SECURITIES AND EXCHANGE COMMISSION
In the Matter of the Application of
ALLEN DOUGLAS SECURITIES, INC.
For Review of Action Taken by
Member firm of registered securities association sought Commission review of association's determination to disapprove certain proposed subordinated loan agreements. Held, the matter is not subject to Commission review because association's determination does not constitute any of the actions subject to review under Section 19(d) of the Securities Exchange Act of 1934. Application for review is therefore dismissed.
Allan M. Lerner, for Allen Douglas Securities, Inc.
Marc Menchel, Alan Lawhead, and Michael J. Garawski, for NASD.
Appeal filed: February 18, 2004
Last brief received: June 9, 2004
Allen Douglas Securities, Inc. ("Allen Douglas" or the "Firm"), an NASD member firm, seeks review of a January 2004 NASD decision to disapprove, pursuant to NASD's authority under Appendix D to the net capital rule ("Appendix D"),1 certain subordinated loan agreements ("SLAs"). Allen Douglas proposed to execute the SLAs with customers and other creditors (the "Claimants") as a method of dealing with the Firm's liabilities in connection with the settlement of several arbitration and other actions that the Claimants had brought against Allen Douglas between 2000 and 2003 (collectively, the "Proceedings"). Allen Douglas hoped that, by executing the SLAs, it would eliminate a net capital deficiency identified by the Commission's staff during an inspection of the Firm in late 2003. NASD contends that Allen Douglas's appeal should be dismissed for lack of jurisdiction. Our findings are based on an independent review of the record.
Background. In November 2003, members of the Commission's staff performed an inspection of the Firm. In the course of that inspection, the staff informed Allen Douglas that, based on the staff's calculations, the Firm had a net capital deficiency of at least $485,000.2 The cause of that deficiency appears to have been, in significant part, liabilities the Firm incurred as a result of its settlement of the Proceedings. As part of the settlement agreements, the Claimants agreed to relinquish their claims against Allen Douglas and look solely to its parent corporation, American Trading and Brokerage, Inc. ("ATB"), for payment. According to Allen Douglas, the Commission's staff took the position that the settlement liabilities should be treated as debt and subtracted from the Firm's assets in calculating net capital, notwithstanding that the Firm had sought to transfer the liabilities to ATB.3
According to Allen Douglas, "the staff indicated that it based its determination" of net capital deficiency on a July 2003 Commission staff interpretative letter (the "Interpretative Letter"). The Interpretative Letter stated, in relevant part, that a broker-dealer must record an expense as its own liability for net capital purposes, even though a third party has agreed to accept responsibility for that expense, unless the broker-dealer demonstrates that the third party has adequate resources independent of the broker-dealer to pay the liability.4 Although the Claimants had agreed to look solely to Allen Douglas's parent corporation for payment under the settlement agreements,5 ATB (whose sole source of revenue was the compensation it received under a management agreement with Allen Douglas) did not have adequate resources independent of Allen Douglas to pay the settlement liabilities.
While Allen Douglas disputes the reasoning of the Interpretative Letter, it does not dispute that, based on the Interpretative Letter, it had the net capital deficiency that the staff identified.6 Following the staff's deficiency determination and at the staff's direction, Allen Douglas gave notice to the Commission of its net capital deficiency,7 and ceased operations.
NASD Proceedings. In an effort to address the staff's deficiency determination and to resume operations, Allen Douglas then proposed to enter into a series of SLAs with the Claimants.8 Under a provision of the net capital rule,9 indebtedness subordinated to the claims of other creditors pursuant to SLAs approved under Appendix D is not included in the calculation of a firm's aggregate indebtedness for net capital purposes. Allen Douglas prepared draft SLAs, which it asserts the Claimants were prepared to execute. On January 6, 2004, it submitted these draft SLAs to NASD for its review under Appendix D.11 Later that month, NASD notified Allen Douglas that it found the draft SLAs unacceptable.12
Our authority to review an action of a self-regulatory organization ("SRO"), including NASD, is governed by Section 19 of the Exchange Act.13 That provision authorizes Commission review of an SRO action that:
Although we have not previously considered the question of whether we can review NASD action disapproving proposed SLAs, we have considered the extent of Commission jurisdiction to hear appeals from other types of SRO actions. Based on those earlier rulings, we conclude that Allen Douglas's appeal does not fall within the categories identified in Section 19(d).14
A. Imposition of Disciplinary Sanction. Section 19(d) authorizes Commission review when an SRO, through its disciplinary process, determines to impose a final disciplinary sanction on a member, or on a person associated with a member. That did not happen here. In finding the SLAs unacceptable, NASD did not employ its disciplinary procedures, did not make a determination that Allen Douglas had violated a statute or rule, and did not impose a final disciplinary sanction.15 Instead, NASD merely responded to Allen Douglas's request to evaluate the SLAs to determine whether they were acceptable under Appendix D.
In Morgan Stanley & Co., we declined to review an NASD exemption denial involving operation of Municipal Securities Rulemaking Board Rule G-37 because we found, among other things, that the exemption denial did not constitute a "disciplinary sanction."16 Although the effect of the exemption denial was that the appealing firm was prohibited from engaging in certain municipal securities business for two years, we concluded that NASD's action was not disciplinary in nature because it did not involve a "determination of wrongdoing."17
Similarly, in Joseph Dillon, we declined to find jurisdiction to consider the appeal of a firm that had requested an exemption from NASD Conduct Rule 3010(b)(2) because, among other reasons, NASD's action was not disciplinary in nature.18 As in Morgan Stanley, NASD had made no finding of wrongdoing and did not "employ its disciplinary procedures in reaching its conclusion."19
We believe that our decisions in Morgan Stanley and Joseph Dillon govern here. As in those other cases, it was Allen Douglas, not NASD, that initiated the NASD action at issue (review of the SLAs) as a means of addressing a perceived regulatory deficiency and, thereby, a way to continue operating as a broker-dealer without running afoul of regulatory requirements.20 In disapproving the SLAs, NASD made no finding of wrongdoing and did not employ its disciplinary procedures, but "merely exercis[ed] the discretionary authority granted it under" Appendix D.21
Allen Douglas asserts that we have jurisdiction to consider its appeal because NASD's action was, in its view, "tantamount to a disciplinary sanction." According to Allen Douglas, NASD made it clear that, if the firm resumed operations, Allen Douglas would be subject to disciplinary proceedings for net capital violations.22 The possibility, however likely, of Allen Douglas becoming subject to disciplinary proceedings does not, by itself, give rise to a right of review under Section 19(d).23 In contrast, if Allen Douglas had proceeded with the execution of the SLAs notwithstanding NASD's disapproval, operated as a broker-dealer despite an apparent net capital deficiency, and became subject to an NASD disciplinary sanction as a result, the ."disciplinary action would be reviewable,"24 as would relevant issues including the proper calculation of Allen Douglas's net capital. Moreover, although NASD's determination to disapprove the SLAs undoubtedly made it more difficult for Allen Douglas to resume operations as a broker-dealer, we have held that "SRO action is not reviewable merely because it adversely affects the applicant."25
B. Other Bases of Jurisdiction. We also conclude that NASD's action does not constitute a denial of membership or participation. NASD's disapproval of the SLAs has no bearing on the Firm's NASD membership status, which is unaffected by NASD's consideration of the SLAs. Allen Douglas asserts that NASD's action in disapproving the SLAs "had the ultimate impact of precluding the participation of the Firm in the business of a securities dealer and a fortiori, participation as a member of the NASD." We disagree.
NASD did not impose any condition or restriction on Allen Douglas's NASD membership or its ability to participate as an NASD member, but merely disapproved a means Allen Douglas had proposed to satisfy its net capital requirement, a requirement imposed by federal law.26 Notwithstanding NASD's determination regarding the SLAs, Allen Douglas remains free to participate in NASD as an NASD member and can resume operations as a broker-dealer so long as it, like every other NASD member, is in regulatory compliance.
NASD's action in disapproving the proposed SLAs does not constitute a denial of access to services offered by NASD because it has no impact on Allen Douglas's access to any such service. Allen Douglas argues that the NASD service it was denied was "access to the use of a reasonable subordinated loan agreement as proposed by the Applicant." Under Appendix D, however, NASD is required only to review proposed SLAs, a service that it clearly provided to Allen Douglas in this case.
Decisions in which we have found jurisdiction based on this third prong of Section 19(d) have emphasized the impact that SRO decisions have on members' access to fundamentally important services provided by the SRO.27 For example, in Tower Trading and Scattered Corporation,28 we held that the termination by an SRO of the member firm's status as a market-maker and the determination not to process a member firm's application for registration as a market-maker, respectively, limited the firms' access to member services by preventing the firms from availing themselves of the guaranteed transaction participation that comes with designated market-maker status. In William J. Higgins,29 we granted review under the third prong of Section 19(d) where the New York Stock Exchange denied a member firm's request to install a telephone link to permit direct communication between the trading floor and non-member customers, based on the premise that "[t]he operation of a trading floor and access to that floor is the principal service offered by a national securities exchange to its members, and by its members to investors."30 NASD's disapproval of the SLAs did not deny Allen Douglas access to any similar NASD member service.
NASD's action in disapproving the proposed SLAs did not bar any person from becoming associated with Allen Douglas. Allen Douglas does not specifically argue that this fourth prong of Section 19(d) provides a basis for a finding of jurisdiction here. However, in another context, the Firm cites our decisions in Rubba and Exchange Services, both of which found jurisdiction based on this fourth prong of Section 19(d). In those cases, we found that SRO denials of requests for exemptions from examination requirements for registered representatives seeking to become associated with member firms had the effect of barring those persons from becoming associated with those firms. NASD's disapproval of the proposed SLAs here had no similar effect on Allen Douglas or any of its associated persons, all of whom remain free to be associated with the Firm.31
Under the circumstances, we have determined to dismiss Allen Douglas's appeal.32
An appropriate order will issue.33
By the Commission (Chairman DONALDSON and Commissioners GOLDSCHMID, ATKINS and CAMPOS); Commissioner GLASSMAN not participating.
Jonathan G. Katz
In the Matter of the Application of
ALLEN DOUGLAS SECURITIES, INC.
On the basis of the Commission's opinion issued this day, it is
ORDERED that Allen Douglas Securities, Inc.'s petition for review be, and it hereby is, dismissed.
By the Commission.
Jonathan G. Katz
Rule 3010(b)(2) requires any NASD member firm that employs a specified number of registered persons who were, within a specified period, associated with any "disciplined firm" to establish and enforce special telemarketing supervisory procedures, including the taping of customer calls.
Allen Douglas seeks to distinguish its application from cases involving SRO denials of exemptions from the operation of certain rules. See, e.g. Morgan Stanley; Joseph Dillon; Whitehall Wellington Investments, Inc., Exchange Act Rel. No. 44367 (May 30, 2001), 75 SEC Docket 314 (finding no authority for Commission review of NASD denial of taping requirement exemption). Characterizing NASD's action in disapproving the SLAs as, in effect, a determination that Allen Douglas had violated the net capital rule,10 Allen Douglas argues that such SRO action is more serious than a mere denial of an exemption. Allen Douglas contends that NASD's disapproval involved, "either directly or indirectly, the employment of disciplinary procedures and is thus more deserving of review than a mere denial of an exemption." However, as discussed above, NASD never made a determination that Allen Douglas had violated the net capital rule. NASD merely found that the SLAs Allen Douglas proposed to use to address its net capital deficiency were unacceptable under Appendix D.
Although we based jurisdiction there on a finding that the CBOE's action constituted a denial of access to services – the third prong under Section 19(d) – we expressly declined to find jurisdiction on the basis that the CBOE's determination constituted a disciplinary action. Noting that "we have interpreted the term ‘disciplinary' to refer to action responding to an alleged violation . . . or action ‘in which a punishment or sanction is sought or intended,'" we concluded that the applicant in that case had not been subject to a disciplinary action because the CBOE's decision was based on performance, not violative activity, and did not result in the imposition of a sanction. 79 SEC Docket at 3195 (citations omitted). Similarly, the NASD action at issue here did not involve any allegation of a violation and did not result in a sanction.
Allen Douglas argues that it should not be required to risk its license and thus its ability to conduct future business by "playing chicken" with NASD regarding interpretations of the net capital rule. While we are not unsympathetic to Allen Douglas's position, we nevertheless observe that our oversight of SROs is governed by the statutory scheme established by the Exchange Act, and does not extend beyond the authority granted therein. Cf. Tower Trading, 79 SEC Docket at 3194 (noting that, prior to the adoption of Section 19(d), which was enacted as part of the Securities Acts Amendments of 1975, "the Commission did not have authority to review disciplinary or other actions of exchanges").
We also observe in this connection that Allen Douglas has been, in certain respects, far less adversely affected by the NASD action at issue than was the applicant firm in Morgan Stanley. The applicant firm's sole means of avoiding the impact of the municipal securities bar at issue in that earlier case was the exemption NASD had denied it and which was the subject of the appeal. Here, by contrast, approval of the SLAs under Appendix D was presumably one of several options available to Allen Douglas to return to net capital compliance and, thereby, resume operations. For example, while Allen Douglas claims that the SLAs constituted the "only alternative open to" the Firm, it appears that the Firm always had (and still has) the option of eliminating any net capital deficiency through a capital contribution or a subordinated loan of cash to the Firm.
We note that, in Joseph Dillon, we rejected the applicant firm's argument that, in denying its exemption request, NASD had conditioned its membership on the firm's ability to comply with the taping requirement at issue, which the firm claimed it was unable financially to do. Conceding that the costs of compliance might be high, we held there that "[t]he membership of every NASD member is conditioned on the member's continued compliance with NASD rules." 73 SEC Docket at 2261. Similarly, Allen Douglas's ability to function as a broker-dealer is dependent on its ability to satisfy its regulatory requirements; that the costs of doing so may be significant does not alter our conclusion regarding jurisdiction.
Nor would it be appropriate in this proceeding for us to review reasoning contained in the Interpretative Letter, which Allen Douglas claims is "at odds with, and beyond the scope of," the net capital rule. As we previously have observed, staff interpretative letters (like the numerous other written and verbal expressions of views offered to the public by the Commission's staff in various contexts) "do not necessarily reflect the views of the Commission [and] do not have the force of law." Marc N. Geman, Exchange Act Rel. No. 43963 (Feb. 14, 2001), 74 SEC Docket 999, 1020-21 n.50 (citing Lowell H. Listrom, 50 S.E.C. 883, 886 n.3 (1992), aff'd, 975 F.2d 866 (8th Cir. 1992)), aff'd, 334 F.3d 1183 (10th Cir. 2003). We have further observed that, "[w]here a conclusion is not dictated by the literal terms of a regulation, the fact that a broker-dealer's conduct does not conform to the standards set forth in a staff no-action or interpretative position does not command the conclusion that the conduct violates the regulation." Listrom, 50 S.E.C. at 886 n. 3. We "'may choose to adopt or reject the staff's previously-stated reasoning with respect to the application of the particular regulation at issue.'" Geman at 1020-21 n.50.
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