20232 Federal Register / Vol. 63, No. 78 /Thursday, April 23, 1998 / Notices

11NASD Regulation notes that it has a proposed

amendment to Rule 10304, rule filing SR–NASD–

97–44, pending approval with the SEC. Under the

proposed rule change all claims are presumed to be

eligible; however, the presumption can be overcome

if the respondent challenges the claim on the basis

that more than six years have elapsed since the act

or occurrence giving rise to the claim.

12 15 U.S.C. 78–-3.

13 17 CFR 200.30–3(a)(12).

1 15 U.S.C. 78s(b)(1).

2 17 CFR 240.19b–4.

3See Securities Exchange Act Release No. 39361

(November 26, 1997), 62 FR 64422 (File No. SR–

NASD–97–69). Amendment No. 1 to the proposed

rule filing was filed on November 12, 1997. The

changes contained in this amendment were

included in the Notice. See Letter from Mary N.

Revell, Associate General Counsel, NASD

Regulation, to Katherine A. England, Assistant

Director, Division of Market Regulation,

Commission (November 17, 1997).

4See Letter from R. Gerald Baker, Securities

Industry Association (‘‘SIA’’), to Jonathan G. Katz,

Secretary, Commission, dated February 11, 1998.

5See letter from Mary N. Revell, Associate

General Counsel, NASD Regulation, to Katherine A.

England, Assistant Director, Office of Market

Supervision, Division of Market Regulation (March

9, 1998). In Amendment No. 2, NASD Regulation:

(1) Applies the proposal to firms that have a work

force comprised of a specified number of registered

persons who were employed by a ‘‘disciplined

firm’’ within the last three years instead of two

years; (2) requires firms to establish special

procedures to supervise the telemarketing activities

of registered persons instead of registered

representatives; (3) amends the definition of

registered persons to include those persons who

register as municipal securities principals or

representatives pursuant to Municipal Securities

Rulemaking Board Rule G–3; and (4) provides

guidance on what would constitute ‘‘reasonable

procedures for reviewing the tape recordings made

pursuant to the requirements of’’ the taping rule in

a Notice to Members announcing approval of the

rule.

6Staffs of the NASD, New York Stock Exchange

(‘‘NYSE’’), North American Securities

Administrators Association (‘‘NASAA’’), and the

Office of Compliance Inspections and

however, if more than six years have

elapsed from the transaction,

occurrence, or event giving rise to the

claim, under Rule 10304 of the Code,

the claim will not be eligible for

submission to arbitration.11 All claims

involving general securities broker/

dealers will continue to be accepted for

arbitration consistent with past practice.

Claims previously submitted that the

Office has already declined to arbitrate

under the old policy cannot be

resubmitted under the policy being

announced herein.

2. Statutory Basis

NASD Regulation believes that the

proposed rule change is consistent with

the provisions of Section 15A(b)(6) of

the Act 12 in that eliminating a barrier to

the arbitration of disputes involving

exempted securities, public customers

and members will have access to a fair,

efficient, and cost-effective forum for

the resolution of such disputes.

B. Self-Regulatory Organization’s

Statement on Burden on Competition

The NASD does not believe that the

proposed rule change will impose any

inappropriate burden on competition.

C. Self-Regulatory Organization’s

Statement on Comments on the

Proposed Rule Change Received From

Members, Participants, or Others

No written comments were either

solicited or received.

III. Date of Effectiveness of the

Proposed Rule Change and Timing for

Commission Action

Within 35 days of the publication of

this notice in the Federal Register or

within such longer period (i) as the

Commission may designate up to 90

days of such date if it finds such longer

period to be appropriate and publishes

its reasons for so finding or (ii) as to

which the self-regulatory organization

consents, the Commission will:

(A) by order approve the proposed

rule change, or

(B) institute proceedings to determine

whether the proposed rule change

should be disapproved.

IV. Solicitation of Comments

Interested persons are invited to

submit written data, views, and

arguments concerning the foregoing,

including whether the proposed rule

change is consistent with the Act.

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 the proposed rule

change that are filed with the

Commission, and all written

communications relating to the

proposed rule change between the

Commission and any person, other than

those that may be withheld from the

public in accordance with the

provisions of 5 U.S.C. 552, will be

available for inspection and copying at

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–98–04 and should be

submitted by May 14, 1998.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.13

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 98–10754 Filed 4–22–98; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–39883; File No. SR–NASD–

97–69]

Self-Regulatory Organizations; Order

Granting Approval of Proposed Rule

Change, as Amended, and Notice of

Filing and Order Granting Accelerated

Approval of Amendment No. 2 to the

Proposed Rule Change by the National

Association of Securities Dealers, Inc.

Relating to the Tape Recording of

Conversations

April 17, 1998.

I. Introduction

On September 12, 1997, the National

Association of Securities Dealers, Inc.

(‘‘NASD’’), through its regulatory

subsidiary NASD Regulation, Inc.

(‘‘NASD Regulation’’) filed with the

Securities and Exchange Commission

(‘‘SEC’’ or ‘‘Commission’’) a proposed

rule change pursuant to Section 19(b)(1)

of the Securities Exchange Act of 1934

(‘‘Act’’),1 and Rule 19b–4 thereunder.2

In this filing, NASD Regulation

proposed amendments to Rule 3010 to

require the tape recording of

conversations where members hire more

than a specified percentage of registered

persons from certain firms that have

been expelled or that have had their

broker/dealer registration revoked for

violations of sales practices rules. The

proposed rule change also includes a

conforming rule change to Rule 9610.

Notice of this proposed rule change was

published in the Federal Register on

December 5, 1997 (as amended, the

‘‘Notice’’).3 The Commission received

one comment letter, which expressed

concerns about using tape recording as

a method of supervision, in response to

the Notice.4 On March 9, 1998, NASD

Regulation filed Amendment No. 2 with

the Commission.5 This order approves

the rule change, as amended, and grants

accelerated approval of Amendment No.

2 to the rule change.

II. Background

At its meeting in July 1996, the NASD

Regulation Board of Directors

authorized the staff to issue a Notice to

Members soliciting comment on

proposed changes to NASD supervisory

Rule 3010 to require the tape recording

of telephone conversations of registered

representatives in certain

circumstances. The Rule was developed

both to respond to concerns expressed

in the Joint Regulatory Sales Practice

Sweep (‘‘Sweep’’) Report 6 regarding the
Federal Register / Vol. 63, No. 78 /Thursday, April 23, 1998 / Notices 20233

Examinations, SEC, Joint Regulatory Sales Practice

Sweep: A Review of the Sales Practice Activities of

Selected Registered Representatives and the Hiring,

Retention, and Supervisory Practices of the

Brokerage Firms Employing Them (March 1996).

The Sweep was an initiative involving the staffs of

the NASD, the SEC, the NYSE, and representatives

of the NASAA (collectively, the ‘‘Working Group’’)

to review the sales practice activities of selected

registered representatives and the hiring, retention,

and supervisory practices of the brokerage firms

employing them in order to identify possible

problem registered representatives, review their

sales practices, and assess whether adequate hiring,

retention, and supervisory mechanisms are in place.

The Sweep Report was released on March 18, 1996.

7The current proposal focuses on the disciplinary

history of the firm that formerly employed the

registered representative.

8 Id. at ii, iv.

9NASD Notice of Members 97–19 (April 1997);

NYSE Information Memo 97–20 (April 15, 1997).

10See Letter from Lynn K. Gilbert, Deputy

Director, Commodity Futures Trading Commission,

to Daniel J. Roth, General Counsel, NFA (January

19, 1993).

11See Notice to Members 96–59 (September

1996).

12NASD Regulation received the following

comment letters: (1) Letter from Brian C.

Underwood, A.G. Edwards & Sons, Inc.

(‘‘Edwards’’), dated October 31, 1996; (2) Letter

from Kevin P. Howe, American Express Financial

Advisors (‘‘AEFA’’), dated October 31, 1996; (3)

Letter from G. Thomas Mitchell, Aurora Insurance

and Securities, Inc. (‘‘Aurora’’), dated October 10,

1996; (4) Letter from Jerome Snyder, Barington

Capital Group, L.P. (‘‘Barington’’), dated October 23,

1996; (5) Letter from Leslie D. Smith, Berthel Fisher

Company (‘‘Berthel’’), dated October 25, 1996; (6)

Letter from Walter I. Miller, Capital Growth

Planning, Inc. (‘‘Capital’’), dated September 24,

1996; (7) Letter from Sanford D. Greenberg,

Chatfield Dean & Co. (‘‘Chatfield Dean’’), dated

October 31, 1996; (8) Letter from Neil Lawrence

Lane, Citicorp Investment Services (‘‘CIS’’), dated

October 31, 1996; (9) Letter from David J. Master,

Coastal Securities (‘‘Coastal’’), dated October 31,

1996; (10) Letter from John Polanin, Jr., Cowen &

Company (‘‘Cowen’’), dated November 7, 1996; (11)

Letter from Richard L. Sandow, Cullum & Sandow

Securities, Inc. (‘‘Cullum’’), dated October 17, 1996;

(12) Letter from Gregg Thaler, Duke & Company,

Inc. (‘‘Duke I’’), dated October 10, 1996; (13) Letter

from William Rotholz, Duke & Company, Inc.

(‘‘Duke II’’), dated October 29, 1996; (14) Letter from

Shannon Braymen, Duncan-Smith Securities, Inc.

(‘‘Duncan-Smith’’), dated October 22, 1996; (15)

Letter from James H. Pyle et al., E.E. Powell &

Company, Inc., dated October 21, 1996; (16) Letter

from Nancy K. Port, Equity Services, Inc. (‘‘ESI’’),

dated October 30, 1996; (17) Letter from Rick

Fetterman, Fetterman Investments, Inc., dated

October 1, 1996; (18) Letter from Herbert O. Sontz,

GKN Securities (‘‘GKN’’), dated October 31, 1996;

(19) Letter from Lawrence E. Wesneski, Hoak

Breedlove Wesneski & Co. (‘‘Hoak’’), dated October

21, 1996; (20) Letter from Cabell B. Birdsong,

Investors Security Company, Inc. (‘‘ISC’’), dated

October 22, 1996; (21) Letter from David A. Rich,

Jefferies & Company, Inc., dated November 8, 1996;

(22) Letter from Thomas P. Koutris, John Hancock

Distributors, Inc., dated September 23, 1996; (23)

Letter from A.E. Monahan, Keystone Capital

Corporation (‘‘Keystone’’), dated October 7, 1996;

Continued

need for heightened supervision of

certain registered representatives with

troubled regulatory and compliance

records and also to address the

particular problems that occur when a

firm hires a larger number of

individuals who formerly worked at a

firm that has been expelled or has had

its registration revoked (a ‘‘Disciplined

Firm’’) where they were inadequately

supervised and trained.

NASD Regulation stated in its filing

that one of the key findings of the

Sweep Report concerned the

willingness of some firms to employ

registered representatives with a history

of disciplinary actions or customer

complaints.7 Based on this finding, the

Working Group collectively

recommended that firms that hire

registered representatives with a recent

disciplinary history involving sales

practice abuse or other customer harm

should implement special supervisory

procedures tailored to the individual

registered representative, which include

a heightened level of scrutiny of the

registered representative’s activities by

his or her supervisor, for a period of

time.8 The Sweep Report recommended

that, if firms fail to establish such

special supervisory procedures, the selfregulatory organizations (‘‘SROs’’)

should consider revising their rules to

specifically require that registered

representatives with a recent history of

disciplinary actions involving sales

practice abuse or other customer harm

be placed under special supervision by

the firm for a period of time.

NASD Regulation and the NYSE have

issued a memorandum discussing the

Sweep Report and providing guidance

on actions firms could take to provide

heightened supervision of problem

registered representatives.9 While the

special procedures designed to provide

a heightened level of supervision

recommended by the Sweep Report and

described in the NASD/NYSE

memorandum may provide adequate

supervision of associated persons in

most circumstances, NASD Regulation

proposes to adopt specific procedures in

certain situations in order to provide the

level of supervision required by Rule

3010.

NASD Regulation proposes to amend

NASD Rule 3010 to require firms that

hire a specified number of individuals

from Disciplined Firms to tape-record

telephone conversations between their

registered persons and existing and

potential customers. The proposed Rule

would apply when a firm hires a

substantial number of registered persons

from a firm or firms that have been

expelled or had their registrations

revoked for sales practice abuse. The

measures are designed to prevent a

reoccurrence of sales practice abuse or

other customer harm that caused the

Disciplined Firm to be expelled or have

its registration revoked. The proposal is

similar to an interpretation adopted by

the National Futures Association

(‘‘NFA’’) in 1993 to combat abusive cold

calling.10 The NFA’s interpretation is

discussed below.

A. Notice to Members 96–59 and

Original Proposal

In its filing with the Commission,

NASD Regulation described Notice to

Members 96–59 (‘‘NTM 96–59’’), which

contained the original proposed Rule

(‘‘original proposal’’ or ‘‘original

Rule’’).11 NASD Regulation’s original

proposal captured a broader swath of

firms. It would have been triggered

whenever a significant portion of a

member’s work force was comprised of

associated persons who formerly were

employed by a Disciplined Firm or

firms or when the firm itself was a

Disciplined Firm. The original proposal

defined a Disciplined Firm, for purposes

of the Rule, as one that had been

disciplined (e.g., expelled, suspended,

or enjoined) by a regulatory entity, an

SRO, or a court within the previous five

years for telemarketing or sales-practice

abuses in connection with the

solicitation, offer, or sale of securities.

NASD Regulation’s original proposal

also stated that if more than 20 percent

of a member’s sales force of associated

persons previously were employed by a

Disciplined Firm, the member would

have been required to adopt special

written procedures to supervise the

telemarketing activities of its associated

persons. Firms that were themselves

Disciplined Firms also would have been

required to adopt these procedures. The

procedures would have required, at a

minimum, that the employer member

tape record all telephone conversations

between all of its associated persons and

both existing and potential customers,

and maintain these procedures for two

years. For each firm that was itself a

Disciplined Firm, at the end of the twoyear period, NASD Regulation would

have conducted an evaluation to

determine whether, and for how long,

the firm would continue to be subject to

the requirements of the Rule. The Rule

also would have required firms subject

to the taping requirement to review the

tapes periodically to ensure compliance

with securities laws and NASD rules, to

submit reports to NASD Regulation on

their supervision of telemarketing

activities, and to retain and index the

tapes.

B. Comments and Response on the

Original Proposal

NASD Regulation received 42

comment letters in response to its initial

Notice to Members.12 Of the 42
20234 Federal Register / Vol. 63, No. 78 /Thursday, April 23, 1998 / Notices

(24) Letter from Paul B. Uhlenhop, Lawrence,

Kamin, Saunders & Uhlenhop (‘‘Lawrence,

Kamin’’), dated October 29, 1996; (25) Letter from

Kathryn S. Reinmann, Lehman Brothers Inc.

(‘‘Lehman’’), dated October 31, 1996; (26) Letter

from Kenneth S. Spirer, Merrill Lynch, Pierce,

Fenner & Smith (‘‘Merrill Lynch’’), dated November

14, 1996; (27) Letter from Jack G. Levin,

Montgomery Securities (‘‘Montgomery’’), dated

January 16, 1997; (28) Letter from Frederick W.

Bogdan, Morgan Stanley & Co., Incorporated

(‘‘Morgan Stanley’’), dated October 30, 1996; (29)

Letter from Dennis S. Kaminski, Mutual Service

Corporation (‘‘MSC’’), dated October 29, 1996; (30)

Letter from Richard Berenger, Nathan & Lewis

Securities, Inc. (‘‘Nathan & Lewis’’), dated October

18, 1996; (31) Letter from Douglas L. Dunahay,

Neidiger/Tucker/Bruner Inc. (‘‘Neidiger’’), dated

October 29, 1996; (32) Letter from Edward T. Borer,

Philadelphia Corporation (‘‘PC’’), dated October 17,

1996; (33) Letter from Michael Flannigan, Protective

Group Securities Corporation (‘‘PGSC’’), dated

September 24, 1996; (34) Letter from Robert A.

Fitzner, Jr., RAF Financial Corporation (‘‘RAF’’),

dated October 29, 1996; (35) Letter from Glen F.

Hackmann, Robert W. Baird & Co., Incorporated

(‘‘Baird’’), dated October 31, 1996; (36) Letter from

Douglas F. Schofield, Schofield Investments, Inc.,

dated September 18, 1996; (37) Letter from Richard

O. Scribner, Allen B. Holeman, and C. Evan

Steward, SIA, dated November 4, 1996; (38) Letter

from Dov S. Schecter, Smith Barney Inc. (‘‘Smith

Barney’’), dated October 31, 1996; (39) Letter from

Patrick G. Haayes, Stratton Oakmont, Inc.

(‘‘Stratton’’), dated October 30, 1996; (40) Letter

from Walter H. Schlobohm, dated February 10,

1997; (41) Letter from John Maceranka, The

Windmill Group, Inc., dated September 28, 1996;

and (42) Letter from Stanley J. Allen Jr., Yee,

Desmond, Schroeder & Allen, Inc. (‘‘Yee’’), dated

October 28, 1996.

13See, e.g., letters from Lehman and Morgan

Stanley.

14See, e.g., letters from Edwards, Morgan Stanley,

Nathan & Lewis, PC, SIA, and Stratton.

15See, e.g., letters from Edwards, Barington,

Chatfield Dean, Cullum, Duke II, ESI, ISC, Morgan

Stanley, Baird, and Stratton.

16See, e.g., letters from CIS, Duke II, ESI, Lehman,

Merrill Lynch, MSC, Nathan & Lewis, and SIA.

17The commenters stated that small firms would

be disproportionately effected both in the cost of

taping and in the numbers of firms likely to become

subject to the threshold percentage of 20%. See

letters from Capital, Cowen, Duncan-Smith, Hoak,

SIA, and Yee.

18The NASD revised the definition of Disciplined

Firm to include only expelled and revoked firms in

order to focus, at least initially, on the most

egregious cases with the greatest supervisory and

disciplinary problems. For the two-year period

1995–1996, 14 firms met the definition of

Disciplined Firm: 4 firms were expelled from SRO

membership and 10 had their registrations revoked.

This approach is similar to the one taken by the

NFA, and will allow the NASD to gain experience

with the implementation of the Rule before it

considers expanding the definition of Disciplined

Firm to include firms that have been suspended

from SRO membership or from SEC registration.

comment letters, 39 were opposed to the

proposal, including those filed by the

Securities Industry Association, Lehman

Brothers, Merrill Lynch, Morgan

Stanley, and Smith Barney. NASD

Regulation stated that most of the

commenters supported the NASD’s

objective in proposing the taping Rule

and agreed that firms should be

discouraged from recruiting groups of

registered persons from a Disciplined

Firm, however, they did not believe that

tape recording of conversations was an

appropriate regulatory requirement and

feared that regulators will require even

more comprehensive tape recording in

the future.

The definition of a Disciplined Firm is

too broad: NASD Regulation stated that

many of the commenters believe the

definition of a Disciplined Firm in the

original Rule was too broad. For

example, the original definition would

have included a firm that was the

subject of an injunction for a technical

or inadvertent violation of state law or

as the result of a consensual injunction

involving only a fraction of the firm’s

business and employees. NASD

Regulation responded by narrowing the

definition of a Disciplined Firm to

include firms that have been expelled

from membership in a securities

industry SRO or that have had their

registration revoked by the SEC due to

telemarketing or sales practice abuses.

The Rule is too broad with respect to

the individuals included in the

percentage calculation and the time

frame: NASD Regulation stated that

commenters complained the Rule was

too broad in several respects. First,

commenters said the Rule would target

firms and individuals for the actions of

other firms and individuals of which

they had no knowledge or control 13

Second, the commenters criticized the

Rule’s application to all individuals that

had ever been employed by a

Disciplined Firm in the calculation of

the percentage that would trigger the

special supervisor procedures.14

Finally, NASD Regulation stated that

commenters believed the Rule should be

limited to personnel who have contact

with customers, such as registered

representatives, and should exclude

clerical and ministerial employees from

both the 20% calculation and the taping

requirement.15

In response, NASD Regulation

narrowed the scope of the original Rule

to apply only to firms that hire a

specified percentage of individuals who

were employed at a Disciplined Firm

within the last three years. NASD

Regulation also limited the individuals

calculated in the percentage to register

persons, leaving out clerical and

ministerial personnel. Also, NASD

Regulation limited the persons subject

to the taping requirement to registered

representative in conversations with

both existing and potential customers.

The Rule does not achieve the stated

purpose: NASD Regulation noted that

several commenters questioned whether

the original Rule goes beyond the scope

of the Sweep Report and would be

effective in achieving the Sweep Report

recommendations because taping is not

an effective means of supervising sales

efforts.16

NASD Regulation responded by

emphasing that the taping requirement

is being restricted to particularly

egregious situations. They stated their

concern that when a firm hires high

percentages of employees from firms

that have been expelled by an SRO or

that have had their registration revoked

by the Commission, these groups of

employees are unlikely to have been

trained or supervised adequately. In

addition, NASD Regulation stated its

belief in the in terrorem effect of

recording telephone conversations to

deter sales practice abuses. Finally, the

NASD believes the Rule directly

addresses the issues raised when a firm

hires a high percentage of individuals

who were employed by a Disciplined

Firm where they were inadequately

trained and supervised.

The costs of the Rule are too great:

The NASD noted that some commenters

expressed concerns that the costs of the

original Rule would be too high,

considering the limited benefits of the

Rule. The commenters also stated that

the Rule would have a disproportionate

effect on small firms.17

The NASD stated that its narrowing of

many aspects of the Rule would result

in lower compliance costs. Specifically,

in the revised proposal, the NASD

exempted firms with five or fewer

registered persons from the Rule and

tiered the structure for determining the

percentage of employees that trigger the

taping requirement so that smaller firms

would have to hire 30% or more of their

registered persons from Disciplined

Firms before they would trigger the

requirement. In addition, the NASD

stated that by narrowing the definition

of a Disciplined Firm, fewer firms will

be subject to the taping requirement.18

Finally, with respect to certain practical

compliance difficulties, the NASD

agreed to provide firms with all the

relevant information they need to

determine whether they are in

compliance with the Rule.

Privacy concerns: The NASD stated

that many commenters felt the original

Rule would invade the privacy of both

a firm’s customers as well as the firm’s

registered representatives, which would

be unfair to both firms and registered

representatives that did not have

disciplinary histories. Commenters also

believe that the Rule would conflict

with federal and state wiretapping laws.

Finally, they are concerned that the
Federal Register / Vol. 63, No. 78 /Thursday, April 23, 1998 / Notices 20235

19See, e.g., letters from AEFA, Duke II, Lawrence,

Kamin, Lehman, Morgan Stanley, MSC, Neidiger,

Montgomery, SIA, and Smith Barney.

20See Interpretive Notice to NFA Compliance

Rule 2–9, Supervision of Telemarketing Activity,

9021 (February 18, 1997).

21 18 U.S.C. §§ 2519 et seq.

22 In one-party statute states, the only issue is

whether the registered representative knows of and

consents to the tape recording. Since the recording

requirement would run to the firm, and the

equipment would be the firm’s, it might be argued

that the firm, and not the representative, is doing

the recording. Therefore, it would be necessary for

the firm to insure that the representative has notice

and consents to the tape recording of his or her

telephone conversations. This could be

accomplished through a clause in an employment

agreement or employee handbook or other written

notice to the representative.

23 In two-party statute states, it would be

necessary to insert on the firm’s telephone line a

recording stating that all telephone conversations

are being taped, similar to customer service lines in

other industries. Some states require a system of

beeps or buzzers that sound throughout the

conversation. Another possibility is to insert a

clause into the customer agreement notifying

customers that their calls will be tape recorded.

Some states also have a ‘‘business use exception’’

to the two-party statute consent requirement, but it

is worded and applied differently in each state.

24See Interpretive Notice to NFA Compliance

Rule 2–9, Supervision of Telemarketing Activity,

¶ 9021 (February 18, 1997).

25 In early 1997, 44 firms met the NFA definition

of Disciplined Firm. See Interpretive Notice to NFA

Compliance Rule 2–9, Supervision of Telemarketing

Activity, ¶ 9021 (February 18, 1997).

26Telephone conversation between Mary N.

Revell, Associate General Counsel, NASD, and

Daniel Driscoll, Vice President, Compliance, NFA

(February 26, 1997).

Rule does not restrict the accessibility

and manner in which the tapes may be

used.19

As stated above, because the Rule has

been revised to address only the most

egregious situations, the impact on

privacy will be minimized. Also, upon

approval, NASD Regulation will inform

NASD members that, in complying with

this Rule, they must also comply with

federal and state civil and criminal

statutes governing the tape recording of

conversations. This is the same

approach the NFA has taken with

respect to this issue.20

Each state has a statute governing

wiretapping; there also is a federal

statute governing wiretapping and

electronic surveillance.21 The federal

statute and the majority of the state

statutes permit taping of telephone

conversations with the consent of one

party (‘‘one-party statutes’’),22 a

minority of state statutes require the

consent of all parties to the conversation

(‘‘two-party statutes’’).23 Three issues

arise from the proposed Rule: what is

necessary to comply with one-party

statutes; what is necessary to comply

with two-party statutes; and how to

comply where a conversation occurs

between a person in a one-party state

and a person in a two-party state. The

NASD has left compliance with the state

statutes on wiretapping and privacy for

each broker-dealer.

C. Proposed Rule

As revised and filed with the

Commission, the proposed Rule would

apply whenever a specified percentage

of a member firm’s sales force is

comprised of registered persons who

were employed within the last three

years by a firm that has been expelled

from membership in a securities

industry SRO or has had its registration

as a broker/dealer revoked by the SEC.

The requisite percentage varies

depending on the size of the firm, from

40 percent for a small firm to 20 percent

for a larger firm. The firm must establish

the required supervisory procedures

within 30 days of receiving notice from

NASD Regulation or obtaining actual

knowledge that it is subject to the

provisions of the Rule.

Under the proposed Rule, if the

requisite percentage of a member’s sales

force previously was employed by a

Disciplined Firm, the member would be

required to adopt special written

procedures to supervise the

telemarketing activities of all of its

registered persons. The procedures

would require, at a minimum, that the

member tape record all telephone

conversations between all of its

registered persons and both existing and

potential customers for a period of three

years, and maintain these supervisory

procedures for two years. The Rule

would require firms to ensure that they

tape record all regularly used means of

telecommunications, including cellular

phones. The Rule also would require

firms subject to the taping requirement

to establish reasonable procedures for

reviewing the tape recordings to ensure

compliance with securities laws and

NASD rules, to submit reports to the

NASD on their supervision of

telemarketing, and to retain and catalog

the tapes.

While each firm is responsible for

complying with the Rule, NASD

Regulation will provide firms with all of

the information that they need to

determine if they are subject to the

requirements of the Rule. NASD

Regulation believes that firms should be

able to rely on the accuracy of the

information provided to them by the

NASD. Therefore, the NASD anticipates

that a firm will be disciplined for failure

to comply with the Rule only if it has

actual knowledge of information that

would make the firm subject to the Rule

that is inconsistent with the information

provided by NASD Regulation to the

firm that indicated that the firm was not

subject to the Rule.

NASD Regulation will compile and

maintain several lists that firms will be

able to review on a quarterly basis to

assist them to determine if they are in

compliance with the Rule. The primary

list that will be prepared will be a list

of firms that meet the definition of

Disciplined Firm. Two additional lists

will be prepared that should be helpful.

One list will contain an alphabetical

listing of all registered persons who had

worked for Disciplined Firms within the

last three years. Another list will be

compiled containing the same list of

people grouped according to the firm for

which they currently work. In order to

alert firms that they are approaching the

percentage that would make them

subject to the requirements of the Rule,

the second list will contain a

computation of the percentage of all

registered persons at the firm

represented by registered persons who

had been employed at a Disciplined

Firm within the last three years.

The Rule is thus very similar to an

NFA interpretation concerning

supervision of telemarketing activity.24

NFA member firms subject to the

requirements of the interpretation must

tape record all sales solicitations. The

NFA interpretation applies to firms that

meet criteria relating to the percentage

of the firm’s associated persons who

formerly were employed at a firm that

was closed down and barred from the

industry through enforcement actions

for deceptive telemarketing practices.25

These firms are required by the NFA

interpretation to tape record sales

solicitations. An NFA member subject to

these procedures may seek a waiver of

the taping requirement upon a

satisfactory showing that its current

supervisory procedures provide

effective supervision over its employees,

including enabling the member to

identify potential problem areas before

customer abuse occurs. The NFA has

rarely granted such waivers. In one

instance, a waiver was granted to a firm

that did not engage in telemarketing and

had only institutional customers. In two

other instances, partial waivers were

granted to firms that hired outside

consultants. NFA informed NASD

Regulation that they were not satisfied

with the work performed by the outside

consultants and would not grant such

waivers in the future.26 In response to

commenter requests, NASD Regulation

has included a waiver provision in the

proposed Rule, and also has proposed a
20236 Federal Register / Vol. 63, No. 78 /Thursday, April 23, 1998 / Notices

27See, e.g., letters from Edwards, Barington,

Cullum, Duke I, Duke II, Duncan-Smith, GKN,

Hoak, Morgan Stanley, Baird, and Montgomery.

28 15 U.S.C. § 78o–3(b)(6).

29Amendment No. 2 also makes several technical

amendments which clarify the application of the

previously noticed changes to Rules 3010 and 9610.

30 15 U.S.C. § 78o–3.

31 15 U.S.C. § 78s(b)(2).

32 17 CFR 200.30–3(a)(12).

1 15 U.S.C. 78s(b)(1).

2 17 CFR 240.19b–4.

conforming change to the Rule 9600

Series.27

III. Discussion

For the reasons discussed below, the

Commission finds that the proposed

rule change is consistent with the

requirements of the Act and the rules

and the regulations thereunder

applicable to registered securities

associations, in particular the

requirements of Section 15A(b)(6) of the

Act.28 Among other things, Section

15A(b)(6) of the Act requires that the

rules of a national securities association

be designed to foster cooperation and

coordination with persons engaged in

regulating, clearing, settling, processing

information with respect to, and

facilitating transactions in securities, to

remove impediments to and perfect the

mechanism of a free and open market

and a national market system, and in

general, to protect investors and the

public interest.

In particular, the Commission

believes that the proposed rule change

will discourage the revival of

disciplined firms that have been barred

by the industry or that have had their

registrations revoked by the

Commission. In essence, firms that

decide to hire significant numbers of

employees from disciplined firms will

be required to ensure a proper

supervisory environment that protects

investors and prevents fraudulent and

manipulative telemarketing acts and

practices. The monitoring of registered

persons’ telephone conversations will

help to provide additional supervision

of individuals who formerly worked at

a disciplined firm where they were

inadequately trained and supervised.

In the Notice, the Commission

requested comments on all aspects of

the proposal, as well as the need to

inform investors that their calls are

being taped. The Commission received

one comment letter concerning the

proposal. The SIA expressed general

concerns about tape recording

conversations as a method of

supervision. While the Commission

recognizes the limitations of this form of

supervision, the Commission believes

that if registered persons know their

phone calls are being taped then they

are more likely to avoid making false or

exaggerated representations. In addition,

compliance officals will have another

tool to monitor persons who worked

previously at firms with significant sales

practice problems. Moreover, the fact

that tapes of the telephone

conversations will be available to

persons who have disputes with brokerdealer firms will spur firms with a

substantial percentage of representatives

from an expelled firm to take extra

measures to supervise these persons.

No comments were received

concerning the issue of notice to

investors that their calls are being taped.

NASD Regulation has indicated its

belief that the issue of notification is

addressed by state privacy laws and that

firms will be required to independently

determine that state laws are satisfied.

The Commission believes that the best

practice would be for member firms to

notify their registered persons and

customers that their telephone calls are

being tape recorded.

The Commission expects the NASD to

monitor the Rule and assess its

effectiveness. For example, the NASD

should monitor the number of firms that

become subject to the Rule as well as

firms that hire representatives from

disciplined firms but do not trigger the

taping requirement to see if there is a

need to adjust the percentages. Also, the

NASD should monitor the number of

firms exempt from the Rule because

they have five or fewer employees to

determine if this is an effective

exclusion. Furthermore, the NASD

should make sure firms comply with

state laws on notification.

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. Amendment No. 2

applies the proposal to member firms

with a work force comprised of a

specified number of registered persons

who were employed by a ‘‘disciplined

firm’’ within the last three years instead

of two years.29 In the Notice, the

Commission requested comment on

whether the original two-year time

frame was appropriate. Although no

comments were received on this issue,

NASD Regulation and the Commission

believe that a three-year time frame will

better capture registered persons who

worked at disciplined firms during a

period of inadequate training,

supervision, and sales practice abuses.

Therefore, the Commission believes that

granting accelerated approval to

Amendment No. 2 is appropriate and

consistent with Section 15A of the

Act.30

IV. Solicitation of Comments

Interested persons are invited to

submit written data, views and

arguments concerning Amendment No.

2 to the proposed rule change, including

whether the proposed rule change is

consistent with the Act. 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

No. 2 that are filed with the

Commission, and all written

communications relating to Amendment

No. 2 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. § 552,

will be available for inspection and

copying in the Commission’s Public

Reference Room. Copies of the 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–97–69 and should

be submitted by May 15, 1998.

V. Conclusion

It is therefore ordered, pursuant to

Section 19(b)(2) of the Act,31 that the

proposed rule change (SR–NASD–97–

69), including Amendment No. 2

thereto, is approved on an accelerated

basis.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.32

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 98–10796 Filed 4–22–98; 8:45 am]

BILLING CODE 8010–01–M

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–39881; File No. SR–PCX–

98–16]

Self-Regulatory Organizations; Notice

of Filing of Proposed Rule Change and

Amendment No. 1 Thereto by the

Pacific Exchange, Inc., Relating to

Communication Devices on the

Trading Floor

April 16, 1998.

Pursuant to Section 19(b)(1) of the

Securities Exchange Act of 1934

(‘‘Act’’),1 and Rule 19b–4 thereunder,2

notice is hereby given that on March 31,

1998, the Pacific Exchange, Inc. (‘‘PCX’’