AXA Advisors, LLC
John M. Lefferts, CFP, CLU, ChFC
(Filed electronically in Word format: firstname.lastname@example.org)
December 18, 2002
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
RE: Release No. 34-46859; File No. SR-NASD-2002-162
Dear Mr. Katz:
AXA Advisors, LLC ("AXA Advisors") appreciates the opportunity to comment on the new Rule 3012 and amendments to Rules 2510, 3010, 3110 and IM-3110 ("Proposed Rules"), proposed by the National Association of Securities Dealers Regulation ("NASDR") relating to the supervisory and supervisory control procedures of member firms.
AXA Advisors is a registered broker/dealer and investment advisor, and is a member of the National Association of Securities Dealers, Inc. ("NASD"). AXA Advisors has approximately 7,000 financial professionals serving 2.5 million households & businesses throughout the continental United States, Hawaii, Puerto Rico and the Virgin Islands. AXA Advisors offers a wide range of advisory services, and investment and insurance products. AXA Advisors is a subsidiary of AXA Financial, Inc. ("AXA Financial"). AXA Financial is one of the world's premier financial services organizations with over $441 billion in assets under management at June 30, 2002. In addition to AXA Advisors, AXA Financial's subsidiaries include The Equitable Life Assurance Society of the U.S., Alliance Capital Management L.P., and Sanford C. Bernstein & Co. AXA Financial is a member of the global AXA Group, a worldwide leader in financial protection and wealth management with operations in 50 countries.
At the outset, AXA Advisors wishes to emphasize that it understands the important role that adequate supervisory systems play in assuring investor protection and the integrity of our financial markets. AXA Advisors supports reasonable regulatory enhancements that are designed to meaningfully improve investor protection, provided that they do so at a cost that is not unreasonably or disproportionately burdensome to member firms. Regrettably, however, it is our view that much of what is set forth in the Proposed Rules, if adopted, will not materially improve investor protection and may impose burdensome costs on member firms, particularly those that operate from small branch offices, that are wholly disproportionate to the benefits that they would produce.
It is our understanding that the Proposed Rules were, in large part, a response to the recent and well-publicized Gruttadauria case, which involved the fraudulent misappropriation of customer funds. In that case we understand the facts to be that over a number of years, a registered representative had instructed his brokerage firm to send customers' statements and correspondence to a post office box designated by him in order to facilitate his creation of forged statements to be sent to those customers. The forged statements masked the fact that the representative was withdrawing funds from customers' accounts and diverting those funds to his own use.
To be sure, the Gruttadauria case, shocking in its very simplicity, is a stark reminder of the need for brokerage firms to be ever vigilant and to maintain and enforce adequate supervisory procedures. Having said this, however, we believe that the Proposed Rules do not address or solve the essential problem presented by the Gruttadauria case. The Gruttadauria case involved criminal fraud, intentionally obviating existing systems and procedures to misappropriate client funds. In our view, most of the regulatory requirements sought to be imposed by the Proposed Rules, and particularly those focused on branch office inspections, would not have prevented this kind of intentional fraudulent activity. Indeed, experience teaches that the large majority of registered representatives who are intent on committing fraud typically are careful not to leave evidence of such fraud accessible to branch office examiners. We believe that the only way such fraud could potentially be detected, if at all, is through enhanced surveillance by the firm at appropriate control points.
AXA Advisors believes that the existing regulatory framework and rules appear more than adequate to impose on members the responsibility to take reasonable steps to conduct such surveillance. Rule 3010 generally requires each member to establish and maintain an appropriate supervisory system, including the development of written procedures. Under Rule 3010, a member's supervisory system is already required to encompass the activities in which the member engages as well as the activities of the member's registered representatives and associated persons in order to achieve compliance with applicable securities laws and regulations and NASD rules. Not only must supervisory procedures be established, but it is implicit in the existing rules that such procedures must also be appropriately tested and verified through a system of supervisory control procedures to ensure appropriate application and effectiveness. In addition, the NASD has established comprehensive examination procedures for supervisory controls. The examination procedures focus on supervisory controls as they relate to several areas of a firm, including senior management, internal audit and trading risk controls.
While a significant portion of the Proposed Rules, in our view, add little of substance to the supervisory responsibilities or standards currently in existence, at least one aspect of the proposal has the potential to be infeasible for a significant portion of NASD members that operate from small branch offices. Specifically, Proposed Rule 3010(c) would require that all branch office inspections be conducted by a person who is independent from the activities performed at the office and the persons providing supervision to the office. Since, as described below, it is by no means clear that the persons currently conducting such inspections would qualify as "independent," this requirement would add substantially to the costs of supervision for many firms, potentially rendering it infeasible or less feasible to maintain smaller branch offices. And it would do so, in our view, without enhancing materially the protection of investors for the reasons discussed above.
Registered representatives working from small branch offices are not only an essential and necessary component to the distribution systems of many companies, but also make it possible for customers outside major U.S. cities to be served locally. Consistent with their business models, member firms that operate small branch offices frequently rely on properly licensed and trained professionals in field or regional offices to conduct branch office inspections. Often, these individuals may be compensated in part by incentive arrangements that may be determined by branch managers and/or linked, at least to some degree, to branch office (or other business unit) performance.1 Linking compensation to business unit performance, of course, is quite common throughout the broker/dealer industry at all levels of management. Indeed, we would submit that the overwhelming majority of persons in the industry who have some supervisory responsibility are paid, at least in part, based on business unit performance. Unfortunately, however, the Proposed Rules seemingly would render such individuals ineligible to conduct branch office inspections without a substantial change to how their compensation is structured or determined. To require firms to drastically alter their compensation and/or business models, to advance a supervisory objective that, for the reasons noted above, cannot be reasonably expected to detect the type of violative conduct that it was purportedly designed to uncover, makes little sense. Accordingly, we submit that the Proposed Rules should not be prescriptive or presumptive in requiring of independence for branch exams.2 Instead, consistent with the mandate of NASD Rule 3010(a)3, the determination of how best to assure the effectiveness of branch inspections should be left to the discretion and good judgment of the firm.4 This, of course, is in no way intended to usurp the regulatory prerogative that NASDR already has under its existing rules to challenge the effectiveness of such system.
AXA Advisors applauds the focus of NASDR on enhancements to supervisory requirements to prevent fraudulent and manipulative acts and practices. However, we believe that, as a general proposition, the Proposed Rules add little to the existing regulatory construct and therefore do not meaningfully reduce the potential for fraud. Moreover the specific independence requirements have the potential to impose substantial burdens on firms, particularly those who operate from small branch locations, again without meaningfully enhancing investor protection.
Again, we appreciate the opportunity to comment on these proposals and hope that the Commission will give appropriate consideration to the views expressed in this letter.
/s/ John M. Lefferts
John M. Lefferts
|cc:||Barbara Z. Sweeney, Senior Vice President and Corporate Secretary, NASD,|
Office of the Corporate Secretary
|1||It should be noted that branch office performance is not necessarily synonymous with branch office production. Indeed, branch office performance may take account of (in addition to production), e.g., compliance, customer complaints, registered representative recruiting/retention, expense management, etc.|
|2||In making this recommendation, we are in no way suggesting that potential conflicts of interest ought not be recognized. To be sure, a firm must always seek to identify such conflicts and take steps to assure that they do not compromise the integrity of its compliance program. Moreover, it goes without saying that any person conducting a branch office inspection must be appropriately licensed, trained and supervised.|
|3||NASD Rule 3010(a) states "Final responsibility for proper supervision shall rest with the member."|
|4||We are not unmindful that the Proposed Rules provide that the independence requirements may be satisfied "by reasonable means based on the size and resource of the firm and the scope and nature of its responsibilities" and that the rule does specifically empower the NASD to grant exemptive relief for good cause. Far from providing comfort, however, the lack of clarity around the independence standard renders it, potentially, a trap for the unwary upon examination. Moreover, while the opportunity for exemptive relief may provide some solace, we question the wisdom of adopting a rule for which such a large proportion of member firms may be incapable of reasonably complying.|