Document ID: SEC-2005-0291-0001
Agency: sec
Document Type: Notice
Title: Self-regulatory organizations; proposed rule changes: National Association of Securities Dealers, Inc.
Posted Date: 2005-11-29T05:00Z

[Federal Register: November 29, 2005 (Volume 70, Number 228)]
[Notices]               
[Page 71573-71574]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr29no05-110]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-52799; File No. SR-NASD-2005-084]

 
Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Approving Proposed Rule Change and Amendment Nos. 
1 and 2 Thereto Relating to Amendments to the Rule Regarding 
Supervisory Control Systems, Rule 3012, To Require Notification of 
Reliance on ``Limited Size and Resources'' Exception

November 18, 2005.

I. Introduction

    On June 23, 2005, the National Association of Securities Dealers, 
Inc. (``NASD'') 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 amending the rule regarding 
supervisory control systems, Rule 3012, to require members relying on 
the ``limited size and resources'' exception to Rule 3012's general 
supervisory requirement for conducting producing managers' supervisory 
reviews to report electronically to NASD their reliance on the 
exception. On July 8, 2005, NASD submitted Amendment No. 1 to the 
proposed rule change.\3\ On July 27, 2005, NASD submitted Amendment No. 
2.\4\ The proposed rule change, as amended, was published for comment 
in the Federal Register on August 9, 2005.\5\ The Commission received 
one comment on the proposal. For the reasons discussed below, the 
Commission is approving the proposed rule change, as amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 clarified the rule's text.
    \4\ Amendment No. 2 replaced and superseded Amendment No. 1. 
Amendment No. 2 further clarified the rule's text.
    \5\ See Exchange Act Release No. 52195 (Aug. 3, 2005), 70 FR 
46242 (Aug. 9, 2005) (the ``Notice'').
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II. Description of the Proposed Rule Change

A. Description of the Proposal

    Rule 3012 (Supervisory Control System) requires members to have a 
system of supervisory control policies and procedures that tests and 
verifies that a member's supervisory procedures are reasonably designed 
with respect to the activities of the member and its registered 
representatives and associated persons to achieve compliance with 
applicable securities laws and regulations, and with applicable NASD 
rules, and to amend those supervisory procedures when the testing and 
verification demonstrate a need to do so. Rule 3012 also requires that 
a member's supervisory control policies and procedures include, among 
other things, procedures that are reasonably designed to review and 
supervise the customer account activity conducted by a member's 
producing managers.
    Generally, only a person senior to or ``otherwise independent'' of 
a producing manager may conduct the producing manager's reviews. 
However, Rule 3012 provides a limited exception for any member firm 
that is so limited in size and resources (the ``limited size and 
resources'' exception) that the member does not have independent 
associated persons who can conduct the required supervisory reviews. In 
such situations, a principal who is sufficiently knowledgeable of the 
member's supervisory control procedures may conduct the required 
supervisory reviews.
    In its Order approving Rule 3012, the SEC specified that NASD must 
notify the SEC of those members that elect to rely on Rule 3012's 
``limited size and resources'' exception.\6\ To fulfill this 
obligation, NASD will need to identify those members relying on the 
exception. Accordingly, NASD is filing this rule change requiring firms 
that rely on the ``limited size and resources'' exception to notify 
NASD of their reliance on the exception. In Notice to Members 04-71 
(October 2004), the Notice announcing the SEC's approval of the 
Supervisory Control Amendments, NASD advised its members of its intent 
to file this rule change.
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    \6\ See Exchange Act Release No. 50477 (Sept. 30, 2004), 69 FR 
59972 (Oct. 6, 2004) (SR-NASD-2004-116).
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    The proposed rule change will require a member that has determined 
that it must rely on the ``limited size and resources'' exception to 
Rule 3012 to conduct any of its producing managers' supervisory 
reviews, to notify NASD electronically (or through any other process 
prescribed by NASD) within thirty (30) days of the date on which the 
member first relies on the exception.\7\

[[Page 71574]]

Afterwards, the member will need to notify NASD of its continued 
reliance on the exception on an annual basis. Members must ensure that 
each ensuing annual notification is effected no later than on the 
anniversary date of the previous year's notification. If a member 
determines that it no longer needs to rely on the ``limited size and 
resources'' exception to Rule 3012 to conduct any of its producing 
managers' supervisory reviews, the member must notify NASD 
electronically (or through any other process prescribed by NASD) within 
thirty (30) days of ceasing to rely on the exception.
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    \7\ Because the ``limited size and resources'' exception became 
effective on January 31, 2005, a member may already be relying on 
the exception prior to the effective date of the proposed rule 
change and, consequently, will be unable to comply with the rule 
change's requirement that NASD be notified within thirty (30) days 
of the date on which the member first relies on the exception. In 
such instance, the proposed rule change would require the member to 
notify NASD within thirty (30) days of the rule change's effective 
date.
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    NASD has recently designed an electronic reporting system that will 
enable members to notify NASD of their reliance on the exception. 
Members will be able to access this reporting system on the effective 
date of this proposed rule change.
    NASD will announce the effective date of the proposed rule change 
in a Notice to Members to be published no later than 60 days following 
Commission approval. The effective date will be 30 days following 
publication of the Notice to Members announcing Commission approval.

B. Comment Summary

    The proposal was published for comment in the Federal Register on 
August 9, 2005.\8\ We received one comment on the proposal. The 
commenter, Lincoln Investment Planning, Inc. (``Lincoln''), expressed 
concern that the proposed annual notification requirement for members 
that rely on Rule 3012's ``Limited Size and Resources'' exception would 
impose an undue burden on members to remember the anniversary date of 
the initial notification.\9\ Instead, Lincoln stated that this burden 
could be reduced by requiring members relying on this exception to only 
provide an initial notification of their reliance and a second 
notification when they cease to rely on it. Alternatively, Lincoln also 
suggested that NASD consider making the notification requirement a part 
of the quarterly updated NASD Control System.\10\
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    \8\ See Notice, supra note 3.
    \9\ See e-mail to rule-comments@sec.gov from Deidre B. Koerick, 
Lincoln Investment Planning, Inc., dated Aug. 30, 2005.
    \10\ Id.
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    In response to the Lincoln letter, NASD stated that ``[t]he annual 
notification requirement helps NASD to provide the SEC with the most 
accurate information possible. To aid members in completing their 
annual notification requirement, the electronic reporting system that 
NASD has designed for members to use, records and displays the date of 
the member's previous notification.'' \11\ Furthermore, to mitigate any 
concerns regarding a member's obligation to remember the anniversary 
date of its reliance of the exception, NASD stated that it ``expects to 
provide members with reminders, electronic or otherwise, in advance of 
the members' anniversary date for notification of continued reliance on 
the exception.'' \12\
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    \11\ See letter from Patricia M. Albrecht, Assistant General 
Counsel, NASD, to Katherine A. England, Assistant Director, Division 
of Market Regulation, Commission, dated Oct. 4, 2005.
    \12\ Id.
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III. Discussion and Findings

    After careful review, the Commission finds that the proposed rule 
change, as amended, is consistent with the provisions of Section 
15A(b)(6) \13\ of the Act, which require, among other things, NASD's 
rules to be designed to prevent fraudulent and manipulative acts and 
practices, to promote just and equitable principles of trade, and, in 
general, to protect investors and the public interest.
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    \13\ 15 U.S.C. 78o-3(b)(6).
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    Rule 3012 requires independent supervisory reviews of producing 
managers. It is designed to prevent fraudulent and manipulative 
practices and to protect investors. In approving the rule, the 
Commission said it expected that Rule 3012

will reduce potential conflicts of interests in situations where the 
producing branch manager is responsible for generating substantial 
revenues for the benefit of his supervisor. The Commission believes 
that such heightened supervisory procedures should help address the 
potential conflicts of interest with sufficient flexibility so as 
not to create undue burdens and costs on members.\14\
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    \14\ See Exchange Act Release No 49883 (June 17, 2004).

    The rule recognizes, however, that certain firms may conduct their 
business with significant limitation in size and resources, and 
accounted for this limitation by approving a ``Limited Size and 
Resources'' exception. The Commission concluded that the ``Limited Size 
and Resources'' exception was consistent with Section 15A(b)(6) because 
it accommodated the smallest NASD members that lack the resources to 
implement a full scale program to conduct supervisory reviews.\15\ 
However, in approving this exception, the Commission expected NASD to 
monitor closely the use of this exception to prevent its abuse or use 
by members other than those for which it was intended.\16\
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    \15\ See Exchange Act Release No. 50477 (Sept. 30, 2004).
    \16\ Id.
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    NASD proposed this amendment to Rule 3012 to provide an efficient 
measure for monitoring the use of the exception. The Commission 
believes that this proposed rule change, as amended, accomplishes the 
goals of Section 15(A)(b)(6) by enabling NASD and the Commission to 
efficiently monitor members that rely on the ``Limited Size and 
Resources'' exception in Rule 3012.

IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the Act 
\17\ that the proposed rule change, as amended (SR-NASD-2005-084), be, 
and hereby is, approved.
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    \17\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\18\
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    \18\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. E5-6627 Filed 11-28-05; 8:45 am]

BILLING CODE 8010-01-P