[Federal Register Volume 66, Number 86 (Thursday, May 3, 2001)]
[Notices]
[Pages 22274-22280]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-11049]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-44223; File No. SR-NASD-00-55]


Self-Regulatory Organizations; Order Approving and Notice of 
Filing and Order Granting Accelerated Approval to Amendment Nos. 2 and 
3 to the Proposed Rule Change by the National Association of Securities 
Dealers, Inc. Relating to the Delivery Requirement of a Margin 
Disclosure Statement to Non-Institutional Customers

April 26, 2001.

I. Introduction

    On September 5, 2000, the National Association of Securities 
Dealers, Inc. (``NASD'' or ``Association''), through its wholly owned 
subsidiary, NASD Regulation, Inc. (``NASD Regulation''), filed with the 
Securities and Exchange Commission (``SEC'' or ``Commission''), 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to 
require NASD member firms to deliver a margin disclosure statement to 
their non-institutional customers with margin accounts. On September 
26, 2000, NASD Regulation submitted Amendment No. 1 to the proposed 
rule change.\3\ The proposed rule change and Amendment No. 1 were 
published for comment in the Federal Register on October 23, 2000.\4\ 
The Commission received eight comment letters with respect to the 
proposed rule change and Amendment No. 1.\5\ On March 28, 2001,

[[Page 22275]]

NASD Regulation filed Amendment No. 2 to the proposed rule change 
responding to the comments.\6\ On April 11, 2001, NASD Regulation filed 
a technical Amendment No. 3 to the proposed rule change.\7\ In this 
notice and order, the Commission is approving the proposed rule change 
and Amendment No. 1, and approving Amendment Nos. 2 and 3 on an 
accelerated basis. The Commission is also seeking comment from 
interested persons on Amendment Nos. 2 and 3.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 clarified that if the equity in a customer's 
margin account falls below applicable requirements, an NASD member 
firm can force the sale of any of the securities in any of the 
customer's accounts held at the firm and such liquidations are not 
limited to the customer's margin account. Additionally, NASD 
Regulation deleted the phrase ``under the law'' from its original 
filing to clarify that maintenance margin requirements are 
requirements of self-regulatory organizations. See Letter from Alden 
S. Adkins, General Counsel and Senior Vice President, NASD 
Regulation, to Katherine A. England, Assistant Director, Division of 
Market Regulation (``Division''), Commission, dated September 25, 
2000.
    \4\ See Securities Exchange Act Release No. 43441 (October 12, 
2000), 65 FR 63275 (``Notice'').
    \5\ See letter from Bill Singer, Attorney, Singer Frumento LLP, 
to Jonathan G. Katz, Secretary, Commission, dated October 26, 2000 
(``Singer Letter''); letter from J. Scott Colesanti, Senior 
Compliance Attorney, Edward D. Jones & Co., Inc. to Jonathan G. 
Katz, Secretary, Commission, dated November 10, 2000 (``Edward Jones 
Letter''); letter from Professor Barbara Black and Adjunct Professor 
Jill Gross, Co-Directors, Securities Arbitration Clinic, John Jay 
Legal Services, Inc., Pace University School of Law, to Jonathan G. 
Katz, Secretary, dated November 8, 2000 (``John Jay Letter''); 
letter from Christopher R. Franke, Chairman, Self-Regulation and 
Supervisory Practices Committee, Securities Industry Association 
(``SIA''), to Margaret H. McFarland, Deputy Secretary, dated 
November 13, 2000 (``SIA Self-Regulation Committee Letter''); letter 
from W. Hardy Callcott, Senior Vice President and General Counsel, 
Charles Schwab & Co., Inc., to Jonathan G. Katz, Secretary, dated 
November 14, 2000 (``Charles Schwab Letter''); letter from Albert 
Tylka, Vice President, A.G. Edwards & Sons, Inc., to Margaret H. 
McFarland, Deputy Secretary, dated November 17, 2000 (``A.G. Edwards 
Letter''); letter from George Ruth, Chairman of the Rules and 
Regulations Committee, Credit Division, SIA, to Jonathan G. Katz, 
Secretary, dated November 21, 2000 (``SIA Credit Division Letter''); 
and letter from Jeffrey S. Alexander, Vice President and Senior 
Counsel, Office of the General Counsel, Merrill Lynch, to Jonathan 
G. Katz, Secretary, dated November 22, 2000 (``Merrill Lynch 
Letter'').
    \6\ In Amendment No. 2, NASD Regulation responded to the comment 
letters submitted on the proposed rule change and Amendment No. 1, 
and incorporated several recommendations from the comment letters 
into the proposed rule text. The comments concerned the following: 
the need for flexibility with respect to the type of disclosure 
statement that NASD member firms would be required to provide to 
their customers; the burden and costs of sending a separate 
document; the expense and need for the requirement that the 
disclosure statement be delivered annually; the need for 
clarification of the delivery requirement and method; and the need 
for disclosure of the fact that any of the customers' assets, in 
addition to securities, carried by a broker-dealer firm on behalf of 
such customers may be liquidated to satisfy a margin call. See 
Letter from Jeffrey S. Holik, Vice President and Acting General 
Counsel, NASD Regulation, to Jack Drogin, Assistant Director, 
Division, Commission, dated March 27, 2001 (``Amendment No. 2'').
    \7\ In Amendment No. 3, NASD Regulation provided a technical 
amendment to the proposed rule language clarifying that the annual 
margin disclosure statement may be delivered within or as part of 
other account documentation, and is not required to be provided in a 
separate document. See Letter from Jeffrey S. Holik, Vice President 
and Acting General Counsel, NASD Regulation, to Jack Drogin, 
Assistant Director, Division, Commission, dated April 10, 2001 
(``Amendment No. 3'').
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II. Description of the Proposal

    As described in the proposed rule change and Amendment No. 1, the 
NASD, through NASD Regulation, proposes to add a new NASD Rule 2341 to 
require NASD member firms to deliver to their non-institutional 
customers,\8\ prior to or at the opening of a margin account, a 
specified disclosure statement discussing the operation of margin 
accounts and the risks associated with trading on margin.\9\ NASD 
Regulation also proposes to require NASD member firms to deliver a 
disclosure statement to their non-institutional customers with margin 
accounts on an annual basis.\10\ NASD Regulation proposes the following 
proposed rule text amendments in response to the comment letters 
submitted to the Commission regarding the proposed rule change and 
Amendment No. 1. The amended rule is as follows:
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    \8\ The term ``non-institutional customer'' would mean a 
customer that does not qualify as an ``institutional account'' under 
NASD Rule 3110(c)(4). NASD Rule 3110(c)(4) defines ``institutional 
account'' to mean the account of: (1) A bank, savings and loan 
association, insurance company, or registered investment company; 
(2) an investment adviser registered either with the Commission 
under Section 203 of the Investment Advisers Act of 1940 or with a 
state securities commission (or agency or office performing similar 
functions); or (3) any other entity (whether a natural person, 
corporation, partnership, trust, or otherwise) with total assets of 
at least $50 million.
    \9\ NASD's 2300 series of rules covers Transactions with 
Customers.
    \10\ This annual disclosure statement may be the mandated margin 
disclosure statement as specified in proposed NASD Rule 2341(a), the 
abbreviated disclosure specified in proposed NASD Rule 2341(b), or 
an alternate disclosure that is ``substantially similar'' to the two 
other disclosure statements. In addition, the annual disclosure 
statement may be delivered within or as part of other account 
documentation, and is not required to be provided in a separate 
document. See Amendment No. 2, supra note 6 and Amendment No. 3, 
supra note 7.
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    Proposed new language is italicized. Proposed deletions are in 
[brackets].
* * * * *

Rule 2341. Margin Disclosure Statement

    (a) No member shall open a margin account, as specified in 
Regulation T of the Board of Governors of the Federal Reserve System, 
for or on behalf of a non-institutional customer, unless, prior to or 
at the time of opening the account, the member has furnished to the 
customer, individually, in writing or electronically, and in a separate 
document, the following margin disclosure statement:
    Your brokerage firm is furnishing this document to you to provide 
some basic facts about purchasing securities on margin, and to alert 
you to the risks involved with trading securities in a margin account. 
Before trading stocks in a margin account, you should carefully review 
the margin agreement provided by your firm. Consult your firm regarding 
any questions or concerns you may have with your margin accounts.
    When you purchase securities, you may pay for the securities in 
full or you may borrow part of the purchase price from your brokerage 
firm. If you choose to borrow funds from your firm, you will open a 
margin account with the firm. The securities purchased are the firm's 
collateral for the loan to you. If the securities in your account 
decline in value, so does the value of the collateral supporting your 
loan, and, as a result, the firm can take action, such as issue a 
margin call and/or sell securities or other assets in any of your 
accounts held with the member, in order to maintain the required equity 
in the account.
    It is important that you fully understand the risks involved in 
trading securities on margin. These risks include the following:
    <bullet> You can lose more funds than you deposit in the margin 
account. A decline in the value of securities that are purchased on 
margin may require you to provide additional funds to the firm that has 
made the loan to avoid the forced sale of those securities or other 
securities or assets in your account(s).
    <bullet> The firm can force the sale of securities or other assets 
in your account(s). If the equity in your account falls below the 
maintenance margin requirements or the firm's higher ``house'' 
requirements, the firm can sell the securities or other assets in any 
of your accounts held at the firm to cover the margin deficiency. You 
also will be responsible for any short fall in the account after such a 
sale.
    <bullet> The firm can sell your securities or other assets without 
contacting you. Some investors mistakenly believe that a firm must 
contact them for a margin call to be valid, and that the firm cannot 
liquidate securities or other assets in their accounts to meet the call 
unless the firm has contact them first. This is not the case. Most 
firms will attempt to notify their customers of margin calls, but they 
are not required to do so. However, even if a firm has contacted a 
customer and provided a specific date by which the customer can meet a 
margin call, the firm can still take necessary steps to protect its 
financial interests, including immediately selling the securities 
without the notice to the customer.
    <bullet> You are not entitled to choose which securities or other 
assets in your account(s) are liquidated or sold to meet a margin call. 
Because the securities are collateral for the margin loan, the firm has 
the right to decide which security to sell in order to protect its 
interests.
    <bullet> The firm can increase its ``house'' maintenance margin 
requirements at any time and is not required to provide you advance 
written notice. These changes in firm policy often take effect 
immediately and may result in the issuance of a maintenance margin 
call. Your failure to satisfy the call may cause

[[Page 22276]]

the member to liquidate or sell securities in your account(s).
    <bullet> You are not entitled to an extension of time on a margin 
call. While an extension of time to meet margin requirements may be 
available to customers under certain conditions, a customer does not 
have a right to the extension.
    (b) Members shall, with a frequency of not less than once a 
calendar year, deliver individually, in writing or electronically, the 
disclosure statement described in paragraph (a) or the following bolded 
disclosures to all non-institutional customers with margin accounts:
    Securities purchased on margin are the firm's collateral for the 
loan to you. If the securities in your account decline in value, so 
does the value of the collateral supporting your loan, and, as a 
result, the firm can take action, such as issue a margin call and/or 
sell securities or other assets in any of your accounts held with the 
member, in order to maintain the required equity in the account. It is 
important that you fully understand the risks involved in trading 
securities on margin. These risks include the following:
    <bullet> You can lose more funds than you deposit in the margin 
account.
    <bullet> The firm can force the sale of securities or other assets 
in your account(s).
    <bullet> The firm can sell your securities or other assets without 
contacting you.
    <bullet> You are not entitled to choose which securities or other 
assets in your account(s) are liquidated or sold to meet a margin call.
    <bullet> The firm can increase its ``house'' maintenance margin 
requirements at any time and is not required to provide you advance 
written notice.
    <bullet> You are not entitled to an extension of time on a margin 
call.
    The annual disclosure statement required pursuant to this paragraph 
(b) may be delivered within or as part of other account documentation, 
and is not required to be provided in a separate document.
    (c) In lieu of providing the [margin] disclosures [statement] 
specified in paragraphs (a) and (b), a member may provide to the 
customer an alternative disclosure statement, provided that the 
alternative disclosures [statement] shall be substantially similar to 
the disclosures [statement] specified in paragraphs (a) and (b).
    (d) For purposes of this Rule, the term ``non-institutional 
customer'' means a customer that does not qualify as an ``institutional 
account'' under Rule 3110(c)(4).
* * * * *

A. Background

    The recent growth in the level of customer margin account balances, 
coupled with the increase in customer inquiries and complaints to NASD 
Regulation and SEC staffs relating to the handling of margin accounts, 
has raised concerns as to whether investors understand the operation 
and risks associated with margin trading. NASD Regulation believes that 
investors' misconceptions about margin requirements, particularly with 
respect to maintenance margin, may cause them to underestimate the 
risks of margin trading and misunderstand the operation of and reasons 
for margin calls.
    In this regard, a May 2000 General Accounting Office (``GAO'') 
report (``GAO Report'') noted that the SEC determined from the customer 
complaints it received that many investors who traded on-line did not 
understand margin requirements.\11\ The GAO Report indicated that the 
lack of disclosures relating to when firms would sell securities in a 
margin account to cover margin loans was among the leading margin-
related complaints that the SEC received.
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    \11\ See On-Line Trading, Better Investor Protection Information 
Needed, Report to Congressional Requesters, GAO, GGD-00-43 (May 
2000). Between January 1998 and June 1999, 140 margin-related 
complaints concerning on-line trading firms were submitted to the 
SEC.
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    In addition, the GAO Report collected and summarized information 
from 12 on-line broker-dealers.\12\ All of the on-line firms contacted 
did provide their customers with the limited information required by 
Rule 10b-16 under the Act.\13\ Some firms also provided additional 
information relating to margin, such as requirements for account 
opening, procedures for selling securities to cover account losses, or 
special requirements for volatile stocks. Nearly half of the firms 
contacted, however, automatically opened margin accounts for new 
customers without providing the customer with information relating to 
the risks associated with margin trading. At three of the firms that 
automatically \14\ opened margin accounts, customers would find out 
about their account type only if they read and understood their account 
agreements. Three of the 12 on-line broker-dealers contacted did take 
``extra measures'' to assure that their customers understood that 
stocks could be sold to cover outstanding loans in a margin account. 
These firms included information on their web sites that explained that 
accounts could be liquidated in fast-moving markets before the 
customary period.
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    \12\ While these firms represented less than 10 percent of the 
total estimated number of firms that offer on-line trading, they 
accounted for about 90 percent of the on-line trading volume during 
early 1999.
    \13\ Rule 10b-16 under the Act requires broker-dealers that 
extend credit to customers to finance securities transactions to 
furnish, in writing, specified information regarding the terms of 
the loan. These disclosures must be made on both an initial and 
periodic basis. For example, at the time a customer opens a margin 
account, the broker-dealer must provide the customer with a written 
statement disclosing, among other things, the annual rate of 
interest, the method of computing interest, and what other credit 
charges may be imposed. 17 CFR 240.10b-16.
    \14\ Those firms that provide clear indications of the type of 
account to be opened offered their customers the option on the web 
site to choose either a cash or margin account, or both. However, 
those firms that automatically opened margin accounts only offered 
new customers a choice with respect to account ownership, such as a 
joint or individual account.
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    The GAO Report concluded that better investor protection 
information, including information relating to margin requirements, was 
needed on web sites of some on-line broker-dealers. In this regard, the 
GAO Report recommended that the SEC ensure that broker-dealers with on-
line trading systems include accurate and complete information on their 
web sites regarding, among other things, margin requirements.

B. Specific Areas of Concern

    Based on customer complaints and the inquiries it has received, 
NASD Regulation identified several areas associated with margin trading 
that may have generated confusion and misunderstanding between 
customers and NASD member firms. According to NASD Regulation, these 
areas include:
    Margin Calls--Notification. Some investors hold the mistaken belief 
that their broker-dealer must contact them for a margin call to be 
valid, and that their broker-dealer cannot liquidate securities or 
other assets in their accounts to meet the call unless a specified 
number of days have passed and/or the broker-dealer has contacted the 
customer. There are no such restrictions in Regulation T \15\ 
promulgated by the Board of Governors of the Federal Reserve System or 
NASD Rule 2520.\16\ Moreover, securities that have been purchased on 
margin by a customer and securities and other assets held in any other 
accounts with the firm by a customer are collateral for the margin loan 
and are, therefore, subject to the security claim of the broker-dealer 
until the customer fully pays for the securities. Thus, if a broker-
dealer believes that the collateral for the margin loan is at risk, the 
broker-dealer

[[Page 22277]]

is entitled to take any steps necessary to protect its financial 
interests, including immediate liquidation without notice to the 
customer. Some broker-dealers will attempt to notify their customers of 
margin calls, but they are not required to do so. Even if a broker-
dealer has contacted a customer and provided a specific date by which 
the customer can meet a margin call; however, the broker-dealer can 
still take necessary steps to protect its financial interests, 
including immediate liquidation, without further notice to the 
customer.
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    \15\ 12 CFR 220 et seq.
    \16\ NASD Rule 2520 governs margin requirements.
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    Extension of time on margin calls. Some investors believe they are 
automatically entitled to an extension of time to meet margin calls. 
While an extension of time to meet initial margin requirements may be 
available to the customer under certain conditions, it is only granted 
if the clearing firm chooses to request an extension from its 
Designated Examining Authory--the customer does not have a right to an 
automatic extension.
    In addition, some investors believe that when a maintenance margin 
call has been issued they are entitled to one or more extensions of 
time to meet the call, however, there is no mechanism for extending 
maintenance margin calls. If the customer fails to meet a maintenance 
margin call, the broker-dealer can, under certain circumstances, take a 
charge to its net capital in lieu of collecting the call, but the 
broker-dealer is not required to do so, and the customer has no right 
to demand it.
    Right to dictate which security or other asset is liquidated. Some 
investors believe that they have the right to control which securities 
or other assets are liquidated to meet a maintenance margin call if 
there is more than one security or asset in the NASD customer's 
accounts.\17\ There is no provision in the margin rules that gives the 
customers the right to control liquidation decisions. As discussed 
above, because the securities and other assets in any of the 
customers's accounts are collateral for the margin loan, the broker-
dealer has the right to control the disposition of the collateral in 
order to protect its interests. In this regard, the broker-dealer may 
choose which securities or other assets in the margin account, or any 
other account held by the NASD member firm on behalf of the customer, 
to liquidate, and this selection need not relate to factors associated 
with the individual customer.\18\ For example, the broker-dealer may 
choose a particular security or asset in customer's account to 
liquidate based on a high concentration of the security held by 
customers firm-wide.
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    \17\ See Amendment No. 1, supra note 3.
    \18\ Id.
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    NASD members raising their maintenance margin requirements. Some 
NASD member firms have increased their ``house'' maintenance margin 
requirements (i.e., requirements above those required by law) as a 
result of concerns about the volatility and extreme price run-ups on 
certain stocks, the risks to their customers, and the NASD members's 
own potential exposure to losses from margin defaults. These changes in 
policy often take effect immediately and may result in the issuance of 
maintenance margin call. A customer's failure to satisfy the call will 
usually cause the NASD member firm to liquidate a portion of the 
customers's account.
    Some investors believe that an NASD member firm must provide thirty 
days written notice before implementing this type of change. While Rule 
10b-16 under the Act requires members to disclose to customers the 
credit terms (interest rates and methods of calculating interest) for 
margin transactions and requires advance written notice of such 
changes, it does not require advance notice of the amount of margin 
required.

C. Description of Proposal

1. Delivery Requirement
    NASD Regulation believes that, although some NASD member firms are 
providing additional disclosures to customers relating to margin to 
address customers confusion, the content of these disclosures is not 
consistent from firm-to-firm and may not always be in a form that 
investors find clear and easy to understand.
    Accordingly, the NASD is proposing to require all NASD member firms 
to deliver to each non-institutional customer individually, in hard 
copy or by electronic means, prior to or at the opening of a margin 
account, a disclosure statement that includes all of the information as 
specified in proposed NASD Rule 2341(a), or a substantially identical 
disclosure statement.\19\ NASD member firms would also be required to 
deliver to each non-institutional customer individually, in hard copy 
or by electronic means, a disclosure statement on an annual basis.\20\
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    \19\ NASD member firms would be permitted to develop an 
alternative margin disclosure statement, provided that the 
alternative disclosure statement is substantially similar to the 
mandated disclosure statement and incorporates all of the relevant 
concepts. NASD Regulation represents that it will determine whether 
an alternative disclosure statement contains substantially identical 
information as required by the proposed NASD Rule 2341 during 
routine examinations of NASD member firms.
    \20\ See supra note 10.
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    The proposal, as amended, would require that disclosure at or prior 
to the opening to the margin account be made in a separate 
document.\21\ NASD Regulation represents that the initial disclosure 
statement may be on a separate page of, or as a separate attachment to, 
the margin agreement or other opening account documentation. NASD 
member firms, however, would be permitted to provide the annual 
disclosure within other documentation, such as the customer account 
statement.\22\
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    \21\ An NASD member firm would not satisfy the proposal's 
delivery requirement by posting the disclosure statement on its web 
site.
    \22\ See Amendment No. 3, supra note 7.
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    Furthermore, NASD member firms would be required to provide the 
disclosure statement to existing margin customers a the time the NASD 
member firm is required to send the next annual statement to the 
customer (following the effective date of the proposed rule change, as 
amended), but not to exceed 180 days following the effective date of 
the proposed rule change, as amended.
2. Content of Margin Disclosure Statement
    The margin disclosure statement, as specified in proposed NASD Rule 
2341(a), the abbreviated disclosure specified in proposed NASD Rule 
2341(b), or an alternate disclosure that is ``substantially similar'' 
to the two versions provided by the proposal, as amended, should: (1) 
Describe the operation of a margin account; (2) emphasize that 
customers should carefully review their margin agreements; and (3) 
clarity some of the risks associated with margin trading, including 
among others, that the customer can lose more funds that initially 
deposited, the firm can force the sale of the securities or other 
assets in any of the customers's accounts held by the firm without 
notice the customer, the firm can dictate which securities or other 
assets in any of the customers's accounts may be selected for 
liquidation to meet a margin call, the firm may increase its ``house'' 
maintenance margin requirements at any time and is not required to 
provide the customer with advance written notice, and the customer is 
not entitled to an extension of time on a margin call.
3. Effective Date of the Proposed Rule
    NASD Regulation intends to announce the effective date of the 
proposed rule change, as amended, in a Notice to Members to be 
published no

[[Page 22278]]

later than 60 days following Commission approval of the proposed rule 
change. The effective date would be 30 days following publication of 
the Notice to Members announcing Commission approval of the proposed 
rule change.

III. Summary of Comments

    The Commission received eight comment letters in response to the 
proposal and Amendment No. 1.\23\ While most commenters generally 
favored the concept of providing customers of NASD members firms with a 
disclosure of margin trading risks, they also suggested various 
modifications to the proposal. The comments submitted to the Commission 
are summarized by issue below.
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    \23\ See supra note 5.
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A. Margin Disclosure Statement

    Several commenters stated that the proposal needed to be more 
flexible and that a ``one-size-fits-all'' disclosure statement on 
margin trading is not appropriate for all firms.\24\ Commenters 
indicated that firms should be permitted to develop a method of 
disclosure that is best suited to their individual business, so long as 
they provide the specific disclosure information required by the 
proposal. NASD Regulation responded to these concerns through the new 
proposed rule language in paragraph (c) of proposed NASD Rule 2341 
providing that, in lieu of using the margin disclosure statement 
specified in the proposal, an NASD members firm may use an alternative 
disclosure statement, provided that the alternative disclosure 
statement is substantially similar to the mandated disclosure statement 
specified in the proposal.
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    \24\ See Singer Letter, SIA Self-Regulation Committee Letter, 
Merrill Lynch Letter and SIA Credit Division Letter, supra note 5.
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    One commenter indicated that the proposal should be directed only 
at customers who trade on-line, and not those being assisted by a 
registered representative.\25\ The commenter stated that the proposal 
should address more directly the concerns of the GAO Report \26\ that 
determined that on-line traders do not understand margin requirements. 
The commenter suggested that the disclosure statements would best serve 
on-line customers who do not have accounts with full-services firms 
that can provide appropriate education on margin trading. NASD 
Regulation responded that, although customer accounts of on-line 
brokerage firms were the focus of the GAO Report, margin-related 
complaints received by NASD Regulation and the Commission have 
originated from customers of both on-line and full-service firms. 
Accordingly, NASD regulation believes that the misconceptions about the 
operation of a margin account and margin requirements are not limited 
to those investors who trade on-line, and that all investors would 
benefit significantly from the information provided in the proposed 
margin disclosure statement.
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    \25\ See Merrill Lynch Letter, supra note 5.
    \26\ See GAO Report, supra note 11.
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B. Separate Document

    Several commenters opposed the requirement that the margin 
disclosure be made in a separate disclosure document, stating that such 
a requirement is unnecessary, duplicative, and economically 
burdensome.\27\ These commenters also indicated that presenting the 
disclosure statement in a separate document could confuse customers by 
giving them the impression that it is more important than other 
disclosure requirements not presented in the same format, or by leading 
customers to believe it amends or voids their original agreements. In 
this regard, certain commenters indicated that such mistaken beliefs by 
customers could lead to costly legal challenges for NASD member firms.
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    \27\ See SIA Self-Regulation Committee Letter, Merrill Lynch 
Letter, and A.G. Edwards Letter, supra note 5.
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    In response, NASD Regulation indicated that it believes that the 
initial delivery of the margin disclosure statement should be in a 
separate document. NASD Regulation was concerned that the proposed 
disclosure may be hidden within other documentation and possibly 
overlooked by customers. With respect to the comment that a separate 
document may confuse customers, NASD Regulations responded that NASD 
member firms would be permitted to provide additional statements 
necessary to clarify the purpose of the disclosure document, including 
that the disclosures do not change or supersede the margin agreement in 
any way. With respect to the annual delivery requirement, NASD 
Regulation stated that the annual disclosure statement may be delivered 
within or as part of other account documentation.
    One commenter, while supporting the proposed margin disclosure 
requirement, also indicated that customers should be educated about 
margin trading by their NASD members firms, and firm employees should 
be readily available to customers via dedicated telephone numbers and 
e-mail addresses posted on the firm's Internet sites.\28\ This 
commenter suggests that when communication fails, customers should 
document attempts to contact firms, and firms should be held liable for 
margin-related damages. As a general matter, NASD Regulation responded 
by agreeing that NASD member firms should be prepared to answer 
customer questions relating to margin, and that the proposed margin 
disclosure statement is not intended to replace NASD member firms' 
responsibilities to respond to customer inquiries.
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    \28\ See Singer Letter, supra note 5.
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C. Annual Delivery

    Several commenters opposed the proposed requirement that the 
disclosure statement be delivered annually. The commenters indicated 
that it would present an undue burden and expense for firms and would 
be excessive, redundant, and counter-productive in light of the amount 
of documentation and disclosure statements already sent to 
customers.\29\ One commenter stated that this firm already receives 
numerous complaints from its customers about the amount of paperwork 
being mailed to them.\30\ Another commenter was concerned that repeated 
statements about the risks of margin trading would undermine legitimate 
products associated with central asset accounts.\31\
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    \29\ See Charles Schwab Letter, SIA Credit Division Letter, and 
A.G. Edwards Letter, supra note 5.
    \30\ See Merrill Lynch Letter, supra note 5.
    \31\ See SIA Credit Division Letter, supra note 5.
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    NASD Regulation continues to believe that providing customers with 
information about the operation of margin accounts at account opening 
and annually thereafter will be of significant value to customers in 
understanding the operation of a margin account. Given that the full 
margin disclosure statement would be provided to customers at account 
opening, however, NASD Regulations believes that providing an 
abbreviated version of the disclosures would be appropriate for the 
annual disclosure requirement, thereby addressing some of the 
commenters' concerns. Accordingly, NASD Regulation amended the proposed 
rule language to permit members, at their option, to provide an 
abbreviated version of the disclosures to comply with the annual 
disclosure requirement provided that, at a minimum, such version 
contains all of the ``bulleted information'' as specified in proposed 
NASD Rule 2341(b).
    In addition, NASD Regulation amended the proposed rule language to 
clarify that the annual disclosure

[[Page 22279]]

statement required pursuant to proposed NASD Rule 2341(b) may be 
delivered within or as part of other account documentation, and is not 
required to be provided in a separate document.\32\
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    \32\ See Amendment No. 3, supra note 7.
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D. Timing of Account Opening Delivery Requirement

    One commenter indicated that the proposal needed to clarify better 
when the initial disclosure statement should be delivered.\33\ 
According to the commenter, the proposal directs that the initial 
disclosure statement be delivered when the margin account is opened; 
however, the proposal does not indicate what constitutes the opening of 
the account. The commenter questioned whether an account would be 
considered opened when the customer loan agreement is signed or when a 
loan is extended to the customer by the firm on margin. Another 
commenter requested clarification on whether ``Personal Line of 
Credit'' accounts would invoke the proposed margin disclosure 
requirements.\34\ In order to address these comments, NASD Regulation 
clarified that, under the proposal, the margin disclosure statement is 
required to be sent at the time a margin account is opened, 
irrespective of whether a margin loan is extended. Also, if a 
``Personal Line of Credit'' account is treated by the NASD member firm 
as an extension of credit via a margin account, NASD Regulation 
believes that the proposed disclosure requirement would apply.
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    \33\ See Edward Jones Letter, supra note 5.
    \34\ Id.
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E. Other Comments

    One commenter indicated that the proposed delivery of the 
disclosure statement, ``in writing or electronically,'' is confusing 
and suggests that the proposed rule confuses format with delivery.\35\ 
To clarify, NASD Regulation indicated that the proposed disclosure 
statement may be sent ``in writing,'' meaning that it may be delivered 
to the customer in a hard copy, paper format. The proposed disclosure 
statement also may be delivered ``electronically,'' meaning that it may 
be delivered to the customer via an electronic delivery system 
(Internet, e-mail, etc.), provided that it is sent individually to the 
customer by such means.
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    \35\ See Merrill Lynch Letter, supra note 5.
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    Another commenter indicated that the proposed margin disclosure 
statements should be clarified to state that any asset held by the 
customer, not just securities, can be liquidated.\36\ The commenter 
believed that this clarification would be an important piece of 
information for the customer to understand. In addition, the commenter 
indicated that certain crucial language on the statement should be in 
boldface for better emphasis, and that disclosures using industry 
jargon, such as ``equity,'' ``house requirements'' and ``maintenance 
margin,'' should be avoided. NASD Regulation agreed that a 
clarification that any assets held by the firm on behalf of the 
customer, not just securities, can be liquidated, is appropriate to 
include in the proposed disclosure statement. Accordingly, NASD 
Regulation amended the proposed rule language to indicate that an NASD 
member firm can liquidate securities or other assets held in the 
customer's accounts. With respect to the comment regarding the use of 
industry jargon, NASD Regulation does not believe that the use of those 
terms in confusing within the context of the overall statement and 
indicated that it had endeavored to use a minimal amount of industry 
jargon in the proposed margin disclosure statement.
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    \36\ See John Jay Letter, supra note 5.
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    Finally, one commenter stated that each customer should be required 
to sign the disclosure statement to acknowledge receipt and 
understanding of it.\37\ NASD Regulation believes that such a 
requirement would be overly burdensome for members to comply with, and 
would not significantly increase the informational value to the 
customer of the margin disclosure statement.
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    \37\ Id.
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F. Amendment to the Proposed Rule Language

    NASD Regulation amended proposed NASD Rule 2341(a), in Amendment 
No. 2, to clarify that the initial margin disclosure document must be 
delivered in a separate document.\38\
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    \38\ The proposed rule language is amended to clarify this 
requirement as follows:
    (a) No member shall open a margin account, as specified in 
Regulation T of the Board of Governors of the Federal Reserve 
System, for or on behalf of a non-institutional customer, unless, 
prior to or at the time of opening the account, the member has 
furnished to the customer, individually, in writing or 
electronically, and in a separate document, the following margin 
disclosure statement:
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    NASD Regulation also added the phrase ``or other assets'' 
throughout the text of proposed NASD Rule 2341 to clarify that assets 
other than securities held in the customer's account can be liquidated 
and sold by the NASD member firm to satisfy a margin call.\39\
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    \39\ See Amendment No. 2, supra note 6.
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    Furthermore, NASD Regulation provided an abbreviated disclosure 
statement, as discussed above, in paragraph (b) of proposed NASD Rule 
2341 that NASD member firms could use on an annual basis.\40\
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    \40\ Id.
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    In addition, NASD Regulation amended the proposed rule language, in 
Amendment No. 3, to clarify that the annual disclosure statement 
required pursuant to paragraph (b) of proposed NASD Rule 2341 need not 
be provided in a separate document.\41\
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    \41\ The proposed rule language is amended to clarify this 
requirement as follows:
    The annual disclosure statement required pursuant to this 
paragraph (b) may be delivered within or as part of other account 
documentation, and is not required to be provided in a separate 
document.
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IV. Discussion

    The Commission finds that the proposed rule change, as amended, is 
consistent with the requirements of the Act \42\ and the rules and 
regulations thereunder applicable to a national securities association. 
In particular, the Commission finds the proposal to be consistent with 
the requirements of Section 15A(b)(6) \43\ of the Act, because the 
proposal is 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.
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    \42\ In approving the proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \43\ 15 U.S.C. 78o-3(b)(6).
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    As discussed above, based on the growing number of customer 
complaints and the GAO study, the Commission believes that many 
investors do not fully understand certain significant features of their 
margin accounts. The Commission believes that the proposed rule change 
will better inform investors by requiring NASD member firms to disclose 
to their non-institutional customers, in ``plain English,'' the 
operations and the risks associated with margin trading. The Commission 
also believes that the proposal, as amended, will enhance customer 
protection by requiring that all NASD member firms provide identical or 
substantially identical information, and deliver the disclosures in a 
similar manner (i.e., in the form of a hard copy or through electronic 
means) to their customers, pursuant to proposed NASD Rule 2341. The 
proposal's requirements will provide for uniform information consistent 
across all NASD member firms.
    Specifically, the Commission finds that the mandated disclosure 
statement

[[Page 22280]]

is designed to alleviate customers' confusion and should help to alert 
them to some of the risks associated with margin trading, such as: (1) 
A customer could lose more funds than he/she deposits in a margin 
account; (2) an NASD member firm can force the sale of securities or 
other assets in any of the customer's accounts; (3) a customer does not 
have the right to dictate in which order those securities or other 
assets may be liquidated or sold to meet a margin call; (4) an NASD 
member firm may increase its ``house'' maintenance margin requirements 
at any time and is not required to provide its customer with advance 
written notice; and (5) an NASD customer is not entitled to an 
extension of time on a margin call.
    The Commission also believes that NASD Regulation has responded 
adequately to commenters' concerns and suggestions by incorporating 
most of the recommendations into the proposal and explaining why it is 
not incorporating others. Among other things, in response to comments 
submitted on the published proposal, including Amendment No. 1, NASD 
Regulation clarified that: (1) Any asset held by the NASD member firm 
on behalf of the customer, not just securities, can be liquidated to 
satisfy a customer margin call; (2) the annual margin disclosure 
statement may be provided in an abbreviated form containing all the 
required information as specified in the proposed rule text; and (3) 
the annual disclosures may be delivered within or as part of other 
account documentation.
    The Commission agrees that it was necessary for NASD Regulation to 
clarify that an NASD member firm may liquidate any securities or other 
assets held by such firm on behalf of the customer to meet a margin 
call. The Commission believes that this clarification will warn 
customers of the full extent of the risks of margin trading and ensure 
that such disclosure information is consistent with similar information 
provided in customers' margin agreements.
    The Commission also believes that NASD Regulation's amendment to 
the proposed rule language to provide for an abbreviated version of the 
annual disclosure statement is appropriate because doing so allows NASD 
member firms flexibility as to the form of the annual disclosures, 
while still preserving the core disclosure information to investors.
    Finally, the Commission believes that it is appropriate for NASD 
Regulation to require that, prior to or at the opening of a margin 
account, an NASD member firm must provide the disclosure statement in a 
separate document so that customers do not overlook information that is 
critical to making an informed decision regarding whether to trade on 
margin. As a matter of general business practice, this document should 
be provided at the time the margin agreement is established. It may be 
more cost effective, however, for firms to provide the annual 
disclosure as part of other documentation.
    Furthermore, although NASD Regulation determined not to require the 
signature of customers on the disclosure statement, the Commission 
notes that NASD member firms must have supervisory procedures 
reasonably designed to demonstrate that customers have received the 
margin risk disclosures, as well as to demonstrate compliance with 
Rules 15c2-5 and 10b-16 under the Act.\44\
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    \44\ 17 CFR 240.15c2-5; 240.10b-16.
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    The Commission notes that NASD Regulation will announce the 
operational date of the proposed rule change, as amended, in a Notice 
to Members to be published no later than 60 days following the date of 
approval by the Commission, and that the operational date will be 30 
days following the date of publication of the Notice to Members 
announcing Commission approval. The Commission believes that requiring 
NASD member firms to implement the disclosure requirements pursuant to 
the proposed NASD Rule 2341, 30 days following the date of publication 
of the Notice to Members announcing Commission approval of the 
proposal, will provide NASD member firms with sufficient time to comply 
with the requirements of proposed NASD Rule 2341.

V. Accelerated Approval of Amendment Nos. 2 and 3

    The Commission finds good cause for approving Amendment Nos. 2 and 
3 prior to the thirtieth day after publication in the Federal Register. 
The Commission believes that NASD Regulation has responded adequately 
to commenters' concerns and suggestions by incorporating certain 
commenters' recommendations into the proposed rule language in 
Amendment No. 2, and by explaining why it was not incorporating others. 
Further, the Commission noted that Amendment No. 3 is a technical 
amendment providing clarifying language in the proposed rule text that 
the annual margin disclosure statement is not required to be provided 
in a separate document. Instead, the annual margin disclosure statement 
may be delivered within or as part of other customer account 
documentation. In sum, the Commission believes that the substance of 
the proposed rule change was provided in the Notice and has been the 
subject of a full comment period. Accordingly, the Commission believes 
that there is good cause, consistent with Section 6(b)(5) and 19(b) of 
the Act,\45\ to approve Amendment Nos. 2 and 3 to the proposal on an 
accelerated basis.
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    \45\ 15 U.S.C. 78f(b) and 78s(b).
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VI. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment Nos. 2 and 3, including whether the 
proposed rule change, as amended, is consistent with the Act. Persons 
making written submissions should file six copies thereof with the 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington DC 20549-0609. 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 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-00-55 and should be 
submitted by May 23, 2001.

VII. Conclusion

    The Commission believes that the proposed rule change, as amended, 
is consistent with the Act, and, particularly, with Section 15A.\46\
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    \46\ 15 U.S.C. 78o-3.
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    It Is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\47\ that the proposed rule change (File No. SR-NASD-00-55) is 
approved, as amended.
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    \47\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\48\
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    \48\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 01-11049 Filed 5-2-01; 8:45 am]
BILLING CODE 8010-01-M