Document ID: SEC-2006-0008-0001
Agency: sec
Document Type: Notice
Title: Self-regulatory organizations; proposed rule changes: National Association of Securities Dealers, Inc.
Posted Date: 2006-01-05T05:00Z

[Federal Register: January 5, 2006 (Volume 71, Number 3)]
[Notices]               
[Page 632-634]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr05ja06-58]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-53030; File No. SR-NASD-2005-066]

 
Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Approving Proposed Rule Change and Amendment No. 1 
Thereto Relating to Amendments to NASD Rule 3011 and the Adoption of 
New Related Interpretive Material

December 28, 2005.

I. Introduction

    On May 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 relating to amendments to NASD 
Rule 3011 and the adoption of new related interpretive material. The 
Commission published the proposed rule change for comment in the 
Federal Register on July 6, 2005.\3\ The Commission received three 
comments on the proposal.\4\ On December 15, 2005, NASD filed a 
response to the comment letters,\5\ as well as Amendment No. 1 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. 51935 (June 29, 
2005), 70 FR 38990 (July 6, 2005) (the ``Notice'').
    \4\ See letters from Marianne Czernin, Senior VP, Director, 
Broker/Dealer Client Services, National Regulatory Services to 
Jonathan G. Katz, Secretary, SEC, dated June 9, 2005 (the ``NRS 
Letter''), from John J. Lynch, Jr., Executive Vice President, 
Hartfield, Titus & Donnelly, LLC, to Barbara Z. Sweeney, Senior Vice 
President and Corporate Secretary, NASD, dated July 20, 2005 (the 
``HTD Letter'') and from Alan E. Sorcher, Vice President and 
Associate General Counsel, Securities Industry Association 
(``SIA''), to Jonathan B. Katz, Secretary, SEC, dated July 27, 2005 
(the ``SIA Letter'').
    \5\ See letter from Brant K. Brown, Counsel, NASD, to Lourdes 
Gonzalez, Assistant Chief Counsel, Division of Market Regulation, 
dated December 15, 2005 (the ``NASD Response'').
    \6\ Amendment No. 1 clarified the conditions set forth in 
proposed IM-3011-1(c)(3). See footnote 9 and accompanying text.
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II. Description of the Proposed Rule Change

    Financial institutions, including broker-dealers, must develop and 
implement anti-money laundering (``AML'') programs pursuant to the Bank 
Secrecy Act,\7\ as amended by Section 352 of the Uniting and 
Strengthening America by Providing Appropriate Tools Required to 
Intercept and Obstruct Terrorism (USA PATRIOT) Act of 2001 (``PATRIOT 
Act'').\8\ Consistent with Treasury regulation 31 CFR 103.120 under the 
Bank Secrecy Act, NASD Rule 3011 requires that each member develop and 
implement a written AML program and specifies the minimum requirements 
for those programs.
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    \7\ Currency and Foreign Transactions Reporting Act of 1970 
(commonly referred to as the Bank Secrecy Act), 12 U.S.C. 1829b, 12 
U.S.C. 1951-1959, and 31 U.S.C. 5311-5330.
    \8\ Pub. L. 107-56, 115 Stat. 272 (2001).
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Independent Testing

    One of the AML program requirements is that firms independently 
test their AML programs. Testing allows a member to review and assess 
the adequacy of the firm's AML program and the firm's degree of 
compliance with its written procedures. Test results alert members to 
any deficiencies in their AML programs, thereby allowing them to take 
appropriate corrective action or disciplinary action as the situation 
may warrant. The independent test report also is an important tool for 
regulators during their examinations of firms for AML compliance to, 
among other things, ensure that the firms are following up with 
corrective action when such tests discover AML program deficiencies.

Frequency of Testing

    Neither the Bank Secrecy Act nor NASD Rule 3011 currently specifies 
the frequency of independent testing, and members have asked NASD for 
guidance on this issue. Given the important role that testing plays in 
a firm ensuring that its AML program is effective in preventing money 
laundering activities from occurring at or through the firm and, in 
order to assure that member AML programs are serving their regulatory 
purposes, the proposed rule change would require in most instances that 
firms test their AML programs at least annually (on a calendar-year 
basis). Certain firms, however, because of their business models and 
activities may be able to test on a less frequent basis.

[[Page 633]]

Therefore, the proposed rule change would allow members that do not 
execute transactions for customers or otherwise hold customer accounts 
or act as an introducing broker with respect to customer accounts to 
test at least once every two years (on a calendar-year basis), rather 
than on an annual basis. Examples of these types of firms may include 
firms that engage solely in proprietary trading or that conduct 
business only with other broker-dealers. In either case, the proposed 
rule change establishes a minimum requirement, and members should 
undertake more frequent testing than required if circumstances warrant.

Establishing Independence

    NASD Rule 3011(c) allows the independent testing of a firm's AML 
program to be conducted by either member personnel or by a qualified 
outside party. Some firms may find it more cost effective to use 
appropriately trained firm personnel. In this regard, members have 
asked for guidance on how to sufficiently maintain the independence of 
any internal personnel conducting the test. The proposed rule change 
would require the person conducting the independent test to have a 
working knowledge of the applicable Bank Secrecy Act requirements and 
related implementing regulations. The proposed rule change further 
clarifies that, to ensure sufficient separation of functions for 
independence purposes, the testing cannot be conducted by the AML 
compliance person(s) designated in NASD Rule 3011, by any person who 
performs the AML functions being tested, or by any person who reports 
to any of these persons.
    Recognizing that these limitations may effectively prevent a small 
firm from using appropriate internal personnel to conduct the tests, 
the proposed rule change would allow tests to be conducted by persons 
who report to either the AML compliance person or persons performing 
AML functions if (1) the member has no other qualified personnel to 
conduct the test; (2) the member establishes written policies and 
procedures to address potential conflicts that can arise from allowing 
the test to be conducted by a person in the reporting chain (e.g., 
anti-retaliation procedures); (3) to the extent possible, the results 
of the test are reported to someone senior to the person to whom the 
test conductor reports; and (4) the member documents its rationale, 
which must be reasonable, for determining that it has no other 
alternative than to comply in this manner.\9\ In addition, if the 
person does not report the results to a person senior to the AML 
compliance person or persons performing AML functions, the member must 
document a reasonable explanation for not doing so.
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    \9\ This exception is primarily intended to accommodate small 
firms that, absent the exception, could not use internal personnel 
to conduct an independent test of the firm's AML program. For 
example, assume that all the small firm's employees, even those who 
do not perform any AML functions, report to the firm's AML 
compliance officer who is also the sole compliance officer of the 
firm. The member could elect to use qualified internal personnel who 
do not perform AML functions to conduct the independent test, even 
though they report to the AML compliance officer, provided all the 
conditions set forth in proposed IM-3011-1(c)(3) have been met. NASD 
conducts routine exams of member firms to test the adequacy of AML 
compliance programs with the objective of determining whether member 
firms' AML compliance programs are reasonably designed to achieve 
and monitor compliance with the requirements of the Bank Secrecy Act 
and applicable Treasury, SEC, and NASD rules. During any such exam, 
firms that elect to rely on the exception must be able to 
demonstrate that they have complied with the conditions set forth in 
proposed IM-3011-1(c)(3).
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    Consistent with SEC and NASD recordkeeping requirements, the member 
would need to retain a copy of the documented rationale, which could be 
reviewed by NASD examiners to assess whether the member's rationale 
reasonably supports its determination.
    NASD engaged in extensive discussions with the New York Stock 
Exchange, Inc. (``NYSE'') to coordinate this proposed rule change 
regarding independent testing of AML compliance programs. To the extent 
possible, NASD and the NYSE have tried to develop consistent approaches 
with variations where necessary to account for the differences in NASD 
and NYSE membership, namely, differences in firm size, types of 
businesses conducted, and overall business models.

AML Compliance Person--Review and Update of Contact Information

    Paragraph (d) of NASD Rule 3011 requires that each member designate 
and identify to NASD the member's AML compliance person(s) and notify 
NASD of any changes to the compliance person(s)' contact information. 
NASD requires this information to, among other things, facilitate the 
efforts of the Financial Crimes Enforcement Network, pursuant to 
Section 314(a) of the PATRIOT Act and its implementing regulations, in 
requesting information from financial institutions about persons 
suspected of engaging in money laundering or terrorist activities.
    Given the important role of the AML compliance person in ensuring 
effective communication for purposes of identifying money-laundering 
and terrorist financing activities, NASD believes that members should 
review and update the AML compliance person information periodically to 
ensure its accuracy. As such, the proposed rule change would require 
that each member conduct a review and update, if necessary, of its AML 
compliance person information within 17 business days after the end of 
each calendar quarter.\10\ Quarterly reviews and updates are consistent 
with NYSE requirements.\11\ The proposed rule change also would clarify 
that the AML compliance person would be an associated person of the 
member, but only with respect to the activities performed on behalf of 
the member.
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    \10\ This proposed schedule is consistent with a member's 
quarterly FOCUS reporting schedule, as well as with a member's 
business continuity plan requirement to review and update emergency 
contact information on a quarterly basis (see NASD Rule 3520(b)). 
Similarly, the proposed schedule is consistent with the requirement 
to review and update a member's Executive Representative designation 
and contact information (see NASD Rule 1150) and to designate a 
person to receive notifications relating to continuing education, 
and the need to review and update such designation and contact 
information (see NASD Rule 1120(a)(7)). When members file their 
FOCUS reports each quarter, they are reminded of the need to review 
and update this information on the NASD Contact System.
    \11\ In Information Memo Number 02-41 (Aug. 30, 2002), the NYSE 
stated that its members should review and/or update on a quarterly 
basis (i.e., March, June, September, and December) the information 
furnished on its Electronic Filing Platform, including information 
regarding the member's or member organization's AML compliance 
person.
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    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 not more than 30 days 
following publication of the Notice to Members announcing Commission 
approval.

III. Summary of Comments Received and NASD Response

    The Commission received three comment letters on the proposal and a 
response to the comment letters by NASD. The HTD Letter expressed 
support for the proposed changes to NASD Rule 3011(c), which NASD noted 
in its response.\12\
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    \12\ HTL Letter, supra note 4. NASD Response, supra note 5. The 
NASD Response stated ``The HTD Letter is limited to support for the 
proposed rule changes to NASD Rule 3011(c); consequently, this 
response will not address the HTD Letter.''
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    The SIA Letter expressed concern that NASD and NYSE proposals may 
set forth different standards as to who is permitted to serve as the 
designated AML compliance person.\13\ NASD noted

[[Page 634]]

that the ``[t]he SIA Letter objected to the proposed rule change on the 
grounds that by requiring the AML Officer to be an associated person of 
the member firm, the proposed rule change would not permit larger 
member firms to designate an individual as the AML Officer unless that 
individual was an employee of the member itself.'' \14\ NASD clarified, 
however, that because NASD considers designated AML compliance persons 
to be associated persons for purposes of their activities on behalf of 
the member, the permissible structures for establishing AML programs 
are similar under the NASD proposal and the NYSE proposal.\15\ 
Specifically, the NASD expressed the view that the NASD proposal 
``would not prohibit a member that is part of a diversified financial 
institution from designating an AML Officer that is employed by the 
member's parent company, sister company, or other affiliate; however, 
if such a person is designated as a member's AML Officer, NASD would 
consider that person to be an associated person of the member with 
respect to those activities performed on behalf of the member.'' \16\
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    \13\ SIA Letter, supra note 4, at 2.
    \14\ NASD Response, supra note 5, at 4.
    \15\ NASD Response, supra note 5, at 2-3. In footnote 6 of the 
NASD Response, the NASD clarified that while the Notice states 
``that `[s]erving as an AML Officer, by itself, would not make a 
person an associated person of an NASD member,' as further discussed 
with the SEC staff, NASD believes that the AML Officer would be an 
associated person of the member, but only with respect to the 
activities performed on behalf of the member.''
    \16\ NASD Response, supra note 5, at 3-4.
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    The NRS Letter requested clarification regarding which types of 
broker-dealers are required to test their AML procedures annually and 
which are permitted to have their AML programs tested every two 
years.\17\ The NASD Response indicated that in ``assessing how often a 
member must conduct independent tests, members should begin with the 
premise that they must test annually.'' \18\ NASD also noted that each 
member ``should determine whether its business activities meet the 
requirements set forth in the rule'' for testing every two years.\19\ 
In addition, NASD stated: ``If, after assessing its status, a member 
finds that there is an ambiguity in the application of the express 
standards for testing its AML program every two years (rather than on 
an annual or more frequent basis) to specific factual settings, the 
member may either seek interpretive guidance from NASD staff or test 
the program on at least an annual basis.'' \20\
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    \17\ NRS Letter, supra note 4, at 1-2.
    \18\ NASD Response, supra note 5, at 5.
    \19\ Id.
    \20\ Id.
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IV. Discussion and Findings

    After careful review, the Commission finds that the proposed rule 
change is consistent with the provisions of Section 15A(b)(6) of the 
Act,\21\ which requires, among other things, that NASD rules must 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. The Commission believes that 
the proposed rule change is designed to accomplish these ends by 
requiring members to conduct periodic tests of their AML compliance 
programs, preserve the independence of their testing personnel, and 
ensure the accuracy of their AML compliance person information.
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    \21\ 15 U.S.C. 78o-3(b)(6).
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V. Conclusions

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\22\ that the proposed rule change, as amended (SR-NASD-2005-066), 
be, and it hereby is, approved.
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    \22\ 15 U.S.C. 78s(b)(2).
    \23\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\23\
Nancy M. Morris,
Secretary.
[FR Doc. E5-8282 Filed 1-4-06; 8:45 am]

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