4 February 1998
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[Federal Register: January 8, 1998 (Volume 63, Number 5)]
[Notices]
[Page 1135-1139]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr08ja98-96]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-39511; File No. SR-NYSE-96-26]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change and Notice of Filing and Order Granting Accelerated Approval to
Amendment Nos. 2 and 3 to the Proposed Rule Change by the New York
Stock Exchange, Inc., Relating to NYSE Rules 342, ``Offices--Approval,
Supervision and Control,'' 440, ``Books and Records,'' and 472,
``Communications with the Public''
December 31, 1997.
I. Introduction
On September 12, 1996, the New York Stock Exchange, Inc. (``NYSE''
or ``Exchange'') 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 allow broker-dealers to
establish reasonable procedures for reviewing registered
representatives' communications with the public relating to their
business. On November 7, 1996, the NYSE filed Amendment No. 1 to the
proposal.\3\ The proposed rule
[[Page 1136]]
change and Amendment No. 1 were published for comment in the Federal
Register on November 19, 1996.\4\ The Commission received three comment
letters regarding the proposal.\5\
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\1\ 15 U.S.C. Sec. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Letter from James E. Buck, Senior Vice President and
Secretary, NYSE, to Katherine A. England, Assistant Director,
Division of Market Regulation (``Division''), Commission, dated
November 6, 1996 (``Amendment No. 1''). Amendment No. 1 makes
technical revisions to clarify the proposed changes to NYSE Rules
440, ``Books and Records,'' and 472, ``Communications with the
Public.'' Specifically, Amendment No. 1 modifies NYSE Rule 440 to
indicate that members must preserve books and records as required
under SEC Rule 17a-3 and comply with the recordkeeping format,
medium and retention period specified in SEC Rule 17a-4. In
addition, Amendment No. 1 revises paragraph NYSE Rule 472(c) to
clarify that records retained must be readily available to the
Exchange, upon request. Under NYSE Rule 472(c), the names of the
persons who prepared and who reviewed and approved the material must
be ascertainable from the retained records.
\4\ See Securities Exchange Act Release No. 37941 (November 13,
1996), 61 FR 58919.
\5\ See Letter from Kenneth S. Spirer, Chairman, Technology
Regulatory Subcommittee of the Securities Industry Association's
(``SIA'') Technology Issues Committee, to Jonathan G. Katz,
Secretary, Commission, dated December 9, 1996 (``SIA Letter'');
Letter from Paul Saltzman, Senior Vice President and General
Counsel, PSA The Bond Market Trade Association, to Jonathan G. Katz,
Secretary, Commission, dated December 10, 1996 (``PSA Letter''); and
Letter from Kenneth S. Spirer, First Vice President and Assistant
General Counsel, Merrill Lynch, to Jonathan G. Katz, Secretary,
Commission, dated December 9, 1996 (``Merrill Lynch Letter'').
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On November 3, 1997, the NYSE filed Amendment No. 2 to the
proposal.\6\ On November 26, 1997, the NYSE filed Amendment No. 3 to
the proposal.\7\ This order approves the proposed rule change and
Amendment No. 1, and approves Amendment Nos. 2 and 3 to the proposal on
an accelerated basis. The Commission also is approving a substantially
identical proposal by the National Association of Securities Dealers,
Inc. (``NASD'').\8\
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\6\ See Letter from James E. Buck, Senior Vice President and
Secretary, NYSE, to Katherine A. England, Assistant Director,
Division, Commission, dated October 31, 1997 (``Amendment No. 2'').
Prior to filing Amendment No. 2, the NYSE had planned to rescind
Interpretation 342(a)(b)/04 of the NYSE Interpretation Handbook,
thereby eliminating the Exchange's requirement that broker-dealers
review all incoming correspondence. Amendment No. 2 rescinds
Interpretation 342(a)(b)/04 and replaces it with Interpretation
342.16/04, which will require broker-dealers to continue to review
all incoming non-electronic communications addressed to registered
representatives. Incoming non-electronic communications directed to
associated persons other than registered representatives, and any
incoming communications received in electronic format (e.g., e-
mail), will be subject to supervisory procedures established by the
broker-dealer.
\7\ See Letter from James E. Buck, Senior Vice President and
Secretary, NYSE, to Katherine England, Assistant Director, Division,
Commission, dated November 25, 1997 (``Amendment No. 3''). Amendment
No. 3 contains the final version of an information memorandum (the
``Information Memo'') to members which describes the new rules for
supervision of public communications and provides guidance
concerning implementation of the new rules.
\8\ See Securities Act Release No. 39510 (December 31, 1997)
(order approving File No. SR-NASD-97-24).
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II. Description of the Proposal
According to the NYSE, new technology and means of communication
(e.g., e-mail and the Internet) have impacted the way that NYSE member
organizations and their associated persons conduct business and
communicate with customers and other members of the public. The
Exchange states that it worked with a committee comprised of
representatives from NYSE member organizations to study questions
relating to the supervision and review of these new means of
communication and, as a result of its review, developed the proposed
amendments to NYSE Rules 342, ``Offices--Approval, Supervision, and
Control,'' 440, ``Books and Records,'' and 472, ``Communications with
the Public.''
Currently, NYSE Rule 342.16 ``Supervision of registered
representatives,'' requires supervisors to review all written and
electronic correspondence of registered representatives prior to use.
The NYSE proposes to amend Exchange Rule 342.16 to replace the current
pre-use review requirement with a rule that will allow broker-dealers
to establish reasonable procedures for review of registered
representatives' communications with the public relating to their
business. Under the proposal, a broker-dealer may continue to require
pre-use review of all public communications,\9\ alternatively, any
broker-dealer that chooses to implement other reasonable procedures for
reviewing registered representatives' public communications must, among
other things: (1) Develop written supervisory policies and procedures;
(2) design policies and procedures to reasonably supervise each
registered representative; and (3) maintain evidence that its
supervisory policies and procedures have been implemented and make that
evidence available to the NYSE upon request.
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\9\ In this regard, the NYSE notes that, given the complexity
and cost of establishing adequate systems for effectively reviewing
electronic communications, member firms may decide to continue to
require pre-use review of all communications. See Information Memo,
supra note 7, at 2.
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A broker-dealer's policies and procedures for reviewing the public
communications of registered representatives also must satisfy the
requirements of new NYSE Rule 342.17, ``Review of communications with
the public.'' NYSE Rule 342.17, which will apply to the public
communications of all associated persons, requires broker-dealers to
develop written policies and procedures for review of public
communications that are appropriate for the broker-dealer's business,
size, structure, and customers. Under NYSE Rule 342.17, a broker-dealer
that does not require pre-use review of public communications must: (1)
Regularly educate and train employees in the firm's current policies
and procedures governing review of communications; (2) document how and
when employees were educated and trained; and (3) monitor and test to
ensure implementation and compliance with the firm's policies and
procedures.
The NYSE has developed an Information Memo \10\ that provides
additional guidance and requirements for supervisory procedures adopted
pursuant to NYSE Rule 342. In addition to noting that broker-dealers
must develop appropriate supervisory procedures, the Information Memo
requires that broker-dealers, among other things: (1) specify, in
writing, the firm's policies and procedures for reviewing each type of
communication; (2) identify how supervisory reviews will be conducted
and documented; (3) identify the types of communication that will be
pre- or post-reviewed and the organizational position(s) responsible
for conducting reviews of different types of communication; (4) specify
the minimum frequency of reviews for each type of communication; and
(5) periodically re-evaluate the effectiveness of the firm's procedures
for reviewing public communications and consider any necessary
revisions.
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\10\ See Amendment No. 3, supra note 7.
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In addition, the Information Memo requires broker-dealers to: (1)
Specify procedures for reviewing registered representatives'
recommendations to customers; (2) require supervisory review of a
percentage of each registered representative's public communications,
including recommendations to customers; and (3) consider the complaint
and overall disciplinary history (if any) of a registered
representative or other employee in establishing supervisory
procedures. The Information Memo also states that a broker-dealer's
supervisory policies and procedures must ensure that all customer
complaints, whether received via e-mail or in written form, are
reported to the NYSE in compliance with NYSE Rule 351(d),\11\ and that
a broker-dealer must prohibit registered representatives' and other
employees' use of electronic communications to the public unless such
communications are
[[Page 1137]]
subject to supervisory and review procedures by the firm.
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\11\ Among other things, NYSE Rule 351(d) requires members and
member organizations to report to the NYSE statistical information
regarding customer complaints relating to matters specified by the
NYSE.
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The NYSE notes that the standards for communications provided in
NYSE Rule 472 continue to apply to all communications regardless of the
transmission medium used or the policies and procedures for review and
supervision that a broker-dealer adopts pursuant to NYSE rule 342.\12\
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\12\ Amount other things, NYSE Rule 472 prohibits broker-dealers
from using any communications with contains (i) any untrue statement
or omission of a material fact or is otherwise false or misleading;
(ii) promises of specific results, exaggerated or unwarranted
claims; (iii) opinions for which there is no reasonable basis; or
(iv) projections or forecasts of future events which are not clearly
labeled as forecasts.
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The NYSE proposes to amend its requirements for review of incoming
correspondence by rescinding and replacing current Interpretation
342(a)(b)/04 in the NYSE Interpretation Handbook, which requires
members to review all incoming correspondence of all associated
persons, with Interpretation 342.16/04.\13\ Interpretation 342.16/04
will require broker-dealers to review all incoming non-electronic
communications directed to registered representatives. Incoming non-
electronic communications directed to associated persons other than
registered representatives and incoming electronic communications
(e.g., e-mail) will be subject to the supervisory policies and
procedures established by the broker-dealer pursuant to NYSE Rule 342.
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\13\ See Amendment No. 2, supra note 6.
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The Exchange proposes to amend NYSE rule 472(a) to clarify the
types of communications that will continue to require pre-use approval.
NYSE Rule 472(a) currently requires prior approval of any communication
which is generally distributed or made available by a member to
customers or the public. NYSE Rule 472(a), as amended, will require
prior approval of each advertisement, market letter, sales literature,
or other similar communication which is generally distributed or made
available to customers or the public. In addition, the NYSE proposes to
amend NYSE Rule 472(b) to clarify that research reports must be
approved in advance by a supervisory analyst. The NYSE proposes to
amend NYSE Rule 472(c) to provide that the names of persons who
prepared and who reviewed and approved communications with the public
must be readily ascertainable from the retained records.
Finally, the NYSE proposes to amend NYSE Rule 440 to indicate that
members must preserve books and records as required under SEC Rule 17a-
3 and comply with the recordkeeping format, medium and retention period
specified in SEC Rule 17a-4.\14\
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\14\ See Amendment No. 1, supra note 3.
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III. Comments
The Commission received three comment letters regarding the
proposal.\15\ All three commenters supported the proposal.
Specifically, the SIA believes that the proposal will provide broker-
dealers with needed flexibility in developing procedures for review of
correspondence. In addition, the SIA notes that the proposal will not
diminish the general supervisory responsibilities of firms. Instead,
``[t]he burden will now be on firms to develop supervisory approaches
that they can demonstrate are reasonable.'' \16\
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\15\ See note 5, supra.
\16\ See SIA Letter, supra note 5, at 2.
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Similarly, PSA believes that the NYSE's proposal constitutes a
flexible and functional approach to regulation that will allow member
firms to integrate electronic communications into their securities
activities. PSA believes that procedures tailored by individual firms
to meet their needs are preferable to a uniform set of detailed
requirements that may be inappropriate for many firms or that may
quickly become obsolete.\17\
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\17\ See PSA Letter, supra note 5, at 2.
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Merrill Lynch also praises the flexible approach proposed by the
NYSE and believes that the proposal removes a significant impediment to
the use of electronic communications by eliminating the pre-use review
requirement for correspondence.\18\
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\18\ See Merrill Lynch Letter, supra note 5, at 2.
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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 exchange, and, in
particular, the requirements of Section 6(b)(5),\19\ in that it is
designed to prevent fraudulent and manipulative acts and practices and
to protect investors and the public interest. As noted above, NYSE Rule
342.16, as amended, will allow broker-dealers to establish reasonable
procedures for review of registered representatives' communications
with the public relating to their business. New NYSE Rule 342.17 will
require broker-dealers to develop written policies and procedures for
the review of all associated persons' public communications that are
appropriate for the broker-dealer's business, size, structure, and
customers. The Commission believes that the proposed rules will provide
broker-dealers with some flexibility in adopting and implementing
supervisory procedures for reviewing associated persons' public
communications while establishing minimum requirements, guidelines, and
standards governing the supervisory procedures a broker-dealer may
adopt. The Commission believes that these standards and guidelines will
help to ensure that broker-dealers continue to provide appropriate
supervision of the public communications of their associated persons.
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\19\ 15 U.S.C. Sec. 78f(b)(5).
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The Commission agrees with the analysis of the SIA that the
proposal does not diminish the general supervisory responsibilities of
broker-dealers.\20\ In this regard, the Commission emphasizes, as it
has stated previously, that broker-dealers must monitor the trading and
sales activities of their associated persons and establish effective
compliance and supervisory procedures to prevent and detect possible
violations of firm policies and procedures, rules of the self-
regulatory organizations, and federal and state securities laws.\21\
The Commission believes that review of registered representatives' and
other associated persons' public communications is an important
component of a broker-dealer's duty to supervise its employees, and
that broker-dealers have substantial supervisory obligations arising
from the public communications of their associated persons. In
addition, as the NYSE states in its proposal, the standards for
communications set forth in NYSE Rule 472 continues to apply to all
public communications, regardless of the medium of transmission or the
supervisory policies and procedures a firm adopts.\22\
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\20\ See SIA Letter, supra note 5, at 2.
\21\ See NASD, NYSE, North American Securities Administrators
Association, Inc., and Office of Compliance Inspections and
Examinations, Commission, Joint Regulatory Sales Practice Sweep
(1996) (``Joint Sweep Report'') at 1.
\22\ See note 12, supra, and note 24, infra, for discussions of
the requirements of NYSE Rule 472.
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The Commission believes that the minimum standards and requirements
specified in NYSE Rules 342.16 and 342.17 and in the Information Memo
will help to ensure that broker-dealers continue to provide appropriate
supervision of the public communications of their registered
representatives and other associated persons. In this regard, the
Commission notes that NYSE Rule 342.16 states that a broker-dealer's
supervisory policies
[[Page 1138]]
and procedures must be designed to reasonably supervise each registered
representative. Under NYSE Rule 342.17, a broker-dealer that chooses
not to require pre-use review of public communications must educate
employees about the firm's current communications policies and
procedures, document the employees' education and training, and ensure
that the firm's policies are implemented and adhered to.
In addition, the NYSE Information Memo requires broker-dealers to:
(1) Specify, in writing, the firm's policies and procedures for
reviewing different types of communications; (2) identify how
supervisory reviews will be conducted and documented; (3) identify what
types of communications will be pre-reviewed or post-reviewed; (4)
identify the organizational position(s) responsible for conducting
reviews of the different types of communications; (5) specify the
minimum frequency of reviews for different types of communications; (6)
monitor the implementation of and compliance with the firm's procedures
for reviewing public communications; and (7) periodically re-evaluate
the effectiveness of the firm's procedures for reviewing public
communications and consider any necessary revisions.
The Commission believes that these requirements will provide
guidance to broker-dealers in developing policies for supervising
public communications and to associated persons in complying with the
firm's policies. The requirements should help to ensure that broker-
dealers carefully consider the supervisory procedures appropriate for
different types of communications, closely monitor compliance with
their firm's policies, and periodically re-evaluate their firm's
policies and procedures. The Commission expects broker-dealers to
monitor the effectiveness of their supervisory policies and procedures
and to promptly make any necessary revisions.
The Information Memo also requires broker-dealers to: (1) Specify
procedures for reviewing registered representatives' recommendations to
customers; (2) require supervisory review of some of each registered
representative's public communications, including his or her
recommendations to customers; (3) consider the complaint and overall
disciplinary history, if any, of registered representatives and other
employees in developing procedures for supervising their communications
with the public; (4) provide that all customer complaints, whether
received via e-mail or in written form from the customer, are reported
to the NYSE in compliance with NYSE Rule 351(d); and (5) prohibit
employees' use of electronic communications to the public unless the
communications are subject to supervisory and review procedures
developed by the firm.
The Commission believes that these standards will help to ensure
that broker-dealers adopt effective and appropriate supervisory
procedures. For example, reviewing at least some of a registered
representative's recommendations \23\ and providing for the reporting
of customer complaints in compliance with NYSE Rule 351(d) may help
firms to identify potential sales practice problems. Similarly,
considering a registered representative's complaint and overall
disciplinary history will help to ensure that broker-dealers implement
supervisory procedures appropriate for each representative. In this
regard, the Commission would expect a broker-dealer to consider
providing heightened supervision for a registered representative with a
history or pattern of customer complaints, disciplinary actions or
arbitrations.\24\ Moreover, the Commission notes that the requirements
specified in NYSE Rule 342 and in the Information Memo are minimum
requirements; the Commission expects each broker-dealer to implement
any additional procedures the broker-dealer believes are necessary to
provide appropriate supervision of all of its associated persons.
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\23\ With regard to recommendations, the Commission notes that
NYSE Rule 472.40, ``Specific Standards for Communications,''
requires, among other things, that a recommendation have a basis
which can be substantiated as reasonable and that members make
certain disclosures when making recommendations. Regardless of the
supervisory procedures a broker-dealer adopts, the broker-dealer
must continue to ensure compliance with NYSE Rule 472.40.
\24\ Similarly, the Joint Sweep Report stated that ``[f]irms
that hire registered persons that have a history or pattern of
customer complaints, disciplinary actions, or arbitrations are
responsible for imposing close supervision over these persons.
`Normal' supervision is simply not enough; firms must craft special
supervisory procedures tailored to the individual representatives.''
See Joint Sweep Report, supra note 21, at iv. See also NASD Notice
to Members 97-19 (firm that hires a registered representative with a
recent history of customer complaints, final disciplinary actions
involving sales practice abuse or other customer harm, or adverse
arbitration decisions should determine if it is necessary to develop
and implement special supervisory procedures tailored to the
individual registered representative).
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The Commission believes that several requirements specific to
electronic communications will further help to ensure that firms adopt
appropriate supervisory procedures. In this regard, the Commission
notes that the Information Memo provides that a firm's policies and
procedures must prohibit registered representatives' and other
employees' use of electronic communications to the public unless those
communications are subject to supervisory and review procedures
developed by the firm. The NYSE Information Memo also states that the
Exchange expects members to prohibit communications with the public
from employees' home computers or through third party computer systems
unless the firm is capable of monitoring the communications.
The Commission believes that the provisions for review of incoming
correspondence also are designed to protect investors. In this regard,
the Commission notes that the NYSE amended its proposal to adopt
Interpretation 342.16/04 in the NYSE Interpretation Handbook, which
will continue to require review of all incoming non-electronic
correspondence directed to registered representatives.\25\ The
Commission believes that this requirement may provide a broker-dealer
with early notice of sales practice problems and help to ensure proper
handling of customer funds. Incoming non-electronic correspondence
directed to associated persons other than registered representatives,
and all incoming communications in electronic format, will be subject
to the policies and procedures the firm establishes pursuant to NYSE
Rules 342.16 and 342.17.
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\25\ See Amendment No. 2, supra note 6.
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The NYSE represents that it will review members' procedures and
systems periodically to ensure that they are reasonable in view of the
firm's structure, the nature and size of its business, and its customer
base.\26\ The Commission expects the NYSE to monitor closely the
policies and procedures firms adopt pursuant to the proposal to ensure
that they satisfy the requirements of the NYSE Rules 342.16 and 342.17.
In addition, the Commission expects the NYSE to review NYSE Rule 342.16
and 342.17 as it gains experience with the rules and to consider any
necessary revisions, including additional minimum requirements for
broker-dealers' communications policies.
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\26\ See NYSE Information Memorandum, supra note 7, at 5.
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The Commission believes that the NYSE's proposed amendments to NYSE
Rule 472 are reasonable and consistent with the Act. Specifically, the
Commission believes that it is reasonable for the NYSE to amend NYSE
Rule 472(a) to require prior approval of each advertisement, market
[[Page 1139]]
letter, sales literature, or other similar communication (rather than
any communication) which is generally distributed or made available to
customers or the public in order to make NYSE Rule 472(a) consistent
with NYSE Rule 342, as amended. In addition, the Commission believes
that the NYSE's proposal to amend NYSE Rule 472(b) to provide that
research reports must be approved in advance by a supervisory analyst
will clarify NYSE Rule 472(b) and ensure that broker-dealers review
research reports in accordance with NYSE Rule 472(b). The Commission
believes that amendment NYSE Rule 472(c) to provide that the names of
persons who prepared and who reviewed and approved communications with
the public must be readily ascertainable from the retained records, and
that the retained records must be readily available to the NYSE, will
clarify the NYSE's rule and facilitate examination of broker-dealers.
Finally, the Commission believes that it is reasonable for the NYSE
to amend NYSE Rule 440 to indicate that members must preserve books and
records as required under SEC Rule 17a-3 and comply with the
recordkeeping format, medium and retention period specified in SEC Rule
17a-4 \27\ in order to clarify the recordkeeping requirements
applicable to broker-dealers.
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\27\ See Amendment No. 1, supra note 3.
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The Commission finds good cause for approving Amendment Nos. 2 and
3 prior to the thirtieth day after the date of publication of notice of
filing thereof in the Federal Register. Amendment No. 2 is designed to
protect investors by requiring broker-dealers to continue to review all
non-electronic incoming communications directed to registered
representatives. Amendment No. 3 strengthens the NYSE's proposal by
incorporating the Information Memo into the Exchange's proposal. As
discussed more fully above, the Information Memo provides additional
requirements and guidelines for broker-dealers' supervisory policies.
Accordingly, the Commission believes that granting accelerated approval
of Amendment Nos. 2 and 3 is appropriate and consistent with Sections
6(b)(5) and 19(b)(2) of the Act.\28\
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\28\ 15 U.S.C. Secs. 78f(b)(5) and 78s(b)(2).
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V. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reason for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(a) by order approve such proposed rule change, or
(b) institute proceedings to determine whether the proposed rule
change should be disapproved.
VI. Solicitation of Comments
Interested persons are invited to submit written date, views and
arguments concerning Amendment Nos. 2 and 3. Persons making written
submissions should file six copies thereof with the Secretary,
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington,
D.C. 20549. 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 at the Commission's Public Reference Section, 450 Fifth Street,
N.W., Washington, D.C. Copies of such filing will also be available for
inspection and copying at the principal office of the NYSE. All
submissions should refer to the file number SR-NYSE-96-26 and should be
submitted by January 29, 1998.
VII. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\29\ that the proposed rule change (SR-NYSE-96-26), as amended, is
approved.
\29\ 15 U.S.C. Sec. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\30\
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\30\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 98-422 Filed 1-7-98; 8:45 am]
BILLING CODE 8010-01-M