Document ID: SEC-2008-0681-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2008-05-09T04:00Z

[Federal Register: May 9, 2008 (Volume 73, Number 91)]
[Notices]               
[Page 26453-26457]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr09my08-116]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-57775; File No. SR-FINRA-2007-035]

 
Self-Regulatory Organizations: Financial Industry Regulatory 
Authority, Inc.; Notice of Filing and Order Granting Accelerated 
Approval of Proposed Rule Change and Amendment No. 1 Relating to 
Options Supervision Requirements

May 5, 2008.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on December 18, 2007, Financial Industry Regulatory Authority, Inc. 
(``FINRA'') (f/k/a National Association of Securities Dealers, Inc. 
(``NASD'')) filed with the Securities and Exchange Commission 
(``Commission'') and amended on April 17, 2008 \3\ the proposed rule 
change as described in Items I and II below, which Items have been 
substantially prepared by FINRA. This order provides notice of the 
proposed rule change as modified by Amendment No. 1 and approves the 
proposed rule change as amended on an accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 to SR-FINRA-2007-035 replaced and superseded 
the original rule filing filed on December 18, 2007.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA is proposing to amend NASD Rule 1022 (Categories of Principal 
Registration), NASD Rule 2220 (Options Communications with the Public) 
and NASD Rule 2860 (Options) to eliminate the requirement for separate 
designations of Senior Registered Options Principal (``SROP'') and 
Compliance Registered Options Principal (``CROP'') and require a member 
to integrate the responsibility for supervision of its public customer 
options business into its overall supervisory and compliance program.

[[Page 26454]]

    Below is the text of the proposed rule change. Proposed new 
language is in italics; proposed deletions are in brackets.
* * * * *
1022. Categories of Principal Registration
    (a) through (e) No Change.
    (f) Limited Principal--Registered Options and Security Futures
    (1) Every member of [the Association]NASD that is engaged in, or 
that intends to engage in transactions in security futures or [put or 
call] options with the public shall have at least one Registered 
Options and Security Futures Principal who shall have satisfied the 
requirements of this subparagraph. [As to options transactions, each 
member shall also designate a Senior Registered Options Principal and a 
Compliance Registered Options Principal in accordance with the 
provisions of Rule 2860(b)(20) and identify such persons to the 
Association.] Every person engaged in the supervision of options and 
security futures sales practices, including a person designated 
pursuant to Rule 3010(a)(2) [the management of the day-to-day options 
or security futures activities of a member] shall [also] be registered 
as a Registered Options and Security Futures Principal.
    (2) through (5) No Change.
    (g) through (h) No Change.
2220. Options Communications with the Public
    (a) No Change.
    (b) Approval by [Compliance]a Registered Options and Security 
Futures Principal and Recordkeeping
    All advertisements, sales literature (except completed worksheets), 
and educational material issued by a member or member organization 
pertaining to options shall be approved in advance by [the Compliance 
Registered Options Principal or designee]a Registered Options and 
Security Futures Principal designated by the member's written 
supervisory procedures. Copies thereof, together with the names of the 
persons who prepared the material, the names of the persons who 
approved the material and, in the case of sales literature, the source 
of any recommendations contained therein, shall be retained by the 
member or member organization and be kept at an easily accessible place 
for examination by [the Association]NASD for a period of three years.
    (c) through (d) No Change.
2860. Options
    (a) No Change.
    (b) Requirements
    (1) through (15) No Change.
    (16) Opening of Accounts
    (A) through (D) No Change.
    (E) Uncovered Short Option Contracts
    Each member transacting business with the public in writing 
uncovered short option contracts shall develop, implement and maintain 
specific written procedures governing the conduct of such business 
which shall include, at least, the following:
    (i) through (ii) No Change.
    (iii) Designation of [the Senior Registered Options Principal and/
or Compliance Registered Options Principal] a specific Registered 
Options and Security Futures Principal(s) as [the person] responsible 
for approving customer accounts that do not meet the specific criteria 
and standards for writing uncovered short option transactions and for 
maintaining written records of the reasons for every account so 
approved;
    (iv) through (v) No Change.
    (17) No Change.
    (18) Discretionary Accounts
(A) Authorization and Approval
    (i) No Change.
    (ii) [The Senior Registered Options Principal]Each firm shall 
designate specific Registered Options and Security Futures Principals 
to review discretionary accounts. A Registered Options and Security 
Futures Principal other than the Registered Options and Security 
Futures Principal who accepted the account shall review the acceptance 
of each discretionary account to determine that the Registered Options 
and Security Futures Principal accepting the account had a reasonable 
basis for believing that the customer was able to understand and bear 
the risk of the strategies or transactions proposed, and shall maintain 
a record of the basis for such determination. [Each discretionary order 
shall be approved and initialed on the day entered by the branch office 
manager or other Registered Options Principal, provided that if the 
branch office manager is not a Registered Options Principal, such 
approval shall be confirmed within a reasonable time by a Registered 
Options Principal. Each] Every discretionary order shall be identified 
as discretionary on the order at the time of entry. Discretionary 
accounts shall receive frequent appropriate supervisory review by [the 
Compliance Registered Options Principal]a Registered Options and 
Security Futures Principal who is not exercising the discretionary 
authority. The provisions of this subparagraph (18) shall not apply to 
discretion as to the price at which or the time when an order given by 
a customer for the purchase or sale of a definite number of option 
contracts in a specified security shall be executed, except that the 
authority to exercise time and price discretion will be considered to 
be in effect only until the end of the business day on which the 
customer granted such discretion, absent specific, written contrary 
indication signed and dated by the customer. This limitation shall not 
apply to time and price discretion exercised in an institutional 
account, as defined in Rule 3110(c)(4), pursuant to valid Good-Till-
Cancelled instructions issued on a ``not held'' basis. Any exercise of 
time and price discretion must be reflected on the order ticket.
    (iii) Any member that does not utilize computerized surveillance 
tools for the frequent and appropriate review of discretionary activity 
must establish and implement procedures to require specific Registered 
Options and Security Futures Principals who have been designated to 
review discretionary accounts to approve and initial each discretionary 
order on the day entered.
    (B) through (C) No Change.
    (19) No Change.
    (20) Supervision of Accounts
    (A) Duty to Supervise[; Senior Registered Options Principal]
    [Every member shall develop and implement a written program 
providing for the diligent supervision of all of its customer accounts, 
and all orders in such accounts, to the extent such accounts and orders 
relate to options contracts, by a general partner (in the case of a 
partnership) or officer (in the case of a corporation) of the member 
who is a Registered Options Principal and who has been specifically 
identified to the Association as the member's Senior Registered Options 
Principal. A Senior Registered Options Principal, in meeting his 
responsibilities for supervision of customer accounts and orders, may 
delegate to qualified employees (including other Registered Options 
Principals) responsibility and authority for supervision and control of 
each branch office handling transactions in option contracts, provided 
that the Senior Registered Options Principal shall have overall 
authority and responsibility for establishing appropriate procedures of 
supervision and control over such employees. Every such member shall 
also develop and implement specific written procedures concerning the 
manner of supervision of customer accounts maintaining uncovered short 
option positions and specifically providing for frequent supervisory 
review of such accounts.]Each member that conducts a public customer 
options business shall ensure that its written supervisory

[[Page 26455]]

system policies and procedures pursuant to Rules 3010, 3012, and 3013 
adequately address the member's public customer options business.
    [(B) Compliance Registered Options Principal]
    [Every member shall designate and specifically identify to the 
Association a Compliance Registered Options Principal (CROP), who may 
be the Senior Registered Options Principal, who shall have no sales 
functions and who shall be responsible to review and to propose 
appropriate action to secure the member's compliance with securities 
laws and regulations and Association Rules in respect of its options 
business. The CROP shall regularly furnish reports directly to the 
Compliance officer (if the CROP is not himself the Compliance officer) 
and to other senior management of the member. The requirement that the 
CROP have no sales functions shall not apply to a member that has 
received less than $1,000,000 in gross commissions on options business 
for either of the preceding two fiscal years or that currently has ten 
or fewer registered representatives.]
[(C)](B) Branch Offices
    No branch office of a member shall transact an options business 
unless the principal supervisor of such branch office accepting options 
transactions has been qualified as either a Registered Options and 
Security Futures Principal or a Limited Principal--General Securities 
Sales Supervisor; provided that this requirement shall not apply to 
branch offices in which no more than three registered representatives 
are located, so long as the options activities of such branch offices 
are appropriately supervised by either a Registered Options and 
Security Futures Principal or a Limited Principal--General Securities 
Sales Supervisor.
[(D)](C) Headquarters Review of Accounts
    Each member shall maintain at the principal supervisory office 
having jurisdiction over the office servicing customer accounts, or 
have readily accessible and promptly retrievable, information to permit 
review of each customer's options account on a timely basis to 
determine:
    (i) The compatibility of options transactions with investment 
objectives and with the types of transactions for which the account was 
approved;
    (ii) The size and frequency of options transactions;
    (iii) Commission activity in the account;
    (iv) Profit or loss in the account;
    (v) Undue concentration in any options class or classes, and
    (vi) Compliance with the provisions of Regulation T of the Federal 
Reserve Board.
    (21) through (24) No Change.
    (c) No Change.
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, FINRA included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item III below. FINRA has prepared summaries, set forth in sections A, 
B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    FINRA is proposing to amend its options rules to integrate the 
responsibility for supervision of a member's public customer options 
business into its overall supervisory and compliance program. The 
proposed rule change is substantively similar to recent amendments to 
the rules of the Chicago Board Options Exchange (``CBOE''), which were 
approved by the Commission.\4\ As part of these changes, FINRA proposes 
to eliminate the requirement that a firm must designate a SROP and CROP 
to be responsible for the overall supervision and compliance programs, 
respectively, for a member's public customer options activities. FINRA 
believes that the supervisory and compliance function of a member's 
public customer options activities would be better integrated into the 
matrix of a firm's overall supervisory and compliance functions rather 
than separately vested in a SROP and CROP.
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    \4\ See Securities Exchange Act Release No. 56971 (December 14, 
2007), 72 FR 72804 (December 21, 2007) (Approval Order for File No. 
SR-CBOE-2007-106).
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    FINRA does not believe that eliminating the SROP and CROP 
requirements would lead to a reduction in supervision, as firms have an 
obligation to designate an appropriately registered principal(s) to 
supervise their public customer options activities pursuant to NASD 
Rule 3010(a)(2).\5\ The proposed rule change would provide firms 
greater flexibility to incorporate supervision into existing, firm-wide 
supervisory structures.
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    \5\ NASD Rule 3010(a)(2) requires that members designate ``an 
appropriately registered principal(s) with authority to carry out 
the supervisory responsibilities of the member for each type of 
business in which it engages for which registration as a broker/
dealer is required.''
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    The proposed rule change would amend NASD Rule 1022 (Categories of 
Principal Registration) to delete the reference to the SROP and CROP 
and clarify that if a person is engaged in the supervision of options 
and security futures sales practices, including a person designated 
pursuant to NASD Rule 3010(a)(2), then such person must be registered 
as a Registered Options and Security Futures Principal (``ROSFP'').
    The proposed rule change also makes a few technical changes. All 
references to ``Registered Options Principal'' would be changed to 
``Registered Options and Security Futures Principal'' to reflect the 
change in title when rules governing security futures were adopted.\6\ 
All references to ``the Association'' would be changed to ``NASD'' for 
ease of reference while the rules continue to be part of the legacy 
NASD rulebook until such time as the legacy NASD and incorporated NYSE 
rules are consolidated into the FINRA rule book when all references to 
``NASD'' will be changed to ``FINRA.'' Finally, all references to ``put 
and call'' would be deleted before options and ``options'' will mean 
all types of options.
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    \6\ See Securities Exchange Act Release No. 46663 (October 15, 
2002), 67 FR 64944 (October 22, 2002) (Approval Order for File No. 
SR-NASD-2002-040).
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    The proposed rule change would amend NASD Rule 2220(b) (Options 
Communications with the Public) to delete the reference to the CROP and 
instead require that all advertisements, sales literature (except 
completed worksheets), and educational material issued by a member or 
member organization pertaining to options be approved in advance by a 
ROSFP designated by the member's written supervisory procedures.
    In addition, the proposed rule change would amend NASD Rule 2860 
(Options) in several respects. First, paragraph (b)(16)(E)(iii) would 
be amended to delete the reference to the SROP and CROP and require 
that a specific ROSFP(s) be designated to be responsible for approving 
customer accounts that do not meet the specific criteria and standards 
for writing uncovered short option transactions and for maintaining 
written records of the reasons for every account so approved. The 
proposed rule change would allow

[[Page 26456]]

members the flexibility to assign this responsibility, which currently 
rests with the SROP and/or CROP, to a specific ROSFP(s).
    Second, the proposed rule change would amend paragraph (b)(18) and 
the treatment of options discretionary accounts. Specifically, under 
the proposed rule change, each firm would be required to designate 
specific ROSFPs to review discretionary accounts.\7\ A ROSFP other than 
the ROSFP who accepted the account would review the acceptance of each 
discretionary account to determine that the ROSFP accepting the account 
had a reasonable basis for believing that the customer was able to 
understand and bear the risk of the strategies or transactions proposed 
and must maintain a record of the basis for such determination.
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    \7\ Under the existing rule, the SROP must review the acceptance 
of each discretionary account and the CROP must perform frequency 
supervisory review of such accounts.
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    In addition, the proposed rule change would eliminate the 
requirement in paragraph (b)(18) that discretionary options orders be 
approved and initialed on the day of entry by the branch office manager 
or authorized Registered Options Principal (``ROP'') or confirmed 
within a reasonable time by a ROP if the branch office manager is not a 
ROP, if a firm uses computerized surveillance tools. Under the proposed 
rule change, discretionary orders would be required to receive frequent 
appropriate supervisory review by a ROSFP who is not exercising 
discretionary authority (instead of a CROP) and be reviewed in 
accordance with a member's written supervisory procedures. The proposed 
rule change would ensure that supervisory responsibilities are assigned 
to specific ROSFP-qualified individuals, thereby enhancing the quality 
of supervision.
    Firms that do not use computerized surveillance tools for the 
frequent and appropriate review of discretionary activity would be 
required to establish and implement procedures to require ROSFPs who 
have been designated to review discretionary accounts to approve and 
initial each discretionary order on the day entered. FINRA believes 
that any member that does not use computerized tools for the frequent 
and adequate surveillance of options discretionary account activity 
should continue to be required to perform the daily manual review of 
discretionary orders.
    Paragraph (b)(18) also would be revised to limit the duration of 
the time and price discretionary authority to the end of the business 
day on which the customer granted such discretion, absent specific 
written contrary indication signed and dated by the customer. The 
limitation would not apply to time and price discretion exercised in an 
institutional account, as defined in NASD Rule 3110(c)(4), pursuant to 
valid Good-Till-Cancelled instructions issued on a ``not held'' basis. 
The proposed rule change would require any exercise of time and price 
discretion to be reflected on the order ticket. The proposed rule 
change mirrors the limitations to discretionary authority provided in 
NASD Rule 2510(d). FINRA believes that it is appropriate to have 
consistent treatment of discretionary orders for options as for all 
other securities.
    Third, the proposed rule change would amend paragraph (b)(20) to 
delete references to a supervision process involving a SROP and CROP, 
and instead would require each member that conducts a public customer 
options business to ensure that its written supervisory system policies 
and procedures pursuant to NASD Rules 3010, 3012, and 3013 adequately 
address the member's public customer options business. Although the 
proposed rule change would eliminate entirely the positions and titles 
of the SROP and CROP, a member would still be required pursuant to NASD 
Rule 3010(a)(2) to designate ``an appropriately registered principal(s) 
with authority to carry out the supervisory responsibilities of the 
member for each type of business in which it engages for which 
registration as a broker/dealer is required,'' which would include 
designating a ROSFP to supervise a member's public customer options 
activities.
    FINRA will announce the effective date of the proposed rule change 
in a Regulatory Notice to be published no later than 60 days following 
Commission approval. The effective date will be no later than 30 days 
following publication of the Regulatory Notice announcing Commission 
approval.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\8\ which requires, among 
other things, that FINRA 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. FINRA believes that the supervisory and compliance 
function of a member's public customer options activities would be 
better integrated into the matrix of a firm's overall supervisory and 
compliance functions rather than separately vested in a SROP and CROP.
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    \8\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/sro.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number SR-FINRA-2007-035 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-FINRA-2007-035. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/
rules/sro.shtml). 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

[[Page 26457]]

the Commission's Public Reference Room, 100 F Street, NE., Washington, 
DC 20549, on official business days between the hours of 10 a.m. and 3 
p.m. Copies of such filings also will be available for inspection and 
copying at the principal office of FINRA. All comments received will be 
posted without change; the Commission does not edit personal 
identifying information from submissions. You should submit only 
information that you wish to make available publicly. All submissions 
should refer to File Number SR-FINRA-2007-035 and should be submitted 
on or before May 30, 2008.

IV. Commission Findings

    The Commission has carefully reviewed the proposed rule change and 
finds that it is consistent with the requirements of the Act and the 
rules and regulations thereunder applicable to a national securities 
association.\9\ In particular, the Commission believes that the 
proposed rule change would help to better integrate the supervisory and 
compliance functions of a firm's public customer options activities 
into the firm's overall supervisory and compliance functions, thereby 
eliminating any uncertainty about where supervisory responsibility 
lies. Therefore, the Commission finds that the proposed rule change is 
consistent with Section 15A(b)(6) of the Act,\10\ which requires, among 
other things, that FINRA rules 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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    \9\ In approving the proposed rule change, the Commission 
considered the proposal's impact on efficiency, competition, and 
capital formation. 15 U.S.C. 78c(f).
    \10\ 15 U.S.C. 78o-3(b)(6).
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    The Commission also finds good cause to approve the proposed rule 
change prior to the thirtieth day after the date of publication of 
notice of filing of the amendment in the Federal Register. The proposed 
rule change is substantially similar to recent CBOE rule amendments 
concerning options supervision, which were approved by the 
Commission.\11\ The Commission believes that approving the proposed 
rule change will simplify firms' compliance, and is consistent with the 
public interest and the investor protection goals of the Act. Finally, 
the Commission finds that it is in the public interest to approve the 
proposed rule change as soon as possible to expedite its 
implementation.
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    \11\ See Securities Exchange Act Release No. 56971 (December 14, 
2007), 72 FR 72804 (December 21, 2007) (Approval Order for File No. 
SR-CBOE-2007-106).
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    Accordingly, the Commission believes good cause exists, consistent 
with Sections 15A(b)(6) and 19(b) of the Act,\12\ to approve the 
proposed rule change on an accelerated basis.
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    \12\ 15 U.S.C. 78o-3(b)(6), and 78s(b).
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\13\ that the proposed rule change (File No. SR-FINRA-2007-035), as 
modified by Amendment No. 1, be, and hereby is, approved on an 
accelerated basis.
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    \13\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
 [FR Doc. E8-10339 Filed 5-8-08; 8:45 am]

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