22274 Federal Register / Vol. 66, No. 86 / Thursday, May 3, 2001 / Notices

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

2 17 CFR 240.19b–4.

3Amendment 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.

4See Securities Exchange Act Release No. 43441

(October 12, 2000), 65 FR 63275 (‘‘Notice’’).

5See 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

investment company. On April 2, 2001,

applicant made a liquidating

distribution to its shareholders based on

net asset value. Expenses of $8,500

incurred in connection with the

liquidation were paid by applicant’s

investment adviser, Skye Investment

Advisers LLC.

Filing Date: The application was filed

on April 4, 2001.

Applicant’s Address: 985 University

Avenue, Suite 26, Los Gatos, CA 95032.

Kemper Bond Enhanced Securities

Trust, Series 1 and Subsequent Series

[File No. 811–4382]

Summary: Applicant, a unit

investment trust, seeks an order

declaring that it has ceased to be an

investment company. On September 8,

1999, applicant made a final liquidating

distribution to its shareholders based on

net asset value. Applicant incurred no

expenses in connection with the

liquidation.

Filing Date: The application was filed

on March 30, 2001.

Applicant’s Address: 250 North Rock

Road, Suite 150, Wichita, KA 67206–

224.

IGAM Group Funds

[File No. 811–9493]

Summary: Applicant seeks an order

declaring that it has ceased to be an

investment company. On February 15,

2001, applicant made a liquidating

distribution to its shareholders based on

net asset value. Applicant incurred no

expenses in connection with the

liquidation.

Filing Date: The application was filed

on March 27, 2001.

Applicant’s Address: 24 Salt Pond

Road, South Kingstown Office Park,

Suite A5, Wakefield, RI 02879.

Income Opportunities Fund 2000, Inc.

[File No. 811–7240]

Summary: Applicant, a closed-end

investment company, seeks an order

declaring that it has ceased to be an

investment company. On December 27,

2000, applicant made a liquidating

distribution to its shareholders based on

net asset value. As of April 6, 2001,

applicant still had 20 shareholders who

have not redeemed their shares. The

Bank of New York is holding any

unclaimed funds, which will escheat to

each shareholder’s state of residence

after the applicable holding period.

Expenses of $35,133 incurred in

connection with the liquidation were

paid by applicant.

Filing Dates: The application was

filed on February 23, 2001, and

amended on April 18, 2001,

Applicant’s Address: Merrill Lynch

Investment Managers, LLP, 800

Scudders Mill Road, Plainsboro, NJ

08536.

State Farm Balanced Fund, Inc.

[File No. 811–1520]

State Farm Interim Fund, Inc.

[File No. 811–2726]

State Farm Municipal Bond Fund, Inc.

[File No. 811–2727]

Summary: Each applicant seeks an

order declaring that it has ceased to be

an investment company. On April 1,

2001, each applicant transferred its

assets to a corresponding series of State

Farm Associates’ Funds Trust based on

net asset value. Expenses of $66,928,

$7,878, and $25,025, respectively,

incurred in connection with the

reorganizations were paid by each

applicant.

Filing Dates: The applications were

filed on April 6, 2001, and amended on

April 25, 2001.

Applicant’s Address: Three State

Farm Plaza, Bloomington, IL 61710–

0001.

Composite Deferred Series, Inc.

[File No. 811–4962]

Summary: Applicant seeks an order

declaring that it has ceased to be an

investment company. On April 21,

2000, Applicant distributed all of its

shares at net asset value to its sole

shareholder in connection with

Applicant’s liquidation. Total expenses

of approximately $4,000.00 were

incurred in connection with the

liquidation and were paid by WM

Advisors, Inc.

Filing Date: The application was filed

on February 1, 2001.

Applicant’s Address: John T. West,

c/o WM Advisors, Inc., 1201 Third

Avenue, Suite 1400, Seattle, WA 98101.

For the Commission, by the Division of

Investment Management, pursuant to

delegated authority.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 01–11087 Filed 5–2–01; 8:45 am]

BILLING CODE 8010–01–M

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 noninstitutional 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,

Federal Register / Vol. 66, No. 86 / Thursday, May 3, 2001 / Notices 22275

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’’).

8The 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.

9NASD’s 2300 series of rules covers Transactions

with Customers.

10This 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.

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.

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 noninstitutional 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:

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:

• 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).

• 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.

• 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.

• 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.

• 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

22276 Federal Register / Vol. 66, No. 86 / Thursday, May 3, 2001 / Notices

11See 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.

12While 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.

13Rule 10b–16 under the Act requires brokerdealers 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 brokerdealer 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.

14Those 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.

15 12 CFR 220 et seq.

16NASD Rule 2520 governs margin requirements.

the member to liquidate or sell

securities in your account(s).

• 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 noninstitutional 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:

• You can lose more funds than you

deposit in the margin account.

• The firm can force the sale of

securities or other assets in your

account(s).

• The firm can sell your securities or

other assets without contacting you.

• You are not entitled to choose

which securities or other assets in your

account(s) are liquidated or sold to meet

a margin call.

• The firm can increase its ‘‘house’’

maintenance margin requirements at

any time and is not required to provide

you advance written notice.

• 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.

In addition, the GAO Report collected

and summarized information from 12

on-line broker-dealers.12 All of the online 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.

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 T15

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

Federal Register / Vol. 66, No. 86 / Thursday, May 3, 2001 / Notices 22277

17See Amendment No. 1, supra note 3.

18 Id.

19NASD 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.

20See supra note 10.

21An NASD member firm would not satisfy the

proposal’s delivery requirement by posting the

disclosure statement on its web site.

22See Amendment No. 3, supra note 7.

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 brokerdealer can still take necessary steps to

protect its financial interests, including

immediate liquidation, without further

notice to the customer.

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 brokerdealer 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 brokerdealer may choose a particular security

or asset in customer’s account to

liquidate based on a high concentration

of the security held by customers firmwide.

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

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

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

22278 Federal Register / Vol. 66, No. 86 / Thursday, May 3, 2001 / Notices

23See supra note 5.

24See Singer Letter, SIA Self-Regulation

Committee Letter, Merrill Lynch Letter and SIA

Credit Division Letter, supra note 5.

25See Merrill Lynch Letter, supra note 5.

26See GAO Report, supra note 11.

27See SIA Self-Regulation Committee Letter,

Merrill Lynch Letter, and A.G. Edwards Letter,

supra note 5.

28See Singer Letter, supra note 5.

29See Charles Schwab Letter, SIA Credit Division

Letter, and A.G. Edwards Letter, supra note 5.

30See Merrill Lynch Letter, supra note 5.

31See SIA Credit Division Letter, supra note 5.

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.

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.

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, marginrelated complaints received by NASD

Regulation and the Commission have

originated from customers of both online 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.

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.

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 email 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.

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 counterproductive 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

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

Federal Register / Vol. 66, No. 86 / Thursday, May 3, 2001 / Notices 22279

32See Amendment No. 3, supra note 7.

33See Edward Jones Letter, supra note 5.

34 Id.

35See Merrill Lynch Letter, supra note 5.

36See John Jay Letter, supra note 5.

37 Id.

38The 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:

39See Amendment No. 2, supra note 6.

40 Id.

41The 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.

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).

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

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.

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.

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.

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.

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

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

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

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

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.

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

22280 Federal Register / Vol. 66, No. 86 / Thursday, May 3, 2001 / Notices

44 17 CFR 240.15c2–5; 240.10b–16.

45 15 U.S.C. 78f(b) and 78s(b).

46 15 U.S.C. 78o–3.

47 15 U.S.C. 78s(b)(2).

48 17 CFR 200.30–3(a)(12).

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

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.

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

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.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority.48

Jonathan G. Katz,

Secretary.

[FR Doc. 01–11049 Filed 5–2–01; 8:45 am]

BILLING CODE 8010–01–M