Document ID: SEC-2006-0987-0001
Agency: sec
Document Type: Notice
Title: Self-regulatory organizations; proposed rule changes: National Association of Securities Dealers, Inc.
Posted Date: 2006-08-02T04:00Z

[Federal Register: August 2, 2006 (Volume 71, Number 148)]
[Notices]               
[Page 43831-43833]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr02au06-128]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54217; File No. SR-NASD-2006-011)

 
Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Approving a Proposed Rule Change and Amendment 
Nos. 1 and 2 Thereto Relating to Principal Pre-Use Approval of Member 
Correspondence to 25 or More Existing Retail Customers Within a 30 
Calendar-Day Period

July 26, 2006.

I. Introduction

    On January 27, 2006, 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 to amend NASD Rule 2211 
(``Institutional Sales Material and Correspondence'') to require 
principal pre-use approval of member correspondence to 25 or more 
existing retail customers within a 30 calendar-day period. On February 
13, 2006, NASD filed Amendment No. 1 to the proposed rule change. The 
proposed rule change was published for comment in the Federal Register 
on February 28, 2006.\3\ The Commission received five comments on the 
proposal, as amended.\4\ On June 29, 2006, NASD submitted a response to 
the comments \5\ and filed Amendment No. 2 to the proposed rule 
change.\6\ This order approves 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\ See Securities Exchange Act Release No. 53333 (February 17, 
2006), 71 FR 10090.
    \4\ See comment letters to Nancy M. Morris, Secretary, 
Commission, from Caroline B. Austin, CEO, Evolve Securities, Inc., 
dated March 7, 2006 (``Evolve Letter''); Dorothy M. Donohue, 
Associate Counsel, Investment Company Institute, dated March 17, 
2006 (``ICI Letter''); Tim Kelly, Partner, Field Supervision, Edward 
D. Jones & Co., LP, dated March 20, 2006 (``Edward D. Jones 
Letter''); Jack R. Handy, Jr., President and CEO, Financial Network 
Investment Corporation, dated March 21, 2006 (``FNIC Letter''); and 
Dale E. Brown, CAE, Executive Director & CEO, Financial Services 
Institute, dated March 21, 2006 (``FSI Letter'').
    \5\ See letter from Philip A. Shaikun, Associate Vice President 
and Associate General Counsel, NASD, to Katherine England, Assistant 
Director, Division, Commission, dated June 29, 2006 (``NASD Response 
Letter'').
    \6\ Amendment No. 2 made clarifying changes to the proposed rule 
text, thus it is a technical amendment and is not subject to notice 
and comment.
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II. Description of the Proposed Rule Change

    In 2003, as part of NASD's modernization of its advertising rules, 
the SEC approved the adoption of NASD Rule 2211, which included an 
amended definition of ``correspondence.'' \7\ The definition of 
correspondence includes any written letter or electronic mail message 
distributed by a member to one or more of its existing retail customers 
and to fewer than 25 prospective retail customers within a 30 calendar-
day period.\8\ Previously, ``correspondence'' included any written or 
electronic communication prepared for delivery to a single current or 
prospective customer, and not for dissemination to multiple customers 
or the general public.
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    \7\ See Securities Exchange Act Release No. 47820 (May 9, 2003), 
68 FR 27116 (May 19, 2003).
    \8\ NASD has clarified that, for purposes of its rules governing 
member communications with the public, it views instant messaging in 
the same manner in which it views traditional electronic mail 
messages. Accordingly, instant messaging may qualify as 
correspondence or sales literature, depending upon the facts and 
circumstances. See Notice to Members 03-33 (July 2003).
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    The definition of correspondence is significant in several 
respects. Firms generally are not required to have a registered 
principal approve correspondence prior to use, nor are they required to 
file correspondence with the NASD Advertising Regulation Department 
(``Department'').\9\ In addition, correspondence is subject to fewer 
content restrictions than advertisements and sales literature. NASD 
noted that it amended the definition in order to provide firms with 
more flexibility regarding the supervision of certain emails and form 
letters. NASD further noted, however, that it understands that many 
firms continue to require registered principal pre-use approval of some 
correspondence.
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    \9\ NASD Rule 3010(d)(2) requires each member to develop written 
procedures that are appropriate to its business, size, structure, 
and customers for the review of incoming and outgoing correspondence 
with the public relating to its investment banking or securities 
business. Where such procedures do not require review of all 
correspondence prior to use or distribution, they must provide for 
the education and training of associated persons as to the firm's 
procedures governing correspondence, documentation of the education 
and training, and surveillance and follow-up to ensure that the 
procedures are implemented and adhered to.
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Proposed Amendment

    NASD indicated that it has found that some member correspondence to 
multiple existing customers raises the same regulatory concerns as 
member advertisements and sales literature. However, members are not 
currently required to have such correspondence approved by a principal 
prior to use or to file it with the Department. As a result, NASD is 
proposing to amend Rule 2211 to require registered principal pre-use 
approval of any non-clerical correspondence \10\ sent to 25 or more 
existing retail customers within any 30 calendar-day period. NASD 
stated that non-clerical correspondence with such a wide distribution 
often will constitute a solicitation to purchase or sell a security or 
to use a brokerage service.
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    \10\ In Amendment No. 2, in response to comments on the original 
proposal, NASD clarified that registered principal pre-use approval 
would only be required for correspondence that ``makes any financial 
or investment recommendation or otherwise promotes a product or 
service of the member.''
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    NASD is not proposing to require that this correspondence be filed 
with the Department or that it be subject to all of the content 
standards of the advertising rules. A firm may, however, choose to file 
this correspondence with the Department to better ensure that it 
complies with applicable standards, particularly when the 
correspondence promotes the firm's products or services.
    NASD indicated that it will announce the effective date of the 
proposed rule change in a Notice to Members to be published no later 
than 30 days following Commission approval. The effective date will be 
90 days following publication of the Notice to Members announcing 
Commission approval.

III. Summary of Comments and NASD's Response

    As noted above, the Commission received five comments on the 
proposal,\11\ to which NASD has filed a response letter.\12\ Two 
commenters supported the proposal, without reservation.\13\ One of 
these commenters, in expressing its ``unqualified support'' for the 
proposal, noted that the proposal is consistent with recently-announced 
NASD communications policies, as well as the policies of other self-
regulatory organizations, and that the proposal gives firms discretion 
with regard to their internal supervisory procedures ``without 
sacrificing customer

[[Page 43832]]

protections.'' \14\ The other commenter commended NASD for furthering 
the interests of investors without being unnecessarily burdensome.\15\
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    \11\ 11 See supra note 4.
    \12\ 12 See NASD Response Letter, supra note 5.
    \13\ 13 See Edward D. Jones Letter and ICI Letter, supra note 4.
    \14\ 14 See Edward D. Jones Letter, supra note 4.
    \15\ 15 See ICI Letter, supra note 4.
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    Three commenters expressed reservations regarding the proposal.\16\ 
Two of the commenters asserted that NASD has not provided sufficient 
justification for the proposal, which they believe will impose 
significant burdens on the industry.\17\ These commenters argued that 
NASD should provide data to document the pervasiveness of the problem 
it is attempting to address by adopting the proposed amendments.\18\ 
One of these commenters pointed out that the current rules seem 
sufficient to detect and prevent abuse.\19\ The same commenter argued 
that the proposal would interfere with members' ability to allocate 
compliance resources efficiently, which could lead to, among other 
things, delay of important client communications or draining of assets 
that could be directed towards areas of greater compliance concern.\20\ 
The other commenter argued that NASD did not properly analyze the 
resulting burdens of the proposal on the industry and has provided no 
explanation of what occurred in the relatively short period since NASD 
Rule 2211 was adopted to justify the proposed change.\21\ Another 
commenter stated that the proposal is not in and of itself necessarily 
a bad idea or outrageously burdensome but that the Commission should 
examine the body of rules collectively, rather than individual rules, 
in order to understand the true burden of compliance.\22\ Two 
commenters suggested that the proposed pre-use approval only be 
required for firms that are found to display ``risky broker/dealer 
behavior'' \23\ or to violate the current requirements.\24\ One of 
these commenters asserted that principal pre-use approval burdens 
``good people'' who follow the rules without changing the behavior of 
``bad people.''[rparb]\25\ The other commenter suggested a 12-month 
pre-use approval requirement for firms violating the current 
requirements, which would then terminate unless the firm committed 
further violations, at which point NASD could impose more severe 
sanctions.\26\
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    \16\ See Evolve Letter, FNIC Letter and FSI Letter, supra note 
4.
    \17\ See FNIC Letter and FSI Letter, supra note 4.
    \18\ Id.
    \19\ See FSI Letter, supra note 4. This commenter also argued 
that NASD's assertion that many firms already require principal pre-
use approval of correspondence is unsupported and noted that many of 
its members do not currently require principal pre-use approval of 
correspondence. Id.
    \20\ Id.
    \21\ See FNIC Letter, supra note 4. This commenter further noted 
that the lack of justification for the proposal is especially 
troubling given that NASD is not proposing to require members to 
submit correspondence covered by the proposed rule to the 
Department. The commenter argued that the policy is inconsistent 
with NASD's assertion that such correspondence raises the same 
issues as advertisements and sales literature. Id.
    \22\ See Evolve Letter, supra note 4.
    \23\ Id. This commenter further suggested that corrective 
behavior could be implemented in specific divisions of larger firms, 
rather than the entire firm. Id.
    \24\ See FSI Letter, supra note 4.
    \25\ See Evolve Letter, supra note 4.
    \26\ See FSI Letter, supra note 4.
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    In its response letter, NASD reiterated that it believes that 
correspondence sent to large numbers of existing retail customers, 
particularly correspondence intended to promote a member's products or 
services, raises many of the same issues as advertising and sales 
literature, which is subject to approval.\27\ NASD argued that the 
commenters did not show why the risks raised by such correspondence 
differ from those raised by advertisements or sales literature. 
Furthermore, NASD disputed assertions that the problem must be 
pervasive in order for NASD to adopt new rules; rather, it argued, a 
better approach is to try to anticipate problems before they occur.
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    \27\ The Commission notes that advertising and sales literature 
are subject to pre-use approval.
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    Two commenters pointed out problems with pre-use approval of 
email.\28\ One argued that, as a result of pre-use approval, financial 
advisors will not be able to quickly communicate critical information 
to their clients.\29\ The commenter further argued that the proposal, 
if implemented, could lead its members to curtail the use of email by 
registered representatives, in order to avoid the expense of complying 
with the proposal.\30\ The other commenter indicated that members might 
have to require pre-use approval of all email messages since they will 
not be able to easily monitor which messages require pre-use 
approval.\31\
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    \28\ See FNIC Letter and FSI Letter, supra note 4.
    \29\ See FSI Letter, supra note 4.
    \30\ Id.
    \31\ See FNIC Letter, supra note 4.
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    In response, NASD stated that such arguments were ``unpersuasive'' 
in that the commenters suggested that current NASD rules do not require 
principal pre-use approval of any emails. As NASD noted, the current 
rules require pre-use approval of emails sent to 25 or more prospective 
retail customers within a 30 calendar-day period, since such emails are 
considered sales literature. Therefore, NASD noted, the proposed rule 
change would merely add to the categories of email requiring pre-use 
approval.
    One commenter also claimed that the exclusion for clerical or 
ministerial correspondence ``lacks clarity'' and that NASD should make 
clear whether its intent is to have the proposal relate to 
correspondence addressing securities products.\32\ This commenter noted 
that if the exclusion is not clear, all correspondence will have to be 
pre-approved, which could create issues for making timely 
communications.\33\
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    \32\ Id.
    \33\ Id.
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    In its response letter, NASD indicated that it is amending the 
proposed rule change to require pre-use approval of correspondence only 
if it ``makes any financial or investment recommendation or otherwise 
promotes a product or service of the member,''\34\ rather than 
requiring pre-use approval of correspondence that is ``not solely and 
exclusively clerical or ministerial in nature.'' NASD further clarified 
that principal pre-use approval would not be required for 
correspondence concerning clerical or ministerial matters, such as 
dividend notices or changes in office hours, or for correspondence that 
does not promote a product or service of the member, such as emails 
including only market commentary. NASD did note, however, that all 
correspondence must be supervised by members in accordance with NASD 
Rule 3010(d).
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    \34\ See Amendment No. 2.
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IV. Discussion

    After careful consideration of the proposed rule change, the 
comment letters and NASD's response to the comments, the Commission 
finds that the proposed rule change, as amended, is consistent with the 
Act and the rules and regulations thereunder applicable to a national 
securities association.\35\ Specifically, the Commission believes that 
the proposal is consistent with Section 15A(b)(6) of the Act\36\ in 
that it 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 by requiring 
additional supervision of correspondence by broker-dealers. The 
Commission notes that NASD has represented that many firms require 
registered principal pre-use approval of some correspondence, even 
though not required by NASD rules. In addition, NASD carved out 
correspondence that

[[Page 43833]]

does not make any financial or investment recommendation or otherwise 
promote a product or service of the member from coverage of the rule 
and did not require correspondence covered by the rule to be filed with 
the Department. The Commission believes that requiring pre-use approval 
by a principal of correspondence sent to 25 or more existing retail 
customers within any 30 calendar-day period appropriately balances the 
needs of members to contact existing customers without being unduly 
burdened against the goal of having communications with retail 
customers that are fair and balanced.
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    \35\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. See 15 U.S.C. 78c(f).
    \36\ 15 U.S.C. 78o-3(b)(6).
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    The Commission is not persuaded by the commenters' arguments that 
pre-use approval of emails is not workable given that pre-use approval 
is already required for certain emails.\37\ The Commission commends 
NASD for attempting to address problems with correspondence, rather 
than waiting for additional inappropriate materials to reach retail 
customers. Finally, the Commission believes that NASD's proposed 
amendment to the rule text adequately addresses concerns that the 
proposed rule change lacks clarity.
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    \37\ For example, emails sent to 25 or more prospective retail 
customers within a 30 calendar-day period currently require 
principal pre-use approval. See NASD Response Letter, supra note 5.
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\38\ that the proposed rule change (SR-NASD-2006-011), as amended, 
is approved.
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    \38\ Id.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\39\
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    \39\ 17 CFR 200.30-3(a)(12).
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J. Lynn Taylor,
Assistant Secretary.
 [FR Doc. E6-12443 Filed 8-1-06; 8:45 am]

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