January 29, 2004
By email to firstname.lastname@example.org
Mr. Jonathan G. Katz
Re: File No. SR-NASD2003-104
Dear Mr. Katz:
NYLIFE Securities Inc.1 ("NYLIFE") appreciates the opportunity to provide the U.S. Securities and Exchange Commission ("Commission") with its comments in response to the proposed rule change submitted by the National Association of Securities Dealers ("NASD") as File No. SR-NASD-2003-104.2 Under the Proposed Rule, the NASD seeks (i) to amend NASD Rule 3010(g)(2) to revise the definition of the term "branch office;" and (ii) to adopt IM-3010-1 to provide guidance on factors to be considered by a member firm in conducting internal inspections of offices. Our comments in this letter are limited to the proposed revised definition of the term "branch office" (the "Proposed Rule").
More than half of the registered representatives associated with NASD member firms are associated with broker-dealers, such as NYLIFE, that are affiliated with life insurance companies. NYLIFE alone has approximately 6,800 registered representatives. In large part, registered representatives who are associated with life insurance companies act also as insurance agents and serve the insurance needs of people in virtually all areas of the United States, including some relatively remote locations. Unlike the traditional retail securities business, the life insurance business is one where client needs are regularly addressed in face-to-face meetings between registered representatives and their clients and prospective clients. By the nature of their businesses, and in order to adequately address the expectations of clients, firms such as NYLIFE are organized so that a substantial percentage of their registered representatives (approximately 50% in the case of NYLIFE) operate out of one-person and two-person offices, often referred to as "detached locations." These offices are particularly necessary in parts of the country where the population is relatively well dispersed geographically.
If the Proposed Rule were to be adopted in its current form, NYLIFE anticipates that virtually all of its detached locations would for the first time be required to register as branch offices, while now only approximately 425 are registered as branches, and then only pursuant to various state requirements. In other words, NYLIFE would, upon the adoption of the Proposed Rule, suddenly be required to register approximately 3,400 new branch offices. We anticipate that these new registration requirements would pose not only a highly significant administrative burden, but also a heavy financial burden on firms that happen to rely, out of business necessity, on the operation of detached locations. The sudden establishment by regulation of thousands of NASD-registered branch offices would necessitate the payment by NYLIFE of branch office registration fees at both the NASD level and, in due course, the state level. As set forth in greater detail below, the notion advanced by the NASD that the Proposed Rule would result in cost savings to members is not consistent with our analysis.
Contrary to the NASD's apparent expectation that "uniform definition would benefit member firms by reducing regulatory burdens and costs, without jeopardizing investor protection," our analysis of the Proposed Rule shows that it would sharply increase overall expenses by requiring the processing of additional paperwork - and presumably the payment of additional branch office registration and, potentially, principal registration fees - for approximately 3,400 additional branch offices. Affected firms will be required to pay branch registration fees to the NASD and various state regulators, taking the form of initial registration fees and annual renewal fees. In addition, on an ongoing basis, NYLIFE would be required to update our branch office records when affected individual agents are added, terminated, relocated or have passed the exemption thresholds that are found within the amendments.
NYLIFE estimates that if the Proposed Rule were enacted, we would incur in the first year an additional $570,000 in NASD fees related to initial registration and annual renewals. Thereafter, we estimate that we would incur $300,000 annually to cover initial and renewal registrations. Although we cannot accurately gauge our additional costs related to state branch office assessments until we see how states amend their branch office definitions, we expect that, at a minimum, we will incur similar costs with respect to initial registration and renewal fees.
Given the substantial additional branch registration costs that firms such as ours will incur, we respectfully request that less costly alternatives be explored, especially when, as the NASD concedes in its rule filing, the "current branch office definition effectively meets its regulatory objectives." 68 Fed. Reg. 70061 (2003). If the rule's purpose is to promote uniformity and ensure that securities regulators can readily locate all of a firm's representatives, we submit that existing regulations already accomplish such objectives in a far less burdensome manner. That is, pursuant to the amendments to SEC Rule 17a-4, which took effect in May 2003, broker-dealers are required to maintain a list reflecting the offices from which each of its associated persons conducts business. See 17 C.F.R. 240.17a-4(a)(12)(ii).
Absent a centralized branch registration system through the Central Registration Depository ("CRD"), adoption of the Proposed Rule would require firms to file Form BD amendments any time that there is a change in the location from which a registered representative is based. To add an office, NYLIFE would be required to complete a Form U4 for the affected registered representative and an amended Form BD to register the location as a branch. If the location were to move, both the Form BD and the Form U4 would again require amendment. If a representative operating from a single-person branch were to close, both a Form U5 and a Form BD amendment would be required.
Consistent with the experience of our peers in the industry, NYLIFE expects a significant turnover in registered representatives during any given year. If 50% of new hires and terminated agents work from locations that would qualify as branch offices under the Proposed Rule, we would anticipate a very large volume of filings on an ongoing basis. Additional personnel would need to be dedicated to manage this new workload that we forecast to be 800% greater than today's levels.
If the NASD implements a centralized branch registration system through CRD, member firms could perhaps comply without adding significantly to staff levels. Absent such an approach, member firms would be required to hire additional staff to file a substantially increased number of Forms U5 and BD to reflect branch office changes with the NASD.
We anticipate that the NASD membership agreement of NYLIFE and similarly situated firms would require amendment to permit the opening of the number of new branches that the Proposed Rule would create. For example, the maximum number of branch offices that the NASD permits NYLIFE to maintain is well below the number that would require registration under the Proposed Rule. If the Proposed Rule is adopted, we believe that requests to increase the number of permissible branches either not be required or be automatically approved, as they merely result from a definitional change, rather than a change in how member firms conduct business. Absent this or similar relief, we anticipate a related increase in the regulatory burden on many firms, as well as the workload of NASD district offices which would bear the responsibility for processing and passing on such requests.
We strongly support the position taken by the American Council of Life Insurers ("ACLI")(comment letter, dated December 23, 2003) that several aspects of the Proposed Rule would impose unreasonable and unnecessary burdens on competition. Given the organizational structure of most insurance-affiliated broker-dealers, whereby registered representatives tend in significant part to be situated in one-person and two-person offices, such firms would clearly bear an inordinately disproportionate share of the burdens associated with the adoption of the Proposed Rule. Inasmuch as virtually all such detached locations would require registration under the Proposed Rule, costs to insurance-affiliated broker-dealers in both dollars and administrative burdens would rise dramatically. Traditional broker-dealers, on the other hand, which typically employ systems where virtually of all their registered representatives work in centralized offices, would likely see their costs remain static or perhaps even decrease.
The NASD's assertion, for which no support is offered, that it "does not believe the proposed rule change, as amended, would result in any burden on competition that is not necessary or appropriate in furtherance of the Securities Exchange Act of 1934," strikes us as boilerplate language designed to have reviewers gloss over the critical rulemaking question of anti-competitive impact. As the ACLI rightly pointed out in its comment letter, Congress has specifically charged the Commission with the responsibility to evaluate the potential burdens on competition of SRO rules and rule changes. The Commission's duty under Section 23(a) of the Exchange Act is to consider the anti-competitive effects of rule changes and to balance any such impact against the regulatory benefit to be obtained from the proposed change.
We respectfully submit that the Proposed Rule fails to meet the appropriate SRO rule approval standards of protecting both competition and investors. Accordingly, we respectfully request that the NASD be required to address in specific terms the anticipated economic impact of the Proposed Rule on insurance affiliated broker-dealers and independent broker-dealers that employ distribution systems that employ numerous, geographically dispersed locations. The NASD should articulate the aggregate number of such locations which would be transformed into "branch offices" by the adoption of the Proposed Rule, and should set forth the extent of its anticipated increased revenues as a result of these changes. We strongly encourage the Commission to weigh carefully the potentially significant anti-competitive impact of the Proposed Rule in light of the dubious investor protection rationale, especially when, as noted above, the NASD concedes that the existing branch office definition meets its regulatory purpose.
Primary Residence Exception
The Proposed Rule contains an exception from the definition of "branch office" for those locations that are the associated person's primary residence, but only where an enumerated list of conditions is met. Unfortunately, the potential utility of this exception to firms such as NYLIFE is undermined by the prohibitions on (i) the associated person meeting with customers at the residential location; and (ii) handling customer funds at the residential location. Specifically, all of NYLIFE's registered representatives who are engaged in sales activities are also insurance agents. Given the relatively complex nature of insurance products and underwriting requirements that make it necessary to assess a client's health and to witness an applicant's signature on the taking of the application, it is frequently necessary to meet personally with clients. From our perspective, the inapplicability of this exception to NYLIFE and its registered representatives, as well as those similarly situated, raises a real question as to the real need for additional regulation in this area.
NYLIFE, which maintains offices in all fifty states, is well aware of the administrative burdens that result from the differing NASD and state definitions of "branch office," yet those burdens seem small when compared with the prospect of maintaining and paying for branch registrations for 3,400 new offices. The idea that the administrative and regulatory burdens that result from these inconsistent definitions are somehow to be lessened by establishing a requirement to register 3,400 new offices is in our view not plausible. While the notion of a uniform definition perhaps appears desirable for a particular segment of the broker-dealer community (for example, wirehouses), the Commission and the NASD should recognize that there are other constituencies, representing a very substantial percentage of NASD registered representatives, for which the Proposed Rule offers little but increased costs and administrative burdens.
Locations Primarily Used for Non-Securities Activities
We have reviewed another exception to the Proposed Rule relating to locations that are "used primarily to engage in non-securities activities and from which the associated person(s) effects no more than 25 securities transactions per year," provided certain conditions are met. Because the majority of New York Life agents wish to have the freedom to offer securities (especially variable insurance products and mutual funds) to ensure that client needs are fully addressed, this proposed exception would not be expected to obviate the registration of any but a small number of detached locations under the Proposed Rule. Even if the threshold were raised to a more reasonable level (e.g., 100 transactions per year), it would still place an undue burden on securities firms to track the number of transactions "effected" from a particular location so as to ensure compliance with the rule.
We also note as a technical matter that absent a definition of the term "effects" in this exception, the Proposed Rule is unclear as to the precise nature of covered registered representative conduct. For example, would completing a mutual fund application and accepting a customer check for forwarding to a broker-dealer's home office for acceptance constitute "effecting" a securities transaction from the location? Would participating in a conference call with a client and a variable annuity issuer's back office to assist in a reallocation among separate account options constitute "effecting" a securities transaction? Would telephoning a client to set up a sales call, obtaining a mutual fund application at the client's home or place of business, and placing the application and the client's check in an envelope at the detached office constitute "effecting" a securities transaction? Even assuming improved definition of the terms contained in the exception, the Proposed Rule also lacks clarity as to whether firms would be required to maintain records to demonstrate the availability of the exception. NYLIFE would not anticipate that this exception would materially lessen the number of detached locations that it or other similarly situated firms would be required to register upon the adoption of the Proposed Rule.
Evolving business practices
Our business model allows for a substantial percentage of registered representatives to work from small non-branch locations. We believe that this business model is most effective in delivering our services to the many small communities in which our registered representatives conduct business. Given that the number of locations will not materially increase from today's number, that the business model has been effectively meeting client needs, and that our supervisory system is rigorous and far reaching, we see no real benefit to our customers or the public at large by reclassifying these locations as NASD branches. Moreover, NASD rules currently require that stationery, business cards, and sales literature list the supervising branch office in addition to any non-branch location provides adequate protection in that all investors are provided with adequate information to express any grievances to a supervising location. Such protection is bolstered by the recent amendments to Rule 17a-4, which require that all customers be provided the address and telephone number of the department to which complaints may be directed. See 17 C.F.R. 240.17(a)(18)(ii).
In view of technological advances, our current business model, which rests in large part upon the operation of one-person and two person non-branch locations, is highly effective in meeting investor needs. We expect that given an aging and geographically dispersed clientele, more and more business will be conducted in person rather than by telephone. We believe that personal attention and service - especially with clients who have been accustomed to and have come to expect such service in connection with our traditional insurance operation - will continue to play a significant role in the investment process in the years ahead. We have developed systems and management structures that allow us to effectively deliver financial products and services in a personal style to residents of small towns across the country. While we have taken the necessary steps (at a significant cost) to monitor and supervise our non-branch offices, the Proposed Rule, if adopted, has the potential for compelling a redefinition of the limitations on where and how we conduct business due to the concomitant increase in our cost structure. Offices that were once marginally profitable under existing technology and regulation may no longer be viable, and the clients once serviced by a local registered representative may be left with a much more limited set of choices among investment professionals. Alternatively, if we wish to continue with our current business model in what would promise to be a more costly regulatory environment, our additional costs may at least in part have to be passed on to the investing public. As the Proposed Rule appears to offer little in the way of additional investor protection, such a result would be particularly undesirable.
We recommend that the Proposed Rule be carefully reconsidered in light of what we expect would be enormously increased costs and administrative burdens to a significant number of broker-dealers employing the majority of NASD registered representatives. The Commission should also carefully examine the potential anti-competitive impact of the Proposed Rule, as set forth above. These prospects are difficult to accept given the lack of a convincing investor protection rationale for the changes.
We appreciate this opportunity to express our concerns about this very important proposal, which has such potentially far-reaching consequences for our Company and for the industry at large. Should you wish to discuss this matter, you may reach me at (212) 351-6065.