[Federal Register Volume 66, Number 123 (Tuesday, June 26, 2001)]
[Notices]
[Pages 33985-33987]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-15980]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-44451; File No. SR-NASD-99-46]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change, and Notice of Filing and Order Granting Accelerated Approval of 
Amendment No. 3 to the Proposed Rule Change, Filed by the National 
Association of Securities Dealers, Inc. Requiring Registration of Chief 
Compliance Officers

June 19, 2001.

I. Introduction

    On November 22, 1999, the National Association of Securities 
Dealers, Inc. (``NASD'' or ``Association''), through its wholly-owned 
subsidiary, NASD Regulation, Inc. (``NASD Regulation''), submitted to 
the Securities and Exchange Commission (``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 requiring 
registration of chief compliance officers. NASD Regulation filed 
Amendment Nos. 1 \3\ and 2 \4\ to the proposed rule change on December 
11, 2000 and December 6, 2000, respectively.\5\ The proposed rule 
change was published for comment in the Federal Register on January 4, 
2001.\6\ The Commission received two comment letters.\7\ NASD 
Regulation filed Amendment No. 3 to the proposed rule change on June 
15, 2001.\8\ This order approves the proposed rule change, as amended, 
and grants accelerated approval to Amendment No. 3 The Commission is 
also soliciting comment on Amendment No. 3 to the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Letter dated October 28, 1999, from Alden S. Adkins, 
Senior Vice President and General Counsel, NASD Regulation, to 
Katherine A. England, Assistant Director, Divisions of Market 
Regulation (``Division''), Commission (``Amendment No. 1''). 
Amendment No. 1 clarifies that if a person becomes a chief 
compliance officer for the first time after the effective date of 
the proposed rule change for a dual New York Stock Exchange and NASD 
member, that person may elect to take the New York Stock Exchange 
Series 14 exam, and would not be required to take the NASD Series 24 
exam.
    \4\ See Letter dated December 1, 2000, from Alden S. Adkins, 
Senior Vice President and General Counsel, NASD Regulation, to Jack 
Drogin, Assistant Director, Division, Commission (``Amendment No. 
2''). Amendment No. 2 limits the grandfathering provision of the 
proposed rule change to individuals who have been designated as 
chief compliance officers on Schedule A of Form BD for at least two 
years immediately prior to the effective date of the proposed rule 
change and who have not been subject within the previous ten years 
to: (1) Any statutory disqualification as defined in section 
3(a)(39) of the Act; (2) a suspension; or (3) the imposition of a 
fine of $5,000 or more for a violation of any provision of any 
securities law or regulation, or any agreement with or rule or 
standard of conduct of any securities governmental agency, 
securities self-regulatory organization, or as imposed by any such 
regulatory or self-regulatory organization in connection with a 
disciplinary proceeding.
    \5\ Amendment No. 1 is dated October 28, 1999, but was not 
received by the Commission until December 11, 2000.
    \6\ Securities Exchange Act Release No. 43765 (December 21, 
2000), 66 FR 830.
    \7\ See Letter dated January 29, 2001, from Richard B. Levin, 
Assistant General Counsel and Regulatory Affairs Officer, Knight 
Securities, to Jonathan G. Katz, Secretary, Commission; and Letter 
dated January 30, 2001, from Michael T. Dorsey, Senior Vice 
President, General Counsel and Secretary, Knight Trading Group, to 
Jonathan G. Katz, Secretary, Commission. Both comment letters were 
from different entities within the Knight Trading Group Inc. group 
of companies but were substantively identical. Therefore, for 
purposes of this order, the Commission will refer to these letters 
as the ``Knight'' letters.
    \8\ See Letter dated June 14, 2001, from Patrice M. Gliniecki, 
Vice President and Deputy General Counsel, NASD Regulation, to 
Jonathan G. Katz, Secretary, Commission (``Amendment No. 3''). 
Amendment No. 3 completely replaced an earlier version of Amendment 
No. 3 that was filed with the Commission on May 10, 2001. Amendment 
No. 3 addresses three issued: First, NASD Regulation responds to 
Knight's comments (discussed infra.). Second, Amendment No. 3 
revises the proposed rule change to clarify that a chief compliance 
officer for a member whose business is limited to the solicitation, 
purchase and/or sale of government securities may register as a 
government securities principal, instead of a general securities 
principal, and clarifies that because there is no qualifying exam 
for government securities principals, these individuals only must 
register as such. Amendment No. 3 therefore also makes corresponding 
changes to the rule language originally proposed to delete 
references to the Series 73 exam, which does not exist. Third, 
Amendment No. 3 clarifies that chief compliance officers for member 
firms limited to options activities cannot take the Series 4 exam 
(Registered Options Principal) in order to satisfy the registration 
requirement of this proposed rule change. Finally, Amendment No. 3 
clarifies that chief compliance officers that have been employed by 
more than one firm during the grandfathering period will only be 
eligible for the grandfathering provision if the chief compliance 
officer has been working for firms conducting the same type of 
business. See discussion of the grandfathering provision, infra.
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II. Description of the Proposed Rule Change

    The proposed rule change would require the chief compliance officer 
designated on Schedule A of a member's

[[Page 33986]]

Form BD to be registered as a principal. NASD Regulation believes that 
the chief compliance officer of a member should be registered as a 
principal and be subject to continuing education because chief 
compliance officers generally advise registered representatives and 
other principals on compliance issues and devise compliance systems and 
procedures for the firm as a whole. As such, a chief compliance officer 
should be required to demonstrate his or her knowledge through a 
qualifications examination and be subject to continuing education 
requirements.\9\
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    \9\ By requiring chief compliance officers to be registered, 
NASD Regulation noted that it is not creating a presumption that 
chief compliance officers are supervising the member's securities or 
investment banking business or otherwise are control persons. NASD 
Regulation stated that some chief compliance officers are completely 
segregated from a member's supervisory structure. As in the past, 
NASD Regulation will determine whether a person is acting as a 
supervisor or control person by looking at the responsibilities and 
functions he performs for the member, not simply his title.
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    Under the proposed rule change, the chief compliance officer must 
be registered as a Series 24 General Securities Principal, unless the 
member's activities are limited to particular areas of the investment 
banking or securities business. In that case, the individual may apply 
for a limited principal registration. Acceptable limited principal 
categories for a chief compliance officer are the Limited Principal 
Investment Company and Variable Contracts Products (Series 26), Limited 
Principal Direct Participation Programs (Series 39), and the Government 
Securities Principal, if the activities of the chief compliance 
officer's firm are limited to these areas.\10\ To avoid imposing 
duplicative examination requirements on dual NASD/New York Stock 
Exchange (``NYSE'') members, NASD Regulation has determined that for 
purposes of chief compliance officer registration, it will accept the 
NYSE's Series 14 Compliance Official examination in lieu of any of the 
NASD principal examinations noted above, both for persons who have 
taken the NYSE Series 14 Compliance Official examination and are 
``grandfathered'' as discussed below, and for persons who become chief 
compliance officers for dual NASD and NYSE members after the effective 
date of this proposed rule change.\11\
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    \10\ Chief compliance officers for firms engaged in a government 
securities business need not take a qualifying exam, as one does not 
exist; such chief compliance officers need only register with NASD 
Regulation. See Amendment No. 3, supra note 5.
    \11\ See Amendment No. 1, supra note 3.
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    NASD Regulation proposes to make the rule change effective on 
January 1, 2002. A chief compliance officer who is subject to the 
examination requirement would be required to pass the appropriate exam 
within 90 calendar days of the effective date of proposed rule change. 
NASD Regulation also proposes to ``grandfather'' certain chief 
compliance officers who have been designated as a chief compliance 
officer on Schedule A of Form BD for two continuous years prior to the 
effective date of this proposed rule change, who have not been subject 
within the last ten years to the disciplinary procedures described in 
proposed Rule 1022(a), and, if applicable, have been working for firms 
conducting the same type of securities business (as discussed below). 
That is, ``grandfathered'' chief compliance officers would not have to 
take a qualification exam. All chief compliance officers, including 
those grandfathered, however, would be subject to continuing education 
requirements. Individuals who have served as chief compliance officers 
for both general securities firms and limited purpose firms during the 
two year grandfathering period should contact NASD Regulation's 
Qualifications Department to determine whether they qualify for the 
grandfathering provision or, whether they are eligible for a waiver of 
the applicable examination requirement pursuant to NASD Rule 
1070(e).\12\
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    \12\ See Amendment No. 3, supra note 8.
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III. Comments

    The Commission received two comments on the proposal.\13\ Knight 
opposed the proposed rule change because it believed that it could 
unnecessarily and impermissibly interfere with the attorney-client 
relationship and the practice of law. Knight stated that the proposal 
could compel a lawyer to violate his duty of confidentiality and is 
unnecessary because the parties subject to the new rules are already 
subject to NASD and other regulatory oversight. Specifically, Knight 
stated that requiring attorneys who are chief compliance officers to 
register as principals would permit NASD Regulation to exert 
impermissible influence over member firms through the threat of 
enforcement and disciplinary actions against their attorneys for 
failing to either respond to NASD requests for information or failing 
to supervise associated persons.
    In response, NASD Regulation stated that although NASD Regulation's 
Code of Procedure does not include a specific provision addressing the 
attorney-client privilege or the work-product doctrine, both the 
attorney-client privilege and the work-product doctrine would be 
recognized in practice, if validly asserted. NASD Regulation also noted 
that the NASD has an important obligation to detect and address 
violations of its rules and the federal securities laws, and member 
firms are obligated to cooperate. In addition, NASD Regulation stated 
that these privileges do not limit a member's obligation to comply with 
duties imposed by a self-regulatory organization. Finally, NASD 
Regulation stated that it is incumbent upon member firms that employ 
attorneys that serve as legal counsel and the chief compliance officer 
to appropriately separate these functions.
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    \13\ See supra note 7.
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IV. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities association.\14\ In 
particular, the Commission finds that the proposed rule change is 
consistent with the requirements of section 15A(b)(6) \15\ and 
15A(g)(3) \16\ of the Act. Section 15A(b)(6) of the Act requires the 
Association's rules to be designed to promote just and equitable 
principles of trade, and to protect investors and the public interest. 
Section 15A(g)(3) of the Act requires the NASD to prescribe standards 
of training, experience, and competence for persons associated with 
NASD members.
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    \14\ In approving the proposal, the Commission has considered 
its impact on efficiency, competition, and capital formation. 15 
U.S.C. 78c(f).
    \15\ 15 U.S.C. 78o-3(b)(6).
    \16\ 15 U.S.C. 78o-3(g)(3).
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    The Commission believes that the proposed rule change will promote 
just and equitable principles of trade and will protect investors and 
the public interest because the proposal institutes a formal mechanism 
for ensuring that chief compliance officers have attained the requisite 
knowledge of applicable securities laws and regulations. The Commission 
notes that a member's chief compliance officer plays a critical role in 
the operation of NASD member firms in that chief compliance officers 
typically advise registered representatives and other principles on 
compliance issues and devise compliance systems and procedures for the 
firm as a whole. Thus, the chief compliance officer can provide the 
foundation that ensures a member firm's compliance with federal and 
state securities laws and regulations.

[[Page 33987]]

    The Commission also finds that requiring the registration, 
examination and continuing education of chief compliance officers is 
within NASD Regulation's authority to prescribe standards of training, 
experience, and competence for persons associated with NASD members. 
Thus, the Commission finds that it is consistent with the Act to 
require that the chief compliance officer register as a Series 24 
General Securities Principle.\17\ The Commission also finds that it is 
appropriate to permit chief compliance officers whose activities are 
limited to particular areas of the investment banking or securities 
business to register as limited principals and take the appropriate 
exam corresponding to their subject area, if a corresponding exam 
exists and NASD Regulation finds that the exam adequately demonstrates 
a chief compliance officer's knowledge of the subject area.\18\ 
Therefore, the Commission finds that it is appropriate to permit 
limited principal registration for chief compliance officers for 
members whose business is limited to Investment Company and Variable 
Contracts and Direct Participation Programs; to delete references to 
the Series 73, Government Securities Principal exam, in the test of the 
original proposed rule language, as it does not exist; and to require 
that chief compliance officers for member firms engaged in options-
related business take the Series 24 exam, rather than the Series 4, 
Registered Options Principal exam. The Commission also finds that 
requiring chief compliance officers to participate in continuing 
education helps to ensure that chief compliance officers remain 
sufficiently knowledgeable to advise registered representatives and 
other principals on compliance issues, consistent with the requirements 
of the Act.
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    \17\ The Commission notes that permitting chief compliance 
officers to choose between the NYSE's Series 14 examination and the 
NASD's Series 24 examination also should avoid imposing duplicative 
examination requirements on dual NASD/NYSE members. See Amendment 
No. 1, supra note 3.
    \18\ See Amendment No. 3, supra note 7.
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    The Commission finds that the proposed grandfathering provision is 
a reasonable approach to implementing the new registration 
requirements, and notes that all grandfathered chief compliance 
officers will be subject to continuing education requirements. In 
addition, by requiring the firms with whom a grandfathered chief 
compliance officer has worked during the grandfathering period to 
conduct the same type of securities business, NASD Regulation ensures 
that those chief compliance officers have had consistent substantive 
experience during the grandfathering period.
    The Commission further notes that the grandfathering provision is 
effective on January 1, 2002, the proposed effective date of the rule 
change. Whether NASD Regulation actually implements the registration 
requirements for chief compliance officers on January 1, 2002 or delays 
the implementation for other reasons, the Commission has determined 
that the grandfathering provision for chief compliance officers for 
purposes of this rule will continue to be January 1, 2002. Thus, only 
those individuals who have been a chief compliance officer continuously 
from January 1, 2000-January 1, 2002 and who otherwise meet the other 
criteria set forth in this proposed rule change will be eligible for 
the grandfathering provision--regardless of when NASD Regulation 
actually implements the proposed rule change.
    The Commission also finds that NASD Regulation's response to the 
commenter sufficiently address concerns relating to the attorney client 
privilege. The NASD's statutory obligation to ensure compliance with 
its rules and the federal securities laws is mandatory, and the 
Commission agrees that member firms are obligated to cooperate with the 
NASD in its investigations and actions to ensure compliance with the 
Act and the rules and regulations thereunder. The Commission also notes 
that the NASD has stated that it will recognize a validly asserted 
privilege. Finally, the Commission believes that member firms that 
employ attorneys to serve as both the chief compliance officers and 
legal counsel should be able to provide for the appropriate separation 
of these functions.

V. Accelerated Approval for Amendment No. 3

    The Commission finds good cause for accelerating approval of 
Amendment No. 3 to the proposed rule change prior to the thirtieth day 
after publication in the Federal Register. The Commission notes that 
the Amendment provides useful clarifications to the proposed rule 
change. Accordingly, the Commission finds that good cause exists to 
accelerate approval of Amendment No. 3 to the proposed rule change.

VI. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendment No. 3, including whether the amendment 
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 in the Commission's 
Public Reference Room. Copies of such filing will also be available for 
inspection and copying at the principal office of the NASD Regulation. 
All submissions should refer to the File No. SR-NASD-99-46, Amendment 
No. 3, and should be submitted by July 17, 2001.

VII. Conclusion

    It Is Therefore Ordered, pursuant to section 19(b)(2) of the 
Act,\19\ that the proposed rule change (SR-NASD-99-46), as amended, is 
approved.
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    \19\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\20\
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    \20\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-15980 Filed 6-25-01; 8:45 am]
BILLING CODE 8010-01-M