Linsco/Private Ledger, Corp
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January 16, 2003
Jonathan G. Katz
Re: File No. SR-NASD-2002-162
Dear Mr. Katz,
Linsco/Private Ledger, Corp ("LPL") appreciates the opportunity to comment on NASD proposed Rule 3012 and amendments to Rule 3010(c) (collectively, "Proposed Rules"). The principal focus of our comments will be proposed Rule 3012. LPL is a registered broker-dealer, with approximately 4,400 registered representatives and offers a wide selection of financial products, including general securities, mutual funds, fixed and variable annuities and life insurance.
As the leading independent brokerage firm in the nation, we are strongly committed to effective supervision and compliance. Senior management at LPL, including its Chairman, General Counsel and Chief Compliance Officer, take an active role in regulation of the broker/dealer industry, through participation in industry organizations and self-regulatory bodies. LPL's Compliance Department includes over 70 experienced staff who are responsible for conducting oversight and supervision of the firm's registered representatives. The core elements of LPL's proactive approach to compliance are well-trained, knowledgeable staff; an automated compliance review process; regular field audits and a progressive continuing education program that includes individual and group training via conference calls, conferences and workshops.
As such, LPL is fully supportive of the objectives of the Proposed Rules to ensure thorough and effective supervisory systems. We believe, however, that the proposed Rule 3012 is in many instances overly broad and detrimental to existing business practices. It may lead to duplication of effort without substantially improving NASD member firms' supervisory systems.
It is our understanding that the Proposed Rules are intended to address deficiencies in broker-dealer practices and supervisory procedures that have been identified through the misconduct evidenced in the Frank Gruttadauria case. The Gruttadauria case involved an elaborate and regrettably successful scheme to misappropriate client funds over a remarkably long time period. The conduct in the Gruttadauria case is reprehensible and LPL fully supports rule making designed to prevent any recurrence. We are concerned, however, that the expense associated with implementing the Rule 3012 as well as the administrative burden placed on member firms will be excessive when weighed against the remedial effect.
The "Independence" Requirement
Proposed Rule 3012 would require Office of Supervisory Jurisdiction ("OSJ") and branch office audits to be conducted on an annual basis by persons "independent" from activities performed at the branch office and, from compensation derived from that office. In its statement submitted with the Proposed Rules, the NASD has indicated that persons conducting annual audits "must not be connected in function to, or receive direct remuneration from the activities which are the subject of the supervisory control procedures," and "must not report to persons who supervise that activity." The Proposed Rules should further clarify the meaning of the term "independent" to address the ambiguity as to the status of home office and regional personnel.
The Annual Audit Requirement
The conduct at issue in the Gruttadauria case may not be addressed effectively by audits of branch offices, regardless of the "independence" of the person conducting such audits. Individuals intent on perpetrating the type of fraud found in the Gruttadauria case will go to great lengths to hide their actions. Strong, centralized surveillance systems and procedures will better address the concerns raised by the NASD relative to the conduct in the Gruttadauria case. Proposed Rule 3012 requires testing of specific items during the course of each branch audit including the following items:
In most instances, the items noted under the proposed Rule 3012 to be addressed during audit of the typical OSJ or branch office locations are maintained centrally at the member firm home office. For example:
By sending a confirmation letter to the customer from the home office on all address changes, transfer requests or withdrawals from an account, the customer will be alerted to the fraudulent activities at issue in the Gruttadauria case.
Potential for Disparate Impact
We also note that unlike other recent NASD rules, such as amendments to Rule 3010 (d) (2), the recommendations in this rule proposal do not permit the broker-dealer to structure its supervisory systems in a manner appropriate to its business, size and structure Nor do they take into account the availability of automation or the financial resources of the firm. In order for many member firms to achieve the level of "independence" sought by the Proposed Rules, members may be required to incur substantial additional costs, including employing additional audit staff or creating a new supervisory structure. This will impact the capacity of firms to continue to offer much needed services in rural and remote locations where many non-OSJ and satellite offices are located. LPL also believes that the Proposed Rules will disproportionately impact independent contractor firms. Most "wire-house" firm branch locations are of a size and nature that already require audits to be conducted from the home office. In contrast, most independent contractor broker-dealers have numerous non-OSJ locations that proposed Rule 3012 would require home office staff to travel to in order to achieve the independent audit standards.
We believe that there are many ways to achieve the NASD's intended goal. For example, on-site audits of non-OSJ locations are not necessary by home office auditors if duplicate records are maintained at the OSJ branch office. At LPL, the locations identified as OSJ branch offices are audited by home office Compliance personnel ("Compliance Analysts"). Non-OSJ locations are audited by the OSJ manager at least twice a year. OSJ managers are required to submit copies of their audit results to the home office Compliance Department once completed. Additionally, home office Compliance personnel review the results of the OSJ manager's inspection of non-OSJ locations during the annual audit of the OSJ branch office. By requiring maintenance of duplicate records at the OSJ, the home office auditor has the ability to conduct the oversight of account records, customer statements, trade blotters, investment applications, security/check receipts, customer complaints, order tickets, confirmations, correspondence, advertising & sales literature, and other client information during the audit of the OSJ location. Submission of the report of the inspections of non-OSJ branch offices conducted by OSJ registered principals to the Compliance Department allows the home office to verify information found during the on site OSJ audit inspection.
We appreciate the opportunity to comment on the Proposed Rules. While we are in full agreement with the sentiment behind these proposals, we hope that the Commission will take into consideration our suggestions as to the best means of addressing the issues presented in the Gruttadauria case and will evaluate further the significant burden these Proposed Rules, as drafted, will cause the majority of NASD member firms.
cc: Ms. Barbara Sweeney