, as part of the decision explaining the reason for the 
denial, reference the applicable standard(s).
---------------------------------------------------------------------------

    \162\ Proposed Rule 1014(a)(1)-(13). One commenter opined that 
the standards contained in proposed Rule 1014(a)(8) and proposed 
Rule 1014(a)(9) are redundant. Although the subject area for both 
standards is similar, the source for comparison differs. Proposed 
Rule 1014(a)(8) requires the NASD to compare an applicant's 
compliance, supervisory, operational, and internal control practices 
and standards to those practices and standards employed by other 
firms in the securities industry. Proposed Rule 1014(a)(9), on the 
other hand, requires the NASD to evaluate these practices and 
standards in light of the requirements of the federal securities 
laws, the rules and regulations thereunder, and the rules of the 
NASD.
---------------------------------------------------------------------------

    The proposed standards are objective in nature but, at the same 
time, are flexible enough to allow the NASD the discretion it needs to 
properly assess membership matters. By identifying the proper criteria 
for admission, the new rules should help ensure that applicants are not 
required to satisfy criteria not enumerated in the NASD's rules. In 
addition, these objective standards will facilitate the Commission's 
ability to evaluate NASD decisions appealed to it.
3. Business Restrictions
    In the 21(a) Report, the Commission found that the NASD had, in 
certain instances, placed improper restrictions on certain members' 
activities as a condition of membership <SUP>163</SUP> and prevented 
certain members from seeking modifications to their restriction 
agreements.<SUP>164</SUP> The NASD's current rules regarding the 
modification or removal of business restrictions are very open-ended. 
They simply state that members may file a written request that will be 
reviewed by a subcommittee designated by the District Committee for the 
District in which the member currently has its principal place of 
business. There are no set time frames within which the NASD must act. 
In addition, the subcommittee is only required to consider the 
circumstances that gave rise to the imposition of the restrictions, the 
operations of the member since the imposition of the restrictions, and 
any new evidence submitted in connection with the member's request.
---------------------------------------------------------------------------

    \163\ For example, the PMI Subcommittee curtailed the ability of 
certain firms to use the SOES system. The NASD expressly conditioned 
membership on certain firms' acceptance of substantial limitations 
on their SOES trading activity. These restrictions included, in 
certain circumstances, outright prohibitions on the use of SOES, 
limitations on the number of SOES terminals available to a firm, and 
restatement of the order splitting and professional trading account 
rules in the membership agreement. 21(a) Report, supra note 10, at 
A-74.
    \164\ The Commission noted in the 21(a) Report that the NASD had 
applied an informal policy of preventing firms from seeking 
modifications of any restrictions by conditioning membership on the 
requirement that the firm forbear from seeking modifications for six 
months to one year, notwithstanding that the NASD's rules permitted 
a firm to seek a modification at any time. 21(a) Report, supra note 
10, at A-75.
---------------------------------------------------------------------------

    In contrast, the proposal sets forth a detailed procedure for 
applying for the removal or modification of a business restriction: it 
grants applicants seeking to modify or remove previously imposed 
business restrictions the same procedural rights accorded applicants 
seeking membership.<SUP>165</SUP> In addition, the NASD will apply the 
same standards used for evaluating new membership

[[Page 43401]]

applications to such requests.<SUP>166</SUP> Finally, the proposed rule 
change contains a provision that requires the Department to modify or 
remove a restriction on its own initiative if the Department determines 
such action is appropriate.<SUP>167</SUP>
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    \165\ For example, the Department must respond to requests for 
modification or removal of business restrictions within certain time 
frames. See supra Section IV.A.1 for a general discussion of the 
time frames and appellate procedure. See also proposed Rule 1017 
(setting forth the procedure for seeking a modification or removal 
of a business restriction).
    \166\ Proposed Rule 1017(e)(1)(A)(requiring the NASD to utilize 
the standards set forth in proposed Rule 1014 when evaluating a 
request to modify or remove a business restriction).
    \167\ Proposed Rule 1017(h). The Commission noted in the 21(a) 
Report certain instances where the NASD retained Professional 
Trading Account restrictions in membership agreements as much as 18 
months after those rules were repealed. 21(a) Report, supra note 10, 
at n.203.
---------------------------------------------------------------------------

    The Commission believes the detailed procedures contained in the 
proposed rule change will provide both applicants and the NASD greater 
guidance with regard to processing requests to modify or remove 
business restrictions. The establishment of uniform standards by which 
such requests will be evaluated, combined with the NASD's new training 
procedures and establishment of a staff steering committee, will help 
ensure national uniformity and consistency in the treatment of such 
applications.

B. Changes to the Investigations and Sanctions Rules

    For the reasons discussed below, the Commission believes the 
proposed change to the Rule 8000 Series regarding investigations and 
sanctions should provide fair and efficient procedures. The Commission 
also believes that the proposed change is consistent with Section 15A 
of the Act, and in particular, with Sections 15A(b)(6) <SUP>168</SUP> 
and 15A(b)(9) <SUP>169</SUP> of the Act. Further, the Commission 
believes the proposed change to the procedures governing investigations 
and sanctions is reasonably taken in furtherance of and is consistent 
with the Undertakings.
---------------------------------------------------------------------------

    \168\ 15 U.S.C. Sec. 78o-3(b)(6).
    \169\ 15 U.S.C. Sec. 78o-3(b)(9).
---------------------------------------------------------------------------

    Undertaking 4 requires the NASD ``[t]o provide[] for the autonomy 
and independence of the regulatory staff of the NASD and its 
subsidiaries such that the staff, subject only to the supervision of 
the Board of Governors of the NASD and the Boards of Directors of NASDR 
and Nasdaq * * * has sole discretion as to what matters to investigate. 
* * *'' <SUP>170</SUP> In addition, Undertaking 5 requires that the 
NASD ``promulgate and apply on a consistent basis uniform standards for 
regulatory and other access issues * * * and institute safeguards to 
ensure fair and evenhanded access to all services and facilities of the 
NASD.'' <SUP>171</SUP>
---------------------------------------------------------------------------

    \170\ Undertakings, supra note 15.
    \171\ Undertakings, supra note 15.
---------------------------------------------------------------------------

    The Rule 8100 Series currently governs complaints against NASD 
members. Authority permitting the NASD to investigate a member's books 
and to require a member or associated person to provide information in 
connection with an investigation or proceeding conducted by the NASD is 
presently provided by the Rule 8200 Series. The Rule 8200 Series also 
currently gives the NASD the authority to suspend members or associated 
persons who do not comply with the Rule 8200 Series. Finally, the Rule 
8300 Series provides for sanctions against members and persons 
associated with members for violations of NASD Rules.
    The NASD proposes to amend the Rule 8000 Series to reflect the 
proposed changes to the Rule 9000 Series, discussed in detail below, 
<SUP>172</SUP> and to clarify and enhance the certain provisions. The 
Commission finds that these clarifying changes and procedural 
enhancements to the Rule 8000 Series are appropriate and reasonable. In 
the Commission's view, these changes should improve the current Rule 
8000 Series, and provide fair and efficient procedures for 
investigation and sanction proceedings. For example, the Commission 
believes that the inclusion of a provision in the proposed Rule 8000 
Series that requires that any decision to impose a suspension under the 
series must state the grounds for the suspension and the conditions for 
terminating the suspension will promote uniformity.
---------------------------------------------------------------------------

    \172\ See infra discussion of the disciplinary proceedings in 
Section IV.C.1.
---------------------------------------------------------------------------

    In addition, the NASD has also proposed changes to the Rule 8100 
Series, eliminating the ability of any person who believes he or she 
has been aggrieved by any act of any member or associated person to 
initiate formal disciplinary proceedings pursuant to current Rule 8120. 
The Commission notes that, as discussed below, the NASD has proposed 
substantial enhancements to the disciplinary process. <SUP>173</SUP> 
For example, the NASD has proposed to implement staff-initiated 
disciplinary proceedings, to enhance the arbitration process, and to 
institute an expanded and independent NASD internal review function, 
including an Ombudsman Office.
---------------------------------------------------------------------------

    \173\ See infra discussion of the disciplinary proceedings in 
Section IV.C.1.
---------------------------------------------------------------------------

    As a result of these changes to the NASD's disciplinary process, 
the Commission believes it is no longer necessary to permit ``aggrieved 
persons'' the right to invoke NASD processes to institute formal 
disciplinary actions. The Commission notes that the NASD has 
acknowledged its responsibility as an SRO to give due consideration to 
complaints by members, associated persons, or members of the public who 
bring forth information suggesting wrongdoing. Further, the NASD has 
stated it recognizes its duty to investigate and to determine whether 
its disciplinary process should be invoked. In addition, the Commission 
notes that the NASD has proposed to add a provision to the Delegation 
Plan requiring NASD Regulation to establish internal procedures for 
considering complaints by members, associated persons, and members of 
the public who request an investigation or disciplinary action by the 
NASD. <SUP>174</SUP> The procedures established under this provision 
would involve regular oversight by NASD Internal Review. Finally, the 
Commission notes that no other SRO has a similar rule permitting 
``aggrieved persons'' to institute disciplinary proceedings.
---------------------------------------------------------------------------

    \174\ NASD Regulation currently logs, tracks, and investigates 
all customer complaints through the NASD's long-standing customer 
complaint program. The NASD has proposed to amend Section II.A.1.f. 
of the Delegation Plan to specify that NASD Regulation will 
establish procedures to consider requests by members, associated 
person, and members of the public that NASD Regulation initiate 
formal disciplinary action. See Securities Exchange Act Release No. 
38909 (Aug. 7, 1997).
---------------------------------------------------------------------------

    The Commission also believes that the proposal to delete Rule 8130, 
which currently authorizes the DBCCs to file complaints, is in 
furtherance of Undertaking 4. As noted in the discussion of the 
disciplinary process below,<SUP>175</SUP> pursuant to Undertaking 4, 
the DBCCs will no longer have authority to issue complaints. The 
Commission believes that the proposed deletion of current Rule 8130 is 
a reasonable means to address the findings of the Commission's 21(a) 
Report and is consistent with the Undertakings, particularly with 
Undertaking 4.
---------------------------------------------------------------------------

    \175\ See infra discussion of the disciplinary proceedings in 
Section IV.C.1.
---------------------------------------------------------------------------

    As discussed above, one commenter noted that proposed Rule 8210 did 
not differentiate between requests for information to parties, as 
opposed to non-parties. The NASD declined to modify Rule 8210 in 
response to this comment. The Commission notes that parties and non-
parties subject to Rule 8210 requests are NASD members or associated 
persons, and therefore have submitted themselves to the jurisdiction of 
the NASD. Therefore, the Commission believes it is reasonable for the 
NASD not to differentiate in Rule 8210 between requests to parties and 
requests to non-parties. The Commission also believes that the NASD's 
interpretation of proposed Rule

[[Page 43402]]

9146, which permits a hearing officer to issue a protective order upon 
the motion of a party or other person, is a reasonable means to enable 
parties and non-parties to limit the use of materials submitted in a 
disciplinary proceeding.
    Further, the commenter requested that reference to the existence of 
payment plans available to members for the payment of fines, sanctions 
or costs be included in the Code of Procedure. The Commission notes 
that although neither Rule 8320 nor the Code of Procedure specifically 
address the availability of payment plans, the NASD has confirmed that 
it will inform its members of the existence of payment plans through 
the inclusion of information regarding installment plans in the NASD's 
Sanctions Guidelines, which are publicly available.
    In conclusion, the Commission finds that proposed Rule 8000 Series 
is consistent with the Act, and should enhance both the fair and 
efficient operation of the NASD's disciplinary proceedings and the 
dispassionate application of the rules and fairness in the NASD's 
disciplinary process, as well as other regulatory activities.

C. Changes to the Code of Procedure

1. Disciplinary Proceedings
    For the reasons discussed below, the Commission believes that the 
proposed changes regarding the disciplinary proceedings are consistent 
with the Act, improve the current system, and should provide fair and 
efficient procedures to address disciplinary matters. The Commission 
also believes that the proposed rule change is consistent with Section 
15A of the Act, and in particular, with Sections 15A(b)(6) 
<SUP>176</SUP> and 15A(b)(8) <SUP>177</SUP> of the Act.
---------------------------------------------------------------------------

    \176\ 15 U.S.C. Sec. 78o-3(b)(6).
    \177\ 15 U.S.C. Sec. 78o-3(b)(8).
---------------------------------------------------------------------------

    (a) How disciplinary proceedings are initiated. The Commission 
believes that the proposed rule change, which removes the authority to 
authorize and issue a complaint from the District Committees, the 
Market Regulation Committee, and the NBCC, and places it solely on the 
Department of Enforcement of NASD Regulation, is reasonably taken in 
furtherance of and is consistent with Undertaking 4 in the SEC 
Order.<SUP>178</SUP>
---------------------------------------------------------------------------

    \178\ Undertakings, supra note 15.
---------------------------------------------------------------------------

    Pursuant to the NASD's Undertakings in the SEC Order, the NASD has 
agreed to ``provide for the autonomy and independence of the regulatory 
staff of the NASD and its subsidiaries such that the staff * * * has 
sole discretion as to what matters to investigate and prosecute, * * *, 
[ ] and is generally insulated from the commercial interests of its 
members and the Nasdaq market.'' <SUP>179</SUP> In particular, under 
the proposed rules, only the Department of Enforcement of NASD 
Regulation will be permitted to authorize and issue complaints. In 
addition, the Department of Enforcement may be directed to authorize 
and issue a complaint by the NASD Regulation Board or the NASD Board.
---------------------------------------------------------------------------

    \179\ Undertakings, supra note 15.
---------------------------------------------------------------------------

    To further provide the desired level of autonomy to its regulatory 
staff, and to address the Commission's conclusion in the 21(a) Report 
that District Committees were granted overly-broad discretionary 
authority, the NASD proposes to eliminate the District Committees' 
involvement in the disciplinary process. Under the revised procedures, 
the District Committees will no longer have the authority to initiate 
disciplinary proceedings or to authorize the NASD's staff 
recommendation to initiate a disciplinary proceeding, nor will they 
have the ability to veto NASD staff enforcement recommendations. Even 
more significant, the District Committees will no longer serve as 
adjudicative bodies, which historically have provided certain segments 
of the NASD membership with a disproportionate role in the self-
regulatory process.<SUP>180</SUP> They will no longer serve as 
evidentiary hearing panels for disciplinary proceedings, issue final 
decisions, or review or approve final decisions. The District 
Committees' only disciplinary role will be to serve as a pool of 
persons from which two of the three hearing panelists are selected.
---------------------------------------------------------------------------

    \180\ 21(a) Report, supra note 10, at 35 n.91 and accompanying 
text.
---------------------------------------------------------------------------

    Moreover, the NASD's proposed changes to the Market Regulation 
Committee's responsibilities and duties in the disciplinary process 
address the Commission's conclusion in the 21(a) Report that the Market 
Surveillance Committee (now the Market Regulation Committee) 
inappropriately performs a grand jury function with respect to 
disciplinary actions proposed by the NASD's Market Surveillance 
Department.<SUP>181</SUP> Under the proposed changes, like the District 
Committees, the only disciplinary role for the Market Regulation 
Committee will be to serve as a pool of panelists to serve on a hearing 
panel or, if applicable, an extended hearing panel. A person who 
currently serves or who has previously served (not earlier than four 
years before the date the complaint was served upon the respondent) on 
the Market Regulation Committee who is associated with an NASD member, 
or retired therefrom may be chosen to serve as one of the panelists on 
a hearing panel or an extended hearing panel when the complaint alleges 
at least one cause of action involving a violation of a statute or a 
rule within the scope of proposed Rule 9120(r).<SUP>182</SUP>
---------------------------------------------------------------------------

    \181\ 21(a) Report, supra note 10, at 35 n.91.
    \182\ See supra note 23.
---------------------------------------------------------------------------

    One commenter expresses concern that the Department of Enforcement 
may be able to ``pre-select'' panelists from the Market Regulation 
Committee (current or former members) by alleging at least one 
violation set forth in proposed Rule 9120(r), thereby affecting the 
selection process.<SUP>183</SUP> The Commission agrees with the NASD's 
view that proposed Rule 9120(r) does not intend to place all federal 
and state securities laws, rules, and regulations under the advisory 
jurisdiction of the Market Regulation Committee. A current or former 
member of the Market Regulation Committee will serve on a panel only 
when the matter relates to certain subjects, including: quotations of 
securities; execution of transactions; reporting of transactions; and 
trading practices.
---------------------------------------------------------------------------

    \183\ ABA Letter, supra note 9, at 75.
---------------------------------------------------------------------------

    In the Commission's view, by limiting the role of the District 
Committees and Market Regulation Committee, while providing the 
Department of Enforcement with the autonomy and independence to 
authorize and issue complaints, the professional staff of NASD 
Regulation should be able to implement a vigorous and evenhanded 
enforcement program. Moreover, the Commission believes that this shift 
of authority in the complaint process should ensure that member 
participation and peer review is preserved, while eliminating 
problematic aspects of the disciplinary process identified in the 21(a) 
Report.
    (b) The role of the Hearing Officer and Hearing Panel. The 
Commission also believes the proposed change allowing the recently 
established Office of Hearing Officers to preside over all formal NASD 
disciplinary proceedings is reasonably taken in furtherance of and is 
consistent with the Undertaking 3 in the SEC Order. Specifically, in 
Undertaking 3 in the SEC Order, the NASD agreed to ``institute the 
participation of professional hearing officers (who shall be attorneys 
with appropriate experience and training) to preside over disciplinary 
proceedings.'' <SUP>184</SUP>
---------------------------------------------------------------------------

    \184\ SEC Order, supra note 10. See also Undertakings, supra 
note 15.

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[[Page 43403]]

    This undertaking was made in response to the Commission's 
conclusions in the 21(a) Report that the NASD did not adequately guard 
against the influence of particular segments of its membership over its 
regulatory functions and processes. For example, the Commission 
concluded in the 21(a) Report that market makers had exerted 
substantial influence over the administration of the NASD's 
disciplinary process. The Commission concluded that market makers' 
influence over the NASD, which constituted a majority of the District 
Committees and the former Market Surveillance Committee, resulted in 
heightened enforcement of SOES activity, and lax enforcement of the 
firm quote obligations, trade reporting rules, and excused withdrawal 
rules.<SUP>185</SUP>
---------------------------------------------------------------------------

    \185\ 21(a) Report, supra note 10, at 35-39.
---------------------------------------------------------------------------

    NASD Regulation has responded to the Commission's concerns by 
establishing the Office of Hearing Officers as an independent office 
within NASD Regulation. All litigated disciplinary proceedings will be 
decided by a panel composed of one hearing officer and two panelists, 
i.e., the two securities industry representatives. Hearing panel 
decisions are not subject to review by the District Committees or the 
Market Regulation Committee. Once a hearing panel has ruled, the 
decision is subject to review by the NBCC, and the Boards of the NASD 
Regulation and NASD.
    The hearing officer, who is assigned to a disciplinary proceeding 
by the chief hearing officer, presides over all matters relating to the 
proceeding. The hearing officer, among other things, considers all 
procedural and evidentiary matters, discovery requests, and other non-
dispositive matters. The hearing officer presiding over a particular 
disciplinary proceeding also has the authority to impose discretionary 
sanctions for violations of an order issued by the hearing officer, 
hearing panel or, if applicable, extended hearing panel, or for other 
contemptuous conduct during any stage of the disciplinary proceeding.
    One commenter believes that to avoid the perception of unfairness 
and bias, the Office of Hearing Officers should report to the President 
of the NASD, rather than to the President of NASD 
Regulation.<SUP>186</SUP> The Commission believes, however, that the 
NASD has reasonably addressed the commenter's concern by implementing 
various measures, as highlighted above, to assure the independence of 
the chief hearing officer and the hearing officers.<SUP>187</SUP>
---------------------------------------------------------------------------

    \186\ ABA Letter, supra note 9, at 39-40.
    \187\ NASD Response, supra note 6.
---------------------------------------------------------------------------

    The Commission believes the establishment of an office of 
professional hearing officers, with the appropriate legal training, 
should enhance the dispassionate application of the rules and fairness 
in the disciplinary process. Moreover, the Commission believes that 
because industry representatives will continue to be represented on 
each hearing panel, their market expertise will continue to provide a 
central role in the disciplinary process.<SUP>188</SUP>
---------------------------------------------------------------------------

    \188\ One commenter recommends that at least one person serving 
as a panelist on a hearing panel or extended hearing panel ``be 
engaged in similar activities within the securities industry as the 
respondent.'' ABA Letter, supra note 9, at 67. The Commission agrees 
with the NASD's view that in order to avoid selecting a panelist 
with a conflict of interest or bias, ``expertise'' should not be 
considered as the only factor in the selection process.
---------------------------------------------------------------------------

    (c) Ex parte communications prohibited. Proposed Rule 9143 defines 
and prohibits ex parte communications between the disciplinary panels 
and the Parties or their representatives. In the Commission's view, it 
is reasonable for the NASD to prohibit ex parte communications between 
the disciplinary panels and the parties or their representatives during 
the disciplinary proceedings. The Commission also believes that the 
boundaries set by the NASD in the ex parte communication rule should 
help to ensure that no party can unfairly advance his or her position 
in a disciplinary proceeding through discussions outside of the 
proceeding's forum.
    In addition, the Commission believes the parties subject to the 
prohibition on ex parte communications include those who reasonably 
would be expected to participate in a disciplinary proceeding. 
Specifically, the parties defined in Rule 9120(v), persons identified 
with such parties,<SUP>189</SUP> an adjudicator, as defined in Rule 
9120(a), and persons identified with such adjudicator, are subject to 
the ex parte communication rule.<SUP>190</SUP>
---------------------------------------------------------------------------

    \189\ Each group consists of at least a party, and his or her 
counsel or representative. In disciplinary proceedings, the relevant 
group includes the respondent or the several respondents (each a 
member firm or an associated person), and counsel or 
representatives. The Department of Enforcement, and Interested 
Association Staff, as defined in Rule 9120(q) is subject to the ex 
parte prohibition.
    \190\ The adjudicatory group that is prohibited from making or 
receiving prohibited communications includes the adjudicator and any 
person, such as a law clerk or other person, who is engaged in 
advising the adjudicator, including a Governor, a Director or an 
adjudicator who is participating in a decision with respect to that 
proceeding, or [to] an NASD employee who is participating or 
advising in the decision of a Governor, a Director, or an 
adjudicator with respect to that proceeding.
---------------------------------------------------------------------------

    The Commission also believes it is reasonable to establish an 
objectively determinable point in time when the prohibition of ex parte 
communications commences. Specifically, the prohibition applies upon 
``the authorization of a complaint * * * unless the person responsible 
for the communication has knowledge that the complaint will be 
authorized, in which case the prohibitions shall apply beginning at the 
time of his or her acquisition of such knowledge.'' <SUP>191</SUP> The 
proposed rule also indicates that in no case shall the prohibition 
begin to apply later than the time at which a proceeding is noticed for 
hearing. The Commission recognizes the importance of providing parties 
and adjudicators and those associated with each group with an 
identifiable point in time that the prohibition begins. Accordingly, 
the Commission believes that the NASD's proposed standard reasonably 
provides those relevant groups with adequate notice of their 
obligations under this rule.
---------------------------------------------------------------------------

    \191\ Proposed Rule 9143.
---------------------------------------------------------------------------

    In the Commission's view, it is also reasonable for a respondent 
(or potential respondent) to be deemed to have waived his or her 
protections under the ex parte communications prohibition if: (1) a 
respondent submits an offer of settlement; or (2) a member or a person 
associated with a member executes an AWC or a MRV. This waiver should 
help to ensure that the disciplinary process operates efficiently by 
providing all persons involved in the settlement process or the pre-
complaint resolution process with the flexibility to attempt to dispose 
of a disciplinary matter.
    (d) Motions practice, discovery, and pre-hearing procedures. The 
Commission believes it is reasonable for the NASD to establish a formal 
motions practice in the Code of Procedure. The general provisions 
governing motions practice are set forth in proposed Rule 9146. The 
Commission notes that the establishment of a formal motions practice in 
NASD disciplinary proceedings provides a framework for parties to move 
for various forms of relief including, but not limited to, a more 
definite statement; summary disposition; recusal or disqualification of 
an adjudicator; and leave to introduce additional evidence. The 
Commission believes the establishment of a formal motion practice 
should enhance the fair and efficient operation of the disciplinary 
proceedings.
    The Commission also believes that the NASD's proposed discovery 
provisions

[[Page 43404]]

reasonably address the need for respondents subject to a disciplinary 
proceeding to have broader documentary discovery rights.<SUP>192</SUP> 
Specifically, proposed Rules 9251 through 9253 provide for the 
discovery of non-privileged and otherwise unprotected documents by 
respondents in a disciplinary proceeding. Under the proposed rules, a 
respondent has a right to obtain certain documents and the right to 
insist upon their production based upon a schedule set forth in the 
rules.<SUP>193</SUP> The Commission notes that the proposed discovery 
rules should help to ensure that a respondent will receive 
nonprivileged and otherwise unprotected documents in advance of the 
initial hearing (or soon thereafter if the Department of Enforcement 
received the requested document after the commencement of the hearing).
---------------------------------------------------------------------------

    \192\ One commenter suggests that Federal Rule of Evidence 501 
(for privilege issues) and Federal Rule of Civil Procedure 26(b)(3) 
(for work-product immunity issues) should be used as a model. ABA 
Letter, supra note 9, at 89-90. The Commission believes that it is 
reasonable for the NASD to decide not to incorporate these rules 
into the Code of Procedure. The Commission agrees with the NASD's 
view that it must provide a fair process but is not limited by the 
specific evidentiary rules relating to privilege in the Federal 
Rules of Evidence and the Federal Rules of Civil Procedure.
    The commenter also suggests that the right to an interlocutory 
appeal should be available to contest any ruling denying a claim of 
attorney-client privilege or work-product privilege. ABA Letter, 
supra note 9, at 46-48. The Commission agrees with the NASD's view 
that privilege issues are very important, but to grant interlocutory 
review as a right regarding every contested privilege issue would 
impede the effective operation of the SRO adjudicatory process.
    \193\ One commenter believes that the proposed discovery rule 
should not include a standard regarding materiality and relevance in 
the post-complaint time frame. ABA Letter, supra note 9, at 85. The 
Commission believes that it is reasonable for the NASD to subject a 
secondary production of documents to a material relevance standard 
so that the Department of Enforcement is not forced to turn over 
documents that are not relevant to the proceeding initiated and may 
relate to a potential, but yet-to-be named respondent as part of the 
same investigation file.
---------------------------------------------------------------------------

    In addition, the Commission believes it is reasonable for the 
Department of Enforcement to withhold a document that is privileged, 
constitutes attorney work product, is an examination or inspection 
report, is an internal memorandum or writing prepared by NASD staff 
that will not be offered in evidence, or is correspondence between the 
NASD and state, federal, or foreign regulatory authority or an 
SRO.<SUP>194</SUP> Under such circumstances, the hearing officer may 
require the Department of Enforcement to submit a list of the documents 
withheld,<SUP>195</SUP> and may conduct an in camera inspection of any 
such documents to determine whether they should be produced.
---------------------------------------------------------------------------

    \194\ One commenter believes that the only documents that the 
staff should be able to withhold are privileged documents or 
documents constituting attorney work product. ABA Letter, supra note 
9, at 89-90. The Commission believes that the NASD's proposed 
discovery provisions should both protect a respondent's discovery 
rights, while ensuring that the NASD's enforcement efforts are not 
impaired.
    \195\ One commenter believes that the enforcement staff should 
be required to provide a list of all documents it obtains to the 
respondent, and the hearing officer, not the enforcement staff, 
should make determinations of relevance. ABA Letter, supra note 9, 
at 85. The Commission agrees with the NASD' view that it would be 
inappropriate to mandate a withheld document list in every case 
because it might enable a reader to trace the course of an 
investigation, forcing improper disclosure about the investigation 
and the investigatory process in circumstances that could impede a 
continuing investigation of another member or associated person. 
Moreover, the Commission believes that the NASD has proposed a 
reasonable standard in proposed Rule 9251(c) under which a 
respondent may move to require the Department of Enforcement to 
produce a list of documents withheld if the motion is based upon 
``some reason to believe that a document is being withheld in 
violation of the Code.'' Amendment No. 3, supra note 6.
---------------------------------------------------------------------------

    The Commission also believes that the proposed rules regarding pre-
hearing procedures should help to ensure that disciplinary proceedings 
run fairly and efficiently, and should improve the overall quality of 
the hearing. Specifically, the proposed rules grant the hearing officer 
discretionary authority to require the parties to participate in pre-
hearing conferences or to file a variety of informational materials in 
advance of the hearing. According to the NASD, these conferences are 
intended, among other things, to: expedite the disposition of the 
proceeding; establish procedures to manage the proceeding efficiently; 
and improve the quality of the hearing through more thorough 
preparation. In the Commission's view, effective planning and increased 
control over the proceeding by the hearing officer during the pre-
hearing phase should provide for a more fair and efficient disciplinary 
process.
    (e) Pro se respondents. The Commission recognizes that the enhanced 
procedural requirements and protections set forth in the disciplinary 
procedures should improve the fairness and efficiency of a disciplinary 
proceeding, but could disadvantage some pro se respondents. In response 
to the Commission's concerns, the NASD has represented that, through 
the NASD Regulation's Office of Dispute Resolution and the chief 
hearing officer, it is committed to providing a fair forum for all 
parties. Accordingly, the chief hearing officer and all hearing 
officers will adopt as a practice the flexible approach of state and 
federal judicial proceedings. Pro se respondents will be granted 
waivers from certain procedural requirements <SUP>196</SUP> or 
otherwise be excused from fully or partially complying with certain 
procedural or technical rules to the extent that the adjudicator may 
allow, while continuing to: (i) Provide fair notice to other parties of 
the issues before the adjudicator; (ii) provide the parties an 
opportunity to respond to the issues; and (iii) establish and maintain 
a record for any appeal of the matter. The Commission believes that 
this approach should provide a fair method in which to promote the 
efficient administration of disciplinary proceedings with respect to 
pro se respondents.
---------------------------------------------------------------------------

    \196\ For example, the NASD states that in certain circumstances 
it would be appropriate to excuse a pro se respondent from complying 
with certain requirements in Rule 9146 regarding motions practice.
---------------------------------------------------------------------------

    (f) Offers of settlement, AWCs, MRVs. The Commission believes that 
the NASD has proposed a reasonable framework in governing the 
settlement of cases prior to the filing of a complaint, and the 
settlement procedures after a complaint has been filed. Specifically, 
an AWC is a letter that a person or a member agrees to execute to 
resolve a potential disciplinary matter in a pre-complaint environment. 
An MRV is a letter that a person or a member agrees to execute to 
resolve a potential disciplinary matter prior to the issuance of a 
complaint.\197\ Finally, an offer of settlement is an offer made by a 
respondent in order to resolve the matter prior to the issuance of a 
decision on the merits. The Commission notes that current provisions 
governing each of these proceedings have been substantially 
incorporated into the proposed Code of Procedure.
---------------------------------------------------------------------------

    \197\ Proposed Rule IM-9216 (listing those specific types of 
violations appropriate for disposition under the minor rule 
violations plan).
---------------------------------------------------------------------------

    Because AWCs, MRVs, and offers of settlement are executed 
voluntarily by a respondent, or a person about to be named as a 
respondent, the NASD also proposes to require, before going forward 
with such procedures, a party (or a potential party) to agree to waive 
the protections offered against ex parte communications and the 
separation of functions provisions in proposed Rule 9144. As noted 
above, the Commission recognizes that this waiver should help to ensure 
that the disciplinary process operates efficiently by providing all 
persons involved in the settlement process or the pre-complaint 
resolution process with the flexibility to attempt to dispose of a 
disciplinary matter. The Commission notes, however, that if the AWC, 
MRV, or offer of settlement is not accepted by the final adjudicator, 
the

[[Page 43405]]

rejected document does not constitute a part of the record in any 
proceeding. In addition, the NASD proposes to allow the NBCC to 
delegate authority to the General Counsel of NASD Regulation to accept 
or refer to the NBCC for its consideration AWCs, MRVs, and uncontested 
offers of settlement. Further, the NASD proposes to allow the NBCC to 
delegate to the Chair and the Vice Chair of the NBCC the authority to 
accept or reject such AWCs, MRVs, and offers of settlement. A contested 
offer of settlement and order of acceptance may be accepted or rejected 
only by either the full NBCC or the Chair and Vice Chair, as provided 
in proposed Rule 9270(f)(2). The Commission believes that these 
delegation provisions should help to allow the NBCC to concentrate on 
contested disciplinary matters and those matters raising policy 
questions.
    (g) NBCC and NASD Regulation/NASD Board Review. In the Commission's 
view, the call for review and appellate process set forth in the 
proposed Rule 9300 Series provide a reasonable interim system for 
reviewing lower-level decisions. As noted above, the NASD Board has 
recently approved a subsequent corporate restructuring, which will, in 
part, eliminate the additional NASD Regulation Board layer of review. 
The NASD proposed rules provide the NBCC the authority to review any 
disciplinary proceeding for which a first or ``trial-level'' decision 
has been rendered. Also, a respondent or the Department of Enforcement 
may appeal to the NBCC any ``trial-level'' decision, including a 
default decision.\198\ The Commission believes that it is appropriate 
for the Department of Enforcement staff to determine whether an appeal 
should be filed.
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    \198\ A respondent may not ``appeal'' any final action contained 
in an AWC, an MRV or an offer of settlement that has been accepted 
by any of the General Counsel of NASD Regulation, the Chair and the 
Vice Chair of the National Business Conduct Committee, or the 
National Business Conduct Committee (proposed Rules 9216 (a) and 
(b), and 9270).
---------------------------------------------------------------------------

    In addition, the NBCC's decision whether to call a case for review 
rests with an NBCC Review Subcommittee. The two to four person Review 
Subcommittee must be composed of current members of the NBCC, and must 
include a balance of non-industry Directors and industry Directors, or, 
if not balanced, shall include a majority of non-industry Directors. 
Also, the General Counsel of NASD Regulation, by delegation of the 
authority of the NBCC, may determine if a default decision issued 
pursuant to Rule 9269 should be reviewed by the NBCC.
    The NBCC subcommittees and extended proceeding committees act as 
the appeal forum and recommend decisions to the full NBCC in writing 
not later than seven days before the meeting of the NBCC at which the 
disciplinary proceeding is considered. At the same time, all other 
Directors who sit on the NASD Regulation Board also receive the written 
recommended decision. After considering all matters presented in the 
appeal or review, the written recommended decision of the subcommittee 
(or, if applicable, the extended proceeding committee), and after 
reaching its conclusions on the issues, the NBCC prepares a proposed 
written decision.\199\ The proposed written decision of the NBCC may be 
called for review by, respectively, any Director of the NASD Regulation 
Board, and any Governor of the NASD Board. The opportunity for a 
Director or Governor to call a case for review occurs sequentially. In 
the Commission's view, these procedures should provide an efficient, 
fair, and balanced framework for reviewing lower-level decisions.
---------------------------------------------------------------------------

    \199\ Specifically, the decision must include:
    (1) a statement describing the investigative or other origin of 
the disciplinary proceeding;
    (2) the specific statutory or rule provisions that were alleged 
to have been violated;
    (3) a statement setting forth the findings of fact with respect 
to any act or practice the respondent was alleged to have committed 
or omitted;
    (4) the conclusions as to whether the respondent violated any 
provision alleged in the complaint;
    (5) a statement in support of the disposition of the principal 
issues raised in the proceeding; and
    (6) a statement describing any sanction imposed, the reasons 
therefore, and, pursuant to Rule 9360, the date upon which such 
sanction shall become effective.
    Proposed Rule 9349(b) (1)-(6).
---------------------------------------------------------------------------

    (h) Recusal or disqualification. The Commission believes that the 
NASD has proposed a reasonable standard under which an adjudicator must 
recuse him or herself or may be disqualified by motion. Specifically, 
the standard (as set forth in proposed Rules 9160, 9233, 9234, and 
9332) is ``a conflict of interest or bias, or circumstances otherwise 
exist where the * * * [Adjudicator's] fairness might reasonably be 
questioned.'' The NASD sets forth in the rules the various persons or 
groups that may act as an adjudicator and therefore would be subject to 
disqualification or recusal procedures. Specifically, Governors, 
Directors, members of the NBCC and certain subcommittees, panelists of 
hearing panels or extended hearing panels, hearing officers, and 
members of the staff of the Department of Member Regulation are subject 
to possible disqualification under the standard set forth above.
    One commenter recommends that proposed Rule 9160 regarding recusal 
or disqualification set forth procedural steps that must be followed in 
seeking disqualification of Governors, Directors, NBCC Committee 
members, and certain NASD Regulation staff when serving an adjudicatory 
role.\200\ The Commission agrees with the NASD's view that additional 
procedures are unnecessary because an adjudicator will recuse him or 
herself when he or she has a conflict of interest or a bias, and other 
members of a board or committee have the ability to suggest recusal or 
seek disqualification if the member does not act promptly to recuse him 
or herself.
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    \200\ ABA Letter, supra note 9, at 52.
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    The same commenter also proposes that the right to an interlocutory 
appeal should be available to contest any situation in which a panelist 
refuses to recuse him or herself. The Commission agrees with the NASD's 
view that the right of an interlocutory appeal is unnecessary because 
(1) a party may challenge the panelist through a disqualification 
motion; and (2) persons other than parties may inform the chief hearing 
officer or hearing officer of disqualifying factors, providing another 
avenue to remove a panelist from a hearing panel.\201\
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    \201\ NASD Response, supra note 6, at 10.
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    The Commission also notes that clarity in this area is highly 
desirable because the proposed rule allows the Chairs and Vice Chairs 
of the NBCC, and the respective Chairs of the NASD and NASD Regulation 
Boards to order the disqualification of their competitors sitting on 
the applicable boards, committees, and subcommittees. The Commission 
believes the standard set forth in the rules should provide a 
reasonable framework in which to make such determinations.
    (i) Contemptuous conduct. The Commission believes that it is 
appropriate for the NASD to allow for sanctions for conduct that 
violates orders of a hearing officer, a hearing panel or, if 
applicable, an extended hearing panel, and for other contemptuous 
conduct during a hearing. Specifically, the hearing officer, hearing 
panel or, if applicable, an extended hearing panel, can sanction 
contemptuous conduct by ruling, among other things, that: the subject 
matter of the violated order or any other designated facts be taken as 
established for purposes of the proceeding; the violator or 
contemptuous party be precluded from supporting or opposing certain 
claims or defenses, or precluded from introducing evidence on certain

[[Page 43406]]

matters; and particular pleadings or parts thereof be stricken.
    Proposed Rule 9280(b)(2) provides for the imposition of sanctions 
for a party's unjustified refusal to make disclosures required by the 
proposed Rule 9240 and 9250 Series, or otherwise required by order of a 
hearing officer, hearing panel, or, if applicable, an extended hearing 
panel. Unless the failure to make disclosures is harmless, the 
recalcitrant party is precluded from using any of the information 
withheld or the testimony of the witness that was not disclosed as 
evidence at the hearing, or otherwise relying on such information or 
testimony. This sanction may be imposed in addition to, or in lieu of, 
the various restrictions on the conduct of the case authorized by 
proposed Rule 9280(b)(1). Further, under proposed Rule 9280(c), absent 
reasonable basis, a party's failure to admit the genuineness of a 
document that is later found to be genuine may also be subject to the 
sanctions listed in proposed Rule 9280(b)(1).
    Proposed Rule 9280, read in conjunction with proposed Rule 9150, 
also authorizes a hearing officer, hearing panel, or, if applicable, an 
extended hearing panel to exclude an offending attorney or person 
acting in a representative capacity from functioning as such in the 
particular proceedings. In this regard, proposed Rule 9141(b) also 
makes clear that the right to representation in a disciplinary 
proceeding is subject to the power to exclude a party's representative 
or attorney under proposed Rules 9150 and 9280. Under proposed Rule 
9280(c), an attorney or representative who is excluded from 
participating in a disciplinary proceeding may seek immediate review of 
the exclusion order by the NBCC by filing a motion to vacate within 
five days after service of the order. The filing of such a motion 
operates to stay all aspects of the disciplinary proceeding, pending 
expedited consideration and a prompt decision by the NBCC. The 
Commission believes these sanctioning powers provide a reasonable means 
for these adjudicators to maintain acceptable levels of conduct by the 
parties and their representatives when participating in a disciplinary 
proceeding.
2. Members Experiencing Financial or Operating Difficulties; Summary 
Suspensions; and Procedures for Exemptions From Certain NASD Rules
    The Commission believes the proposed changes regarding the Rule 
9400, 9500 and 9600 Series improve the current procedures and should 
provide a fair and efficient means to address: (1) Limitations of the 
activities of members experiencing financial or operational 
difficulties; (2) summary and non-summary suspension, cancellation, 
bar, limitation or prohibition on access to NASD services; (3) 
eligibility; and (4) exemptions from specific NASD rules. The 
Commission believes the proposed rule change is consistent with 
Sections 15A(b)(6),<SUP>202</SUP> 15A(b)(9),<SUP>203</SUP> and 
15A(h)(3) <SUP>204</SUP> of the Act. The Commission also believes the 
proposed changes to these procedures are reasonably taken in 
furtherance of and are consistent with the Undertakings.<SUP>205</SUP>
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    \202\ 15 U.S.C. Sec. 78o-3(b)(6).
    \203\ 15 U.S.C. Sec. 78o-3(b)(9).
    \204\ 15 U.S.C. Sec. 78o-3(h)(3).
    \205\ SEC Order, supra note 10.
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    Undertaking 4 requires the NASD ``[t]o provide[] for the autonomy 
and independence of the regulatory staff of the NASD and its 
subsidiaries such that the staff, subject only to the supervision of 
the Board of Governors of the NASD and the Boards of Directors of NASDR 
and Nasdaq * * * has sole discretion as to what matters to investigate 
* * * .''<SUP>206</SUP> In addition, Undertaking 5 requires that the 
NASD ``promulgate and apply on a consistent basis uniform standards for 
regulatory and other access issues * * * and institute safeguards to 
ensure fair and evenhanded access to all services and facilities of the 
NASD.'' <SUP>207</SUP>
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    \206\ Undertakings, supra note 15.
    \207\ Undertakings, supra note 15.
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    In the Commission's view, the proposal should provide an adequate 
procedural framework for the Rule 9400, 9500, and 9600 Series, 
enhancing the fair and efficient operation of these rule series. 
Specifically, the amended proceedings incorporate a great number of 
procedural improvements that should provide members and persons 
associated with members clearer, more detailed, and more streamlined 
procedures for the above-described proceedings.
    The Commission notes that, pursuant to proposed Rule 9110, the new 
Rule 9400 through 9600 Series procedures are governed by the provisions 
of the Rule 9100 Series, unless a rule specifically provides otherwise. 
As discussed in detail above in Section IV.C.1, the Rule 9100 Series 
defines certain terms and addresses notice, service and filing 
procedures; motions practice; ex parte communications; separation of 
adjudicatory and prosecutorial functions; and disqualification of 
adjudicators under appropriate circumstances. The Commission believes 
that it is reasonable for the NASD to establish these provisions for 
the Rule 9400, 9500, and 9600 Series, because the provisions should 
enhance the fair and efficient operation of the procedures governing 
limitations of the activities of members experiencing financial or 
operational difficulties; summary and non-summary suspension, 
cancellation, bar, limitation or prohibition on access to NASD 
services; eligibility; and exemptions from specific NASD rules.
    In addition, the Commission believes the revisions and enhancements 
to the Rule 9400 through 9600 Series procedures should help ensure that 
participants in the proceedings are aware of their rights and 
obligations under the Series, and will improve the overall quality of 
the procedures and their outcomes. Specifically, the procedures under 
these Series provide for notice to a member or associated person of the 
grounds or basis for a notice or limitation; the nature of the sanction 
or limitation; the effective date of such a notice; the consequences of 
a failure to comply with a notice or the criteria that must be met to 
have a notice removed (where appropriate); the member or associated 
person's rights at a hearing; the definition of the record for each 
proceeding; and the required components of a written decision under 
these Series. For example, the Rule 9510 Series, governing summary and 
non-summary suspension procedures, provides for service of notice of a 
suspension by facsimile or overnight commercial courier to help ensure 
that the subject of the suspension has adequate time to respond to such 
a notice within the time-frames established by the series. In addition, 
the Rule 9400 and 9500 Series provide for the retention of evidence 
that is proffered but not accepted into the record until the date when 
the NASD's decision becomes final or, if applicable, upon the 
conclusion of any review by the Commission or the federal courts.
    Further, the rules provide a mechanism for the member or associated 
person to request and obtain review of a notice issued pursuant to the 
Rule 9400 and 9500 Series. Each of the Rule 9400 and 9500 Series 
procedures also provides for a call for review by the NASD Board (and, 
in most cases, by the NASD Regulation Board as well), under procedures 
similar to those for disciplinary proceedings under the Rule 9200 and 
9300 Series. In addition, the Rule 9400 and 9500 Series require that 
adjudicatory and prosecutorial functions remain 
separated,<SUP>208</SUP> and provide for the disqualification of an 
adjudicator when there is ``a conflict of

[[Page 43407]]

interest or bias, or circumstances otherwise exist where the * * * 
[adjudicator's] fairness might reasonably be questioned.'' 
<SUP>209</SUP>
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    \208\ Proposed Rule 9144.
    \209\ Proposed Rule 9160.
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    The proposed Rule 9600 Series is intended to centralize exemptive 
authority in NASD Regulation staff that is now, pursuant to current 
rules, delegated to various standing committees. The proposed Rule 9600 
Series governing exemptions for certain NASD rules also contains some 
of the procedural enhancements present in the Rule 9400 and 9500 
Series, including service requirements, components of the decision, 
procedure to appeal a decision and obtain a hearing, and the 
opportunity to present oral evidence. The Commission notes that 
applicants for exemptions have a right of appeal, which will be heard 
by a sub-committee appointed by the NBCC. The decision then issued by 
the NBCC constitutes final action of the NASD, and will not be subject 
to a call for review by the NASD Board. The Commission notes that the 
authority of the NBCC over exemption decisions pursuant to the Rule 
9600 Series is a delegation from the NASD Board, leaving the NASD Board 
ultimately responsible for the fairness of the exemption proceedings 
and procedures.<SUP>210</SUP>
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    \210\ The Commission understands that the fairness of exemption 
proceedings will be within the scope of responsibility of the NASD 
Board's Audit Committee.
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    The Commission believes that the NASD's proposal to modify the Rule 
9400 through 9600 Series is reasonable, and should improve the 
procedures for limitations of the activities of members experiencing 
financial or operational difficulties; summary and non-summary 
suspension, cancellation, bar, limitation or prohibition on access to 
NASD services; eligibility; and exemptions from specific NASD rules. 
The Commission believes that the proposed Rule 9400 through 9600 Series 
will assist the NASD in promulgating and applying on a consistent basis 
uniform standards for regulatory and other access issues, as well as 
instituting safeguards to ensure fair and evenhanded access to all 
services and facilities of the NASD, consistent with the 21(a) Report 
and the Undertakings. In conclusion, the Commission finds that proposed 
Rule 9400, 9500 and 9600 Series are consistent with the Act, and should 
enhance both the fair and efficient operation of the NASD, and the 
dispassionate and fair application of the rules in the NASD's 
regulatory activities.

D. Effectiveness of the Proposed Rules

    The NASD has proposed a transition schedule for the procedures 
approved in this order. In the Commission's view, the schedule proposed 
by the NASD for implementation as discussed in detail in Section II.D., 
should help to assist in the transition to the new procedures.

V. Amendment No. 2

    The Commission finds good cause for approving Amendment No. 2 prior 
to the thirtieth day after the date of publication of notice thereof in 
the Federal Register. Specifically, Amendment No. 2 sets forth proposed 
changes to the proposed Rule 9400 and 9500 Series and proposes to seek 
approval of the proposed Rule 9600 Series. The Commission notes that 
Amendment No. 2, which amends the proposed Rule 9400, 9500 and 9600 
Series, was noticed and published for the full 21-day comment period, 
and no comments were received. Further, as discussed above, the 
Commission believes that the proposed Rule 9400, 9500 and 9600 Series 
are consistent with the Act, and should enhance both the fair and 
efficient operation of the NASD's disciplinary proceedings and the 
dispassionate application of the rules and fairness in the NASD's 
disciplinary process, as well as other regulatory activities. Finally, 
the acceleration of the effectiveness of Amendment No. 2 will enable 
the Commission to approve the proposed Rule 9400, 9500 and 9600 Series 
concurrent with the other major modifications to the NASD's rules as 
proposed in SR-NASD-97-28. Therefore, the Commission believes granting 
accelerated approval to Amendment No. 2 is appropriate and consistent 
with Section 19(b)(2) of the Act.<SUP>211</SUP>
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    \211\ 15 U.S.C. Sec. 78s(b)(2).
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VI. Amendment No. 3

    The Commission finds good cause for approving Amendment No. 3 prior 
to the thirtieth day after the date of publication of notice thereof in 
the Federal Register. As noted above, the NASD made several 
modifications to the disciplinary proceeding rules in Amendment No. 3 
to the proposed rule change, including expanding the pool of persons 
eligible to serve as panelists in a disciplinary proceeding, defining 
the administrative and ministerial role of the Counsel to the NBCC, 
providing greater flexibility for an attorney to withdraw from a 
proceeding with good cause without 30 days notice, and eliminating the 
right of the Department of Enforcement to move for summary disposition 
of a disciplinary proceeding. In addition, the proposed changes made to 
the Rule 8000 Series in Amendment No. 3 were technical, non-substantive 
amendments. Finally, the NASD made several modifications to the 
membership application process including adding a requirement that, 
once approved, a member must return an executed membership agreement 
within twenty-five days of service of the agreement, inserting language 
in several sections permitting an applicant and the NASD to modify 
certain deadlines by agreement, codifying the procedural protections 
afforded new member applications in the business restrictions section, 
and certain other clarifying changes.
    The Commission believes the NASD's proposed changes in Amendment 
No. 3 further strengthen and clarify the proposed rule change and raise 
no new regulatory issues. Further, the Commission believes that 
Amendment No. 3 does not significantly alter the Original Proposal 
which was subject to a full notice and comment period. Therefore, the 
Commission believes that granting accelerated approval to Amendment No. 
3 is appropriate and consistent with Section 19(b)(2) of the 
Act.<SUP>212</SUP>
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    \212\ 15 U.S.C. Sec. 78s(b)(2).
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VII. Amendment No. 4

    The Commission finds good cause for approving Amendment No. 4 prior 
to the thirtieth day after the date of publication of notice thereof in 
the Federal Register. Specifically, Amendment No. 4 makes several 
technical non-substantive changes to the proposal such as identifying 
appropriate cross-references and correcting typographical errors in the 
Rule 9100-9300 Series of the Code of Procedure. The Commission believes 
that proposed Amendment No. 4 raises no new regulatory issues. 
Therefore, the Commission believes granting accelerated approval to 
Amendment No. 4 is appropriate and consistent with Section 19(b)(2) of 
the Act.<SUP>213</SUP>
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    \213\ 15 U.S.C. Sec. 78s(b)(2).
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VIII. Amendment No. 5

    The Commission finds good cause for approving Amendment No. 5 prior 
to the thirtieth day after the date of publication of notice thereof in 
the Federal Register. Specifically, Amendment No. 5 makes a technical 
change to the proposal, deleting the requirement for signatures of each 
member of a hearing panel on a disciplinary decision. Further, as 
discussed in detail above, Amendment

[[Page 43408]]

No. 5 describes the effective date for each component of the NASD's 
proposal. The Commission believes that proposed Amendment No. 5 raises 
no new regulatory issues. Therefore, the Commission believes granting 
accelerated approval to Amendment No. 5 is appropriate and consistent 
with Section 19(b)(2) of the Act.<SUP>214</SUP>
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    \214\ 15 U.S.C. Sec. 78s(b)(2).
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IX. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment Nos. 3, 4 and 5 to the proposed rule 
change. Persons making written submissions should file six copies 
thereof with the Secretary, Securities and Exchange Commission, 450 
Fifth Street, N.W., Washington, D.C. 20549. Copies of the submission, 
all subsequent amendments, all written statements with respect to 
Amendment Nos. 3, 4 and 5 that are filed with the Commission, and all 
written communications relating to Amendment Nos. 3, 4 and 5 between 
the Commission and any persons, other than those that may be withheld 
from the public in accordance with the provisions of 5 U.S.C. Sec. 552, 
will be available for inspection and copying in the Commission's Public 
Reference Room. Copies of such filing will also be available for 
inspection and copying at the principal office of the NASD. All 
submissions should refer to File No. SR-NASD-97-28 and should be 
submitted by September 3, 1997.

X. Conclusion

    For all of the aforementioned reasons, the Commission finds that 
the proposed rule change is consistent with the requirements of the Act 
and the rules and regulations thereunder applicable to a national 
securities association.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,<SUP>215</SUP> that the proposed rule change (SR-NASD-97-28) is 
approved, including Amendment Nos. 2, 3, 4, and 5 on an accelerated 
basis.
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    \215\ 15 U.S.C. Sec. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.<SUP>216</SUP>
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    \216\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 97-21330 Filed 8-12-97; 8:45 am]
BILLING CODE 8010-01-P