[Federal Register Volume 66, Number 79 (Tuesday, April 24, 2001)]
[Notices]
[Pages 20697-20702]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-10109]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-44178; File No. SR-NASD-2001-20]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change by National Association of 
Securities Dealers, Inc. Relating to the Suitability Rule and Online 
Communications

April 12, 2001.
    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 19, 2001, the National Association of Securities Dealers, Inc. 
(``NASD''), through its wholly owned subsidiary, NASD Regulation, Inc. 
(``NASD Regulation'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') a proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by NASD 
Regulation.\3\ The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4
    \3\ On March 22, 2001, the NASD Regulation submitted a technical 
amendment to designate a file number for the proposed rule change. 
See letter from Jennifer Piorko, Senior Legal Assistant, NASD 
Regulation, to Nancy Sanow, Senior Special Counsel, Division of 
Market Regulation, Commission, dated March 21, 2001.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    NASD Regulation proposes to issue a Notice to Members (Notice to 
Members 01-23) reminding members that they have suitability obligations 
when they make recommendations to customers online. The text of the 
Notice to Members is provided below.\4\
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    \4\ The text and the footnotes in the Notice to Members are 
formatted and numbered in the manner that they appear in the actual 
Notice to Members that was published by NASD Regulation.
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* * * * *

NASD Notice to Members 01-23

Online Suitability
Suitability Rule And Online Communications

Suggested Routing

Senior Management
Legal & Compliance
Executive Representative

Key Topics

Suitability
Online Communications
Executive Summary
    In light of the dramatic increase in the use of the Internet for 
communication between broker/dealers and their customers, NASD 
Regulation, Inc. (NASD Regulation) is issuing a Policy Statement to 
provide members \1\ with guidance concerning their obligations under 
the National Association of Securities Dealers, Inc. (NASD<Register>) 
general suitability rule, Rule 2310,\2\ in this electronic 
environment.\3\ NASD Regulation filed this Policy Statement on March 
19, 2001, with the Securities and Exchange Commission (SEC). Pursuant 
to Section 19(b)(3)(A) of the Securities Exchange Act of 1934 and SEC 
Rule 19b-4(f)(1), the Policy Statement became immediately effective 
upon filing.
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    \1\ For purposes of this policy Statement, the terms ``member'' 
and ``broker/dealer'' include both firms and their associated 
persons.
    \2\ NASD Rule 2310 provides in pertinent part:
    (a) In recommending to a customer the purchase, sale or exchange 
of any security, a member shall have reasonable grounds for 
believing that the recommendation is suitable for such customer upon 
the basis of the facts, if any, disclosed by such customer as to his 
other security holdings and as to his financial situation and needs.
    (b) Prior to the execution of a transaction recommended to a 
non-institutional customer, * * * a member shall make reasonable 
efforts to obtain information concerning: (1) the customer's 
financial status; (2) the customer's tax status; (3) the customer's 
investment objectives; and (4) such other information used or 
considered to be reasonable by such member * * * in making 
recommendations to the customer.
    NASD Rule 2310 applies to equity and certain debt securities, 
but not to municipal securities. Municipal securities are covered by 
Municipal Securities Rulemaking Board (MSRB) Rule G-19 
(``Suitability of Recommendations and Transactions; Discretionary 
Accounts'').
    \3\ Although the focus of this Policy Statement is on the 
application of the suitability rule to electronic communications, 
much of the discussion is also relevant to more traditional 
communications, such as discussions made in-person, over the 
telephone, or through postal mail.
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    The Policy Statement briefly discusses some of the issues created 
by the intersection of online activity and the suitability rule. The 
Policy Statement then provides examples of electronic communications 
that NASD Regulation considers to be either within or outside the 
definition of ``recommendation'' for purposes of the suitability 
rule.\4\ In addition, the Policy

[[Page 20698]]

Statement sets forth guidelines to assist members in evaluating whether 
a particular communication could be viewed as a ``recommendation,'' 
thereby triggering application of the suitability rule.\5\
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    \4\ This Policy Statement focuses on ``customer-specific'' 
suitability under NASD Conduct Rule 2310. The word 
``recommendation'' appears in quotation marks whenever it is 
discussed in the context of a customer-specific suitability 
obligation. A broker/dealer must also have a reasonable basis ``to 
believe that the recommendation could be suitable for at least some 
customers.'' In re F.J. Kaufman and Company of Virginia, 50 S.E.C. 
164, 168, 1989 SEC LEXIS 2376, *10 (1989) (emphasis in original). 
This is called ``reasonable basis'' suitability, and it ``relates 
only to the particular recommendation, rather than to any particular 
customer.'' Id. See also In re Charles E. Marland & Co., Inc., 45 
S.E.C. 632, 636, 1974 SEC LEXIS 2458, *10 (1974) (recommending 
mutual fund switching creates rebuttable presumption of 
unsuitability); In re Thomas Arthur Stewart, 20 S.E.C. 196, 207, 
1945 SEC LEXIS 318, *25 (1945) (``[T]he lack of reasonable grounds 
for recommending [switching shares of mutual funds]'' was the basis 
for finding broker had violated NASD's suitability rule based on a 
``reasonable basis'' theory.).
    Although not directly addressed in this Policy Statement, in 
certain instances, a suitability violation also can be based on an 
inappropriate frequency of trades, often referred to as excessive 
trading or churning. See IM-2310-2, Fair Dealing With Customers 
(``Some practices that have resulted in disciplinary action and that 
clearly violate this responsibility for fair dealing are * * * 
[e]xcessive activity in a customer's account.''). A broker/dealer 
could violate the suitability rule, for example, where it 
recommended to a customer an excessive (and, based on the customer's 
financial situation and needs, an inappropriate) number of 
securities transactions and the customer routinely followed the 
broker/dealer's recommendations, See, e.g., In re Harry Gliksman, 
Exchange Act Rel. No. 42255, at 4, 1999 SEC LEXIS 2685, at *6 (Dec. 
20, 1999) (``Under [Rule 2310], recommendations may be unsuitable if 
the trading is excessive based on the customer's objectives and 
financial situation.''); In re Rafael Pinchas, Exchange Act Rel. No. 
41816, at 11-12, 1999 SEC LEXIS 1754, at *22 (Sept. 1, 1999) 
(``[E]xcessive trading, by itself, can violate NASD suitability 
standards by representing an unsuitable frequency of trading.'').
    \5\ While other NASD rules may cover circumstances where members 
are making recommendations (see, e.g., Rule 2210, ``Communications 
with the Public''), this Policy Statement is limited to a discussion 
of the suitability rule.
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    NASD Regulation emphasizes, however, that this current Policy 
Statement does not (1) alter member obligations under the suitability 
rule or (2) establish a ``bright line'' test for determining whether a 
communication does or does not constitute a ``recommendation'' for 
purposes of the suitability rule. No single factor discussed below, 
standing alone, necessarily dictates the outcome of the analysis.
    NASD Regulation recognizes that brokerage firms are using 
technology to offer many new beneficial services to customers, and it 
supports the continued development and use of technology to enhance 
investor education and access to information. These technological 
advances may have regulatory implications in the context of rules other 
than the suitability rule, and, therefore, we expect to issue future 
statements or guidance on the subject of online activities in the 
securities industry. NASD Regulation is aware, however, that technology 
is developing rapidly, and we want to avoid impeding the growth of new 
technological services for investors.
Questions/Further Information
    Questions or comments concerning the information contained in this 
Policy Statement may be directed to either Nancy C. Libin, Assistant 
General Counsel, Office of General Counsel, NASD Regulation, Inc., at 
(202) 728-8835 or <a href="/cdn-cgi/l/email-protection#254b444b465c0b494c474c4b654b4456410b464a48"><span class="__cf_email__" data-cfemail="76181718150f581a1f141f1836181705125815191b">[email protected]</span></a>, or James S. Wrona, Assistant 
General Counsel, Office of General Counsel, NASD Regulation, Inc., at 
(202) 728-8270 or <a href="/cdn-cgi/l/email-protection#d6bcbfbbf8a1a4b9b8b796b8b7a5b2f8b5b9bb"><span class="__cf_email__" data-cfemail="19737074376e6b7677785977786a7d377a7674">[email protected]</span></a>.

NASD Regulation Policy Statement Regarding Application Of The NASD 
Suitability Rule To Online Communications

Background

    Technological developments in recent years have profoundly affected 
the securities industry.\6\ One of the most dramatic changes is the way 
in which brokerage firms use the Internet to communicate with their 
customers. In addition to more traditional channels of communication 
such as the telephone and postal mail, broker/dealers and customers now 
transmit information to each other through broker/dealers' Web Sites, 
e-mail, Web phones, personal digital assistants, and hand-held pagers. 
Broker/dealers also use the Internet to provide lower-cost, unbundled 
services to customers. Among other things, broker/dealers have used the 
Internet to provide investors with new tools to obtain access to 
important analytical information, conduct their own research, and place 
their own orders. Technological advancements have provided many 
benefits to investors and the brokerage industry. These technological 
innovations, however, also have presented new regulatory challenges, 
including those arising from the application of the suitability rule to 
online activities.
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    \6\ See SEC Guidance on the Use of Electronic Media (``Use of 
Electronic Media''), Release Nos. 34-7856, 34-42728, IC-24426, 65 
Fed. Reg. 25843, 25843, 2000 SEC LEXIS 847, at *4 (Apr. 28, 2000) 
(``By facilitating rapid and widespread information dissemination, 
the Internet has had a significant impact on capital-raising 
techniques and, more broadly, on the structure of the securities 
industry.'').
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    The NASD's suitability rule states that in recommending to a 
customer the purchase, sale, or exchange of any security, a member 
shall have reasonable grounds for believing that the recommendation is 
suitable for such customer. As the rule states, a member's suitability 
obligation applies to securities that the member ``recommends'' to a 
customer.\7\ The NASD's suitability rule generally has been violated 
when a broker/dealer ``recommends'' a security to a customer that might 
be suitable for some investors, but is unsuitable for that particular 
customer.
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    \7\ A member or associated person who simply effects a trade 
initiated by a customer without a related ``recommendation'' from 
the member or associated person is not required to perform a 
suitability analysis, although members may elect to determine 
whether a security is suitable under such circumstances for their 
own business reasons. See In re Thomas E. Warren, III, 51 S.E.C. 
1015, 1019 n.19, 1994 SEC LEXIS 508, *11 n.19 (1994) (``We do not 
believe the suitability claims brought against the Applicant are 
supported by the record. There is no evidence that Warren 
recommended the transactions that were effected in these 
accounts.''), aff'd, 69 F.3d 549 (10th Cir. 1995) (table format); 
SEC Announcement of Final Rule on Sales Practice Requirements for 
Certain Low-Priced Securities, Release No. 34-27160, 54 Fed. Reg. 
35468, 1989 SEC LEXIS 1603, at *52 (Aug. 22, 1989) (``[T]he NASD and 
other suitability rules have long applied only to `recommended' 
transactions.''); Clarification of Notice to Members (``NtM'') 96-
60, 1997 NASD LEXIS 20 (FYI, Mar. 1997) (stating that a member's 
suitability obligation under Rule 2310 applies only to securities 
that have been recommended by the member). Similarly, the 
suitability rule does not apply where a member merely gathers 
information on a particular customer, but does not make any 
``recommendations.'' This is true even if the information is the 
type of information generally gathered to satisfy a suitability 
obligation.
    Members should nonetheless remember that, under NASD Rule 2110, 
they are required to comply with know-your-customer obligations. 
Pursuant to these obligations, members must make reasonable efforts 
to obtain certain basic financial information from customers so that 
members can protect themselves and the integrity of the securities 
markets from customers who do not have the financial means to pay 
for transactions. See NtM 96-32, 1996 NASD LEXIS 51 (May 1996) 
(reminding members of their know-your-customer obligations), 
supplemented and clarified on different grounds by NtM 96-60 (Sept. 
1996); see also NtM 99-11, 1999 NASD LEXIS 77 (Feb. 1999) (``While 
[this Notice] does not address firms' suitability obligations in 
connection with recommended transactions or their know-your-customer 
obligations, firms are reminded that the existence of these 
obligations does not depend upon whether a trade is executed on-line 
or otherwise.''); NtM 98-66, 1998 NASD LEXIS 81 (Aug. 1998) (noting 
that members should provide a description of ``any internal system 
protocols designed to fulfill a member's `know your customer' 
obligations''). Unlike the suitability rule, the NASD's know-your-
customer requirements apply to members regardless of whether they 
have made a ``recommendation.''
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Applicability of the Suitability Rule to Electronic Communications

    There has been much debate recently about the application of the 
suitability rule to online activities.\8\ Two major

[[Page 20699]]

questions have arisen: first, whether the current suitability rule 
should even apply to online activities, and second, if so, what types 
of online communications constitute ``recommendations'' for purposes of 
the rule. In answer to the first question, NASD Regulation believes 
that the suitability rule applies to all ``recommendations'' made by 
members to customers--including those made via electronic means--to 
purchase, sell, or exchange a security. Electronic communications from 
broker/dealers to their customers clearly can constitute 
``recommendations.'' The suitability rule, therefore, remains fully 
applicable to online activities in those cases where the member 
``recommends'' securities to its customers.
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    \8\ See generally SEC Commissioner Laura Unger, Online 
Brokerage: Keeping Apace of Cyberspace (Nov. 1999) (``Unger 
Report'') (discussing various views espoused by online brokerage 
firms, regulators and academics on the topic of online suitability). 
The Unger Report can be accessed through the SEC Web Site at 
www.sec.gov/news/spstindx.htm (last modified on May 4, 2000). See 
also Developments in the Law--The Law of Cyberspace, 112 Harv. L. 
Rev. 1574, 1582-83 (1999) (The article highlights the broader debate 
by academics and judges over whether ``to apply conventional models 
of regulation to the Internet.'').
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    With regard to the second question, NASD Regulation does not seek 
to identify in this Policy Statement all of the types of electronic 
communications that may constitute ``recommendations.'' As NASD 
Regulation has often emphasized, ``[w]hether a particular transaction 
is in fact recommended depends on an analysis of all the relevant facts 
and circumstances.''\9\ That is, the test for determining whether any 
communication (electronic or traditional) constitutes a 
``recommendation'' remains a ``facts and circumstances'' inquiry to be 
conducted on a case-by-case basis.
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    \9\ Clarification of NtM 96-60, 1997 NASD LEXIS 20 (FYI, Mar. 
1997).
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    NASD Regulation also recognizes that many forms of electronic 
communications defy easy characterization. Nevertheless, we offer as 
guidance the following general principles for member firms to use in 
determining whether a particular communication could be deemed a 
``recommendation.'' As illustrated by the examples provided below, the 
``facts and circumstances'' determination of whether a communication is 
a ``recommendation'' requires an analysis of the content, context, and 
presentation of the particular communication or set of communications. 
The determination of whether a ``recommendation'' has been made, 
moreover, is an objective rather than a subjective inquiry. An 
important factor in this regard is whether--given its content, context, 
and manner of presentation--a particular communication from a broker/
dealer to a customer reasonably would be viewed as a ``call to 
action,'' or suggestion that the customer engage in a securities 
transaction. Members should bear in mind that an analysis of the 
content, context, and manner of presentation of a communication 
requires examination of the underlying substantive information 
transmitted to the customer and consideration of any other facts and 
circumstances, such as any accompanying explanatory message from the 
broker/dealer.\10\ Another principle that members should keep in mind 
is that, in general, the more individually tailored the communication 
to a specific customer or a targeted group of customers about a 
security or group of securities, the greater likelihood that the 
communication may be viewed as a ``recommendation.'' \11\
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    \10\ For example, if a broker/dealer transmitted a research 
report to a customer at the customer's request, that communication 
may not be subject to the suitability rule; whereas, if the same 
broker/dealer transmitted the very same research report with an 
accompanying message, either oral or written, that the customer 
should act on the report, the suitability analysis would be 
different.
    \11\ See Online Brokerage Services and the Suitability Rule, 
NASD Regulatory & Compliance Alert, at 20 (Summer 2000) (noting that 
the more individualized and particular the communication about a 
security, the closer the communication is to being viewed as a 
``recommendation''). The Regulatory & Compliance Alert article is 
also available at www.nasdr.com/rca_summer00.htm. See also Thomas L. 
Taylor III & Alan S. Petlak, Q&A Online: Chat, Research, Compliance 
Reporter, July 31, 2000, at 11 (stating that a factor to consider 
when determining whether a communication is a ``recommendation'' is 
the degree to which it is individualized and specific).
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Scope of the Term ``Recommendation'': Examples

    In order to provide guidance to members, NASD Regulation offers 
some examples of electronic communications that could be viewed as 
within or outside the definition of ``recommendation.'' These examples 
are intended to show the application of the above-mentioned general 
principles.
    In addition to when a member acts merely as an order-taker 
regarding a particular transaction,\12\ NASD Regulation generally would 
view the following activities and communications as falling outside the 
definition of ``recommendation'':
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    \12\ See supra note 7 and accompanying text.
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    <bullet> A member creates a Web Site that is available to customers 
or groups of customers. The Web Site has research pages or ``electronic 
libraries'' that contain research reports (which may include buy/sell 
recommendations from the author of the report), news, quotes, and 
charts that customers can obtain or request.
    <bullet> A member has a search engine on its Web Site that enables 
customers to sort through the data available about the performance of a 
broad range of stocks and mutual funds, company fundamentals, and 
industry sectors. The data is not limited, for instance, to, and does 
not favor, securities in which the member makes a market or has made a 
``buy'' recommendation. Customers use and direct this tool on their 
own. Search results from this tool may rank securities using any 
criteria selected by the customer, and may display current news, 
quotes, and links to related sites.\13\
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    \13\ Note, however, that hyperlinks conceivably could create 
suitability obligations, depending, for example, on the information 
provided to and from the hyperlinked site, the extent to which a 
member endorses the content of the hyperlinked site, the nature of 
the firm's relationship to the hyperlinked site, and other attendant 
facts and circumstances. It should also be noted that NASD 
Regulation has previously issued guidance regarding the 
responsibility of members for the content of hyperlinked sites. See 
Letter from Thomas Selman, Vice President, NASD Regulation, 
Disclosure and Investor Protection to Craig Tyle, General Counsel, 
Investment Company Institute, Nov. 11, 1997. This letter can be 
assessed through NASD Regulation's Web Site at www.nasdr.com/2910/2210 01.htm. See also Use of Electronic Media, supra note 6, at 65 
Fed. Reg. at 25848-25849, *32-49 (discussing responsibility for 
hyperlinked information). In addition, NASD Regulation has provided 
guidance to firms regarding the use of ``chat rooms'' and ``bulletin 
boards.'' See NtM 96-50, 1996 NASD LEXIS 60 (July 1996).
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    <bullet> A member provides research tools on its Web Site that 
allow customers to screen through a wide universe of securities (e.g., 
all exchange-listed and Nasdaq securities) or an externally recognized 
group of securities (e.g., certain indexes) and to request lists of 
securities that meet broad, objective criteria (e.g., all companies in 
a certain sector with 25 percent annual earnings growth). The member 
does not impose limits on the manner in which the research tool 
searches through a wide universe of securities, nor does it control the 
generation of the list in order to favor certain securities. For 
instance, the member does not limit the universe of securities to those 
in which it makes a market or for which it has made a ``buy'' 
recommendation. Similarly, the algorithms for these tools are not 
programmed to produce lists of securities based on subjective factors 
that the member has created or developed, nor do the algorithms, for 
example, produce lists that favor those securities in which the member 
makes a market or for which the member has made a ``buy'' 
recommendation.
    <bullet> A member allows customers to subscribe to e-mails or other 
electronic communications that alert customers to news affecting the 
securities in the customer's portfolio or on the customer's ``watch 
list.'' Such news might include price changes, notice of pre-scheduled 
events (such as an

[[Page 20700]]

imminent bond maturation), or generalized information. The customer 
selects the scope of the information that the firm will send to him or 
her.
    NASD Regulation generally would view the following communications 
as falling within the definition of ``recommendation'':
    <bullet> A member sends a customer-specific electronic 
communication (e.g., an e-mail or pop-up screen) to a targeted customer 
or targeted group of customers encouraging the particular customer(s) 
to purchase a security.\14\
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    \14\ Note that there are instances where sending a customer an 
electronic communication that highlights a particular security (or 
securities) will not be viewed as a ``recommendation.'' For 
instance, while each case requires an analysis of the particular 
facts and circumstances, a member generally would not be viewed as 
making a ``recommendation'' when, pursuant to a customer's request, 
it sends the customer (1) electronic ``alerts'' (such as accounting 
activity alerts, market alerts, or price, volume, and earnings 
alerts) or (2) research announcements (e.g., a firm's ``stock of the 
week'') that are tailored to the individual customer, as long as 
neither--given their content, context, and manner of presentation--
would lead a customer reasonably to believe that the firm is 
suggesting that the customer take action in response to the 
communication.
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    <bullet> A member sends its customers an e-mail stating that 
customers should be invested in stocks from a particular sector (such 
as technology) and urges customers to purchase one or more stocks from 
a list with ``buy'' recommendations.
    <bullet> A member provides a portfolio analysis tool that allows a 
customer to indicate an investment goal and input personalized 
information such as age, financial condition, and risk tolerance. The 
member in this instance then sends (or displays to) the customer a list 
of specific securities the customer could buy or sell to meet the 
investment goal the customer has indicated.\15\
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    \15\ Note, however, that a portfolio analysis tool that merely 
generates a suggested mix of general classes of financial assets 
(e.g., 60 percent equities, 20 percent bonds, and 20 percent cash 
equivalents), without an accompanying list of securities that the 
customer could purchase to achieve that allocation, would not 
trigger a suitability obligation. On the other hand, a series of 
actions which may not constitute ``recommendations'' when considered 
individually, may amount to a ``recommendation'' when considered in 
the aggregate. For example, a portfolio allocator's suggestion that 
a customer could alter his or her current mix of investments 
followed by provision of a list of securities that could be 
purchased or sold to accomplish the alteration could be a 
``recommendation.'' Again, however, the determination of whether a 
portfolio analysis tool's communication constitutes a 
``recommendation'' will depend on the content, context, and 
presentation of the communication or series of communications.
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    <bullet> A member uses data-mining technology (the electronic 
collection of information on Web Site users) to analyze a customer's 
financial or online activity--whether or not known by the customer--and 
then, based on those observations, sends (or ``pushes'') specific 
investment suggestions that the customer purchase or sell a security. 
Members should keep in mind that these examples are meant only to 
provide guidance and are not an exhaustive list of communications that 
NASD Regulation does or does not consider to be ``recommendations.'' As 
stated earlier, many other types of electronic communications are not 
easily characterized. In addition, changes to the factual predicates 
upon which these examples are based (or the existence of additional 
factors) could alter the determination of whether similar 
communications may or may not be viewed as ``recommendations.'' 
Members, therefore, should analyze all relevant facts and 
circumstances, bearing in mind the general principles noted earlier and 
discussed below, to determine whether a communication is a 
``recommendation,'' and they should take the necessary steps to fulfill 
their suitability obligations. Furthermore, these examples are based on 
technological services that are currently used in the marketplace. They 
are not intended to direct or limit the future development of delivery 
methods or products and services provided online.

Guidelines For Evaluating Suitability Obligations

    NASD Regulation believes that members should consider, at a 
minimum, the following guidelines when evaluating their suitability 
obligations. None of these guidelines is determinative. Each is but one 
factor to be considered in evaluating all of the facts and 
circumstances surrounding the communication.
    <bullet> A member cannot avoid or discharge its suitability 
obligation through a disclaimer where the particular communication 
reasonably would be viewed as a ``recommendation'' given its content, 
context, and presentation.\16\ NASD Regulation, however, encourages 
members to include on their Web Sites (and in other means of 
communication with their customers) clear explanations of the use and 
limitations of tools offered on those sites.
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    \16\ Although, as noted previously, a broker/dealer cannot 
disclaim away its suitability obligation, informing customers that 
generalized information provided is not based on the customer's 
particular financial situation or needs may help clarify that the 
information provided is not meant to be a ``recommendation'' to the 
customer. Whether the communication is in fact a ``recommendation'' 
would still depend on the content, context, and presentation of the 
communication. Accordingly, a member that sends a customer or group 
of customers information about a security might include a statement 
that the member is not providing the information based on the 
customer's particular financial situations or needs. Members may 
properly disclose to customers that the opinions or recommendations 
expressed in research do not take into account individual investors' 
circumstances and are not intended to represent ``recommendations'' 
by the member of particular stocks to particular customers.
    Members, however, should refer to previous guidelines issued by 
the SEC and NASD that may be relevant to those and/or related 
topics. For instance, the SEC has issued guidelines regarding 
whether and under what circumstances third-party information is 
attributable to an issuer, and the SEC noted that the guidance also 
may be relevant regarding the responsibilities of broker/dealers. 
Use of Electronic Media, supra not 6, at 65 Fed. Reg. 25848-25849, 
*32-49 (discussing entanglement and adoption theories). See also 
supra note 13 and discussion therein.
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    <bullet> Members should analyze any communication about a security 
that reasonably could be viewed as a ``call to action'' and that they 
direct or appear to direct to a particular individual or targeted group 
of individuals--as opposed to statements that are generally made 
available to all customers or the public at large--to determine whether 
a ``recommendation'' is being made.\17\
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    \17\ We note that there are circumstances where the act of 
sending communication to a specific group of customers will not 
necessarily implicate the suitability rule. For instance, a broker/
dealer's business decision to provide only certain types of 
investment information (e.g., research reports) to a category of 
``premium'' customers would not, without more, trigger application 
of the suitability rule. Conversely, members may incur suitability 
obligations when they send a communication to a large group of 
customers urging those customers to invest in a security.
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    <bullet> Members should scrutinize any communication to a customer 
that suggests the purchase, sale, or exchange of a security--as opposed 
to simply providing objective data about a security--to determine 
whether a ``recommendation'' is being made.\18\
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    \18\ As with the other general guidelines discussed in this 
Policy Statement, the presence of this factor alone does not 
automatically mean that a ``recommendation'' has been made. For 
example, where a customer affirmatively requests to be alerted (by 
e-mail or pop-up screen) when a security reaches a specific price-
point, when a company issues an earnings release, or when an analyst 
changes his or her recommendation of a particular security, the 
broker/dealer's decision to send the customer the requested 
information, without more, would not necessarily trigger a 
suitability obligation.
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    <bullet> A member's transmission of unrequested information will 
not necessarily constitute a ``recommendation.'' However, when a member 
decides to send a particular customer unrequested information about a 
security that is not of a generalized or administrative nature (e.g., 
notification of a stock split or a dividend), the member should 
carefully review the circumstances under which the information is being 
provided, the manner in which the information is

[[Page 20701]]

delivered to the customer, the content of the communication, and the 
original source of the information. The member should perform this 
review regardless of whether the decision to send the information is 
made by a representative employed by the member or by a computer 
software program used by the member.
    <bullet> Members should be aware that the degree to which the 
communication reasonably would influence an investor to trade a 
particular security or group of securities--either through the context 
or manner of presentation or the language used in the communication--
may be considered in determining whether a ``recommendation'' is being 
made to the customer.
    NASD Regulation emphasizes that the factors listed above are 
guidelines that may assist members in complying with the suitability 
rule. Again, the presence or absence of any of these factors does not 
by itself control whether a ``recommendation'' has been made or whether 
the member has complied with the suitability rule. Such determinations 
can be made only on a case-by-case basis taking into account all of the 
relevant facts and circumstances.

Conclusion

    The foregoing discussion highlights some suggested guidelines to 
assist in determining when electronic communications constitute 
``recommendations,'' thereby triggering application of the NASD's 
suitability rule. NASD Regulation acknowledges the numerous benefits 
that are enjoyed by members and their customers as a result of the 
Internet and online brokerage services. NASD Regulation emphasizes that 
it neither takes a position on nor seeks to influence any firm's or 
customer's choice of a particular business model in this electronic 
environment. At the same time, however, NASD Regulation urges members 
both to consider all compliance implications when implementing new 
services and to remember that customers' best interests must continue 
to be of paramount importance in any setting, traditional or online.
    As new technologies and/or services evolve, NASD Regulation will 
continue to provide statements or guidance regarding the application of 
the suitability rule and other rules.\19\ To date, NASD Regulation has 
worked to resolve various suitability-related issues with federal and 
state regulators, NASD Regulation's e-Brokerage Committee, the NASD's 
Legal Advisory Board and Small Firm Advisory Board, NASD Regulation's 
Standing and District Committees, and the NASD membership. This open 
dialogue has been beneficial, and NASD Regulation will continue to work 
with regulators, members of the industry and the public on these and 
other important issues that arise in the online brokerage environment.
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    \19\ In this regard, NASD Regulation is considering further 
discussion of the application of the suitability rule to electronic 
communications involving initial public offerings in future 
guidance.
---------------------------------------------------------------------------

* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, NASD Regulation included 
statements concerning the purpose of, and basis for, the proposed rule 
change. NASD Regulation neither solicited nor received written comments 
on the proposed rule change. The text of these statements may be 
examined at the places specified in Item IV below. NASD Regulation has 
prepared summaries, set forth in Sections (A), (B), and (C) below, of 
the most significant aspects of such statements.

(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    Member firms are increasingly offering online brokerage services to 
their retail customers. The Internet gives retail customers the tools 
to manage their own accounts and conduct their own trading activity and 
the ability to obtain access to an unprecedented amount of information. 
Online trading offers many benefits to member firms and retail 
customers, but member firms must continue to fulfill their suitability 
obligations in the online environment whenever they ``recommend'' to a 
customer the purchase, sale, or exchange of a security.
    The Notice to Members states that the suitability rule (NASD Rule 
2310) remains fully applicable to online activities in those cases 
where a member ``recommends'' securities transactions to its customers. 
The Notice to Members does not alter member obligations under the 
suitability rule,\5\ nor does it establish a ``bright line'' test for 
determining whether a particular communication constitutes a 
``recommendation'' for purposes of the suitability rule. NASD 
Regulation instead provides guidance to members through the use of 
examples of communications that NASD Regulation believes fall within 
and outside the definition of ``recommendation.'' The Notice to Members 
also articulates several broad principles that member firms can use in 
evaluating whether a particular online communication could fall within 
the definition of ``recommendation'' for purposes of the suitability 
rule.
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    \5\ A change to conform the description of the Notice to Members 
with the text of the Notice to Members was made pursuant to a 
telephone conversation between Nancy C. Libin, Assistant General 
Counsel, Office of the General Counsel, NASD Regulation, Inc., and 
Marc McKayle, Special Counsel, Division of Market Regulation, 
Commission, on March 20, 2001.
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2. Statutory Basis
    NASD Regulation believes that the Notice to Members is consistent 
with the provisions of Section 15A(b)(6) of the Act,\6\ which requires, 
among other things, that the Association's rules must be designed to 
prevent fraudulent and manipulative acts and practices, to promote just 
and equitable principles of trade, and, in general, to protect 
investors and the public interest. NASD Regulation believes that member 
firms that make ``recommendations'' to customers in the online 
environment have an obligation to determine whether the 
``recommendations'' are suitable for such customers. NASD Regulation 
believes that this Notice to Members is necessary to protect investors 
and the public interest with respect to online trading.
---------------------------------------------------------------------------

    \6\ 15 U.S.C. 78o-3(b)(6)
---------------------------------------------------------------------------

(B) Self-Regulatory Organization's Statement on Burden on Competition

    NASD Regulation does not believe that the Notice to Members will 
result in any burden on competition that is not necessary or 
appropriate in furtherance of the purposes of the Act, as amended.

(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received from Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    The foregoing proposed rule change constitutes a stated policy, 
practice, or interpretation with respect to the meaning, 
administration, or enforcement of an existing rule and, therefore, has 
become effective pursuant to pursuant to Section 19(b)(3)(A) of the Act 
\7\ and paragraph (f)(1) of Rule 19b-

[[Page 20702]]

4 thereunder.\8\ At any time within 60 days of the filing of this 
proposed rule change, the Commission may summarily abrogate this 
proposal if it appears to the Commission that such action is necessary 
or appropriate in the public interest, for the protection of investors, 
or otherwise in furtherance of the purposes of the Act.
---------------------------------------------------------------------------

    \7\ 15 U.S.C. 78s(b)(3)(A).
    \8\ 17 CFR 240.19b-4(f)(1).
---------------------------------------------------------------------------

IV. Solicitation of Comments

    The Commission notes that although NASD Notice to Members 01-23 
does not expressly discuss electronic communications that recommend 
investment strategies, the NASD suitability rule continues to apply to 
the recommendation of investment strategies, whether that 
recommendation is made via electronic communication or otherwise.\9\
---------------------------------------------------------------------------

    \9\ See F.J. Kaufman, 50 S.E.C. 164, Securities Exchange Act 
Release No. 27535 (December 13, 1989) (Recommendation of margined 
buy-write strategy found unsuitable for certain customers).
---------------------------------------------------------------------------

    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, DC 20549-0609. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the Notice to Members that are filed with 
the Commission, and all written communications relating to the Notice 
to Members 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 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-2001-20 and 
should be submitted by May 15, 2001.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\10\
---------------------------------------------------------------------------

    \10\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-10109 Filed 4-23-01; 8:45 am]
BILLING CODE 8010-01-P


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