Special Studies
The Joint Regulatory Sales Practice Sweep Report
March 5, 1996
THE JOINT REGULATORY SALES PRACTICE SWEEP
A Review of the Sales Practice Activities of Selected
Registered Representatives and the Hiring, Retention, and
Supervisory Practices of the Brokerage Firms Employing Them
EXECUTIVE SUMMARY
This is a report of the findings of the joint regulatory
initiative involving the staffs of the Securities and Exchange
Commission ("SEC" or "Commission"), the National Association of
Securities Dealers, Inc. ("NASD"), the New York Stock Exchange,
Inc. ("NYSE"), and the North American Securities Administrators
Association, Inc. ("NASAA") (collectively, the "Working
Group"-[1]-) to review the sales practice activities of
selected registered representatives and the hiring, retention,
and supervisory practices of the brokerage firms employing them.
This review was commenced as a follow-up to the Commission's
report entitled The Large Firm Project: A Review of Hiring,
Retention and Supervisory Practices (the "Large Firm Project" or
"Large Firm Report"). As described in more detail below, the
registered representatives selected for review were identified
based on specific criteria formulated by the Working Group and,
therefore, the findings of this project should not be viewed as
representative of all brokerage firms.
The objectives of this joint initiative, referred to as the
Joint Regulatory Sales Practice Sweep (the "Sweep") were to
identify possible problem registered representatives, to review
their sales practices, and to assess whether adequate hiring,
retention, and supervisory mechanisms are in place. Where
appropriate, the Sweep will result in enforcement action against
these registered representatives and/or the firms employing them.
The Working Group reviewed and analyzed data received from
various sources to identify individuals who, based on their
disciplinary and employment histories, appeared to warrant
scrutiny during examinations. The criteria for identifying
"profiled registered representatives" ("PRRs") was continuously
refined and resulted in a combination of four different criteria
being employed. After considerable scrutiny, 347 registered
representatives were selected for review. The details of the
selection process are described in further detail in the full
report.
The Sweep examinations encompassed a review of 101 different
brokerage firms, primarily small- and medium-sized
firms.-[2]- The examinations commenced in December 1994 and
were generally completed by November 1995. The reviews consisted
of on-site sales practice examinations of main and branch offices
of the firms employing the PRRs,-[3]- including reviews of
==========================================START OF PAGE ii======
the PRRs' selling activities and interviews of the branch office
managers (and, in some instances, other compliance personnel),
and the PRRs themselves. Working Group examiners interviewed 230
PRRs during 179 branch office examinations. The findings from
those examinations and the Working Group's recommendations are
summarized below and discussed in greater detail in the full
report.
FINDINGS
ù Some Firms Are Willing to Employ Registered Representatives
With a History of Disciplinary Actions or Customer
Complaints
Of the 347 PRRs selected for review, approximately one-third
had moved to at least one new brokerage firm since December 1994
despite a history of disciplinary actions or customer
complaints.-[4]- Thus, some firms are willing to employ
individuals with a history of disciplinary actions involving
sales practice abuse or customer complaints.
ù Many of the Branches Examined Utilize Only Minimum Hiring
Procedures
The review of hiring practices revealed that many of the
branches examined appeared to conduct, before hiring, only the
minimum review required by NASD and NYSE rules of a registered
representative applicant's background, including those with a
disciplinary history or a history of customer complaints. Such
review is generally limited to examining the individual's Forms
U-4-[5]- and U-5-[6]- (or reviewing the applicant's
history on the Central Registration Depository, or
"CRD")-[7]- and contacting the applicant's previous
employers for the past three years. As discussed above, the
significant movement of PRRs within the industry may be
attributable, at least in part, to the minimal hiring procedures
in place at some brokerage firms.
ù One-Fifth of the Examinations Resulted in Enforcement
Referrals and an Additional One-Fourth of the Examinations
Resulted in the Issuance of Letters of Caution or Deficiency
Letters
Not including 104 registered representatives that were
excluded from the review because they were already under
investigation by the SEC or a self-regulatory organization
("SRO"), one-fifth of the Sweep's 179 examinations resulted in
referrals for possible enforcement investigation.-[8]- The
potentially violative activity identified during these
==========================================START OF PAGE iii======
examinations included, among other things, excessive trading,
unauthorized trading, failure to supervise, and improper
registration of registered representatives or failure to update
registration forms. In addition, another one-fourth of the
Sweep's 179 examinations resulted in the issuance of a letter of
caution or a deficiency letter,-[9]- noting violations and
deficiencies not rising to the level of seriousness warranting
enforcement investigation. The letters of caution and deficiency
letters resulting from the Sweep examinations cited violations
and deficiencies in varying degrees of seriousness. In the
examinations resulting in enforcement referrals, letters of
caution, or deficiency letters, inadequate supervision and
deficient written supervisory procedures were the most common
findings. These findings suggest that many firms' supervisory
and compliance systems warrant improvement.
ù Supervisors in Many of the Branches Examined Conduct
Inadequate or No Routine Review of Registered
Representatives' Customer Securities Transactions to Detect
Sales Practice Abuses
The examinations revealed that at many of the branches
examined, supervisors conducted either inadequate or no routine
review of the customer securities transactions effected by the
registered representatives employed at the branch. This finding
suggests that supervision of registered representatives' customer
sales activity must be improved to aid in detecting and
preventing sales practice abuses.
ù Almost One-Half of the Branches That Engage in Some Type of
Cold Calling Evidenced Cold-Calling Violations or
Deficiencies
The interviews of the branch office managers, PRRs, and
other registered representatives selected by the examiners while
on-site revealed that almost one-half of the branches examined
engage in some type of cold-calling activity. Of the branches
that engage in some type of cold-calling activity, almost one-
half did not fully comply with the Telephone Consumer Protection
Act of 1991 (the "Telephone Consumer Protection
Act").-[10]-
RECOMMENDATIONS
These findings suggest, in our view, that firms must devote
additional attention and resources to the prevention and
detection of sales practice abuses by registered representatives.
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Based on the results of the Sweep, a number of areas relating to
the prevention and detection of sales practice violations need
improvement. In particular, we recommend improvements with
respect to: (a) the hiring procedures for registered
representatives, (b) the supervision of registered
representatives, and (c) compliance with cold-calling
requirements. Finally, the findings also suggest that the firms
must be reminded about their obligations to properly supervise
the activities of registered persons and that the Commission, the
SROs, and the state securities regulators will continue to
closely monitor during examinations firms' supervision whenever
sales practice weaknesses, deficiencies, or apparent violations
are detected.
In light of the findings discussed above, the Working Group
proposes the following recommendations.
ù More Stringent Hiring Procedures for Registered
Representatives
In addition to reviewing an applicant's Form U-4 and Form U-
5, reviewing CRD, and contacting the applicant's previous
employers, the Working Group strongly recommends as a "best
hiring practice" that firms (or if delegated to one or more
branches, the branch officer managers or other compliance
personnel) discuss with all applicants the nature of the
applicant's prior customers and the types of securities sold
while associated with the prior employer; conduct a credit and
financial check of the applicant; and obtain from the applicant,
orally or in writing, explanations regarding any customer
complaints and regulatory actions to determine the merit of each
prior to hiring. Moreover, as recommended in the Large Firm
Report, firms should include the compliance department and/or the
legal department in applicant reviews and designate, above the
branch manager level, an individual or committee to approve the
hiring of any registered representative with a history of
compliance problems. In addition, the SROs and state securities
regulators should remind firms of their existing responsibilities
under SRO rules and regulations and applicable state securities
laws to adequately investigate before hiring each applicant's
character, business repute, qualifications and experience and to
maintain documentation of the steps taken in the hiring process,
including the "best practices" described above.
ù Special Supervision for Registered Representatives With a
Disciplinary History
The Working Group believes that registered representatives
with a recent history of final disciplinary actions involving
sales practice abuse or other customer harm warrant enhanced
supervision by their firms. Firms that hire registered persons
that have a history or pattern of customer complaints,
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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 representative.
If firms fail to establish such special supervisory procedures,
SROs will consider whether it is necessary to amend their rules
to specifically require these registered representatives to be
placed under special supervision by the firm for a period of
time. Moreover, if such an employee commits a sales practice
violation during the period of special supervision, firms should
recognize that securities regulators do and will continue to
closely evaluate whether the firm itself should be subject to
disciplinary action for a failure to supervise the registered
representative. In addition, the Working Group recommends that a
firm's compliance personnel perform a thorough review of a
registered representative's customer account activity when that
person is named, during a one-year period, in three customer
complaints alleging sales practice abuse. The customer account
activity of persons with fewer customer complaints or customer
complaints over a longer period of time also should be reviewed
as a matter of course.
ù Branch Manager Compensation
As a means to encourage and enhance supervisory vigilance,
the Working Group believes that firms should consider adopting a
policy of tying a component of a branch office manager's
compensation to the manager's effective supervision of registered
representatives. The Working Group believes that it would be a
good practice for managers to be compensated, in part, for
effective supervision and compliance efforts based on preventing,
detecting, reporting, and correcting sales practice abuses and
other customer harm. These supervision and compliance efforts
may be evidenced by, for example, internal audit review of the
branch, external regulatory review, and an assessment of
arbitrations and customer complaints within the branch.
ù Firm Supervisory Obligations
In light of the findings with respect to inadequate
supervision and supervisory systems, firms must ensure that they
are fulfilling their supervisory obligations under SRO rules. In
order to assist firms in this endeavor, the SROs should remind
members about firms' supervisory obligations under SRO rules.
Moreover, as part of the increased regulatory emphasis on
evaluating the adequacy of supervision and supervisory systems,
as discussed below, the Working Group believes that all
regulators should place increased emphasis during examinations on
determining whether firms have met these requirements.
ù Cold-Calling Training and Supervision and Increased
Regulatory Review and Enforcement
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Firms must ensure that they adequately train and supervise
telemarketers and registered representatives who engage in cold
calling. Firms that employ cold callers or whose registered
representatives engage in cold calling must ensure that the firm
element of the newly implemented continuing education program
incorporates a cold-calling component.-[11]- Firms must
ensure that they maintain a "do-not-call" list, establish
procedures to add names to the list upon request, and provide a
"do-not-call" list to all persons who cold call (or ensure that
such persons have access to a copy of the list). Moreover, the
Commission and regulators that conduct examinations will increase
their focus on their regulatory review of cold-calling practices
during sales practice examinations and on bringing disciplinary
actions for violations in this area. To this end, SROs and the
state securities regulators that conduct sales practice
examinations should ensure that their examination modules
incorporate a cold-calling review. SROs also should consider
whether it is appropriate to add to their minor rule violation
plans minor violations of SRO rules on cold calling.
ù Increased Review During Examinations for Inadequate
Supervision and Deficient Written Supervisory Procedures
Given the number of examinations resulting in findings of
deficient supervision, the Working Group recommends that during
regulatory examinations, the Commission, the SROs, and those
state securities regulators that conduct examinations increase
their emphasis on evaluating the firm's supervision of its
registered representatives. In particular, where a weakness,
deficiency, or apparent violation is detected by examiners,
examiners should determine whether supervisors reasonably carried
out their responsibilities and whether such weakness, deficiency,
or apparent violation is indicative of a defect in the firm's
system of supervision, including its written supervisory
procedures.
ù Follow-Up Review of Firms That Were the Subject of
Enforcement Actions
To ensure that firms that have engaged in sales practice
abuse do not repeat the offense, the Working Group recommends
that the SEC and the appropriate SROs include in their annual
examination priorities follow-up examinations of firms that have
been the subject (or whose management have been the subject) of
SEC or SRO enforcement actions involving serious sales practice
abuses, supervisory breakdowns, or other egregious activity that
harms customers within one year of the enforcement action. The
Working Group also recommends that, as part of the overall
sanctions imposed in enforcement actions, firms be required to
prepare and submit to the appropriate regulator a report of the
steps taken by the firm to address the abusive practices,
including a follow-up review by the firm regarding its
supervisory improvements following such actions. The
==========================================START OF PAGE vii======
improvements contained in this report will then be closely
reviewed during follow-up regulatory examinations.
CONCLUSION
The findings of this Sweep and of the Large Firm Report
suggest generally that, while many firms maintain satisfactory
supervisory mechanisms, firms can and should improve and
strengthen their hiring, retention, and supervisory practices.
Consequently, this report contains specific recommendations aimed
at improving brokerage firms' hiring, retention, and supervisory
practices. Improvements by firms in these areas should, in turn,
result in improvements in the prevention and detection of sales
practice abuses.
The Working Group believes that the implementation of these
recommendations can greatly enhance the prevention and detection
of sales practice problems, thereby protecting the integrity of
the marketplace and the interests of the investing public.
Moreover, members of the Working Group intend to continue to
identify problem brokers and firms and to work toward enhancing
existing supervisory and regulatory systems, and urge members of
the securities industry to continue their efforts in improving
their own supervisory systems.
==========================================START OF PAGE 1======
REPORT ON THE JOINT REGULATORY SALES PRACTICE SWEEP
A Review of the Sales Practice Activities of Selected
Registered Representatives and the Hiring, Retention, and
Supervisory Practices of the Brokerage Firms Employing Them
Federal regulation of the securities industry rests on the
principle of self-regulation. First and foremost, effective
self-regulation begins with the broker-dealer, which must monitor
the trading and sales activities of its associated persons and
establish effective compliance and supervisory procedures to
prevent and detect possible violations of firm policies and
procedures, SRO rules, and federal and state securities laws. At
the next level of the regulatory structure are the SROs, which
are self-regulatory membership organizations overseen by the
Commission. The SROs have established rules that govern the
conduct of their member firms and enforce compliance with those
rules and with the federal securities laws. Broker-dealers and
their registered representatives are regulated by state law, as
well. Each state has adopted securities laws and promulgated
regulations thereunder to govern the conduct of registrants and
their registered representatives within the state and to enforce
compliance with those laws and regulations. To enforce
compliance, both SROs and many state securities authorities
examine firms and registered salespersons subject to their
jurisdiction on a routine basis, and initiate disciplinary
actions where firms or their associated persons violate SRO
rules, or federal or state securities laws.
In addition, the Commission has direct regulatory authority
over the activities of broker-dealers and SROs. The Commission
exercises this authority, consistent with its principal statutory
mandates of investor protection and the public interest, through
its rulemaking authority, its examinations of broker-dealers and
inspections of SROs, and through enforcement actions against
persons and entities that violate the securities laws.
These statutory purposes are best served when broker-dealers
establish effective compliance mechanisms, regulators routinely
examine for and enforce compliance with the securities laws and
their own rules, and the Commission implements effective and
comprehensive SRO oversight and enforcement programs.
I. PREDECESSOR LARGE FIRM REPORT
Work on the Large Firm Report began in 1992, when staff of
the SEC, the NYSE, and the NASD met to discuss concerns regarding
the hiring, retention and supervisory practices of brokerage
==========================================START OF PAGE 2======
firms, and agreed to conduct a series of examinations focusing on
the nine largest broker-dealers in the United States and
individual registered representatives employed by those firms.
The nine firms were selected for review because they accounted
for approximately 49% of all public customer accounts in the
United States. Examinations conducted pursuant to this joint
examination effort commenced in early February 1993, and resulted
in the issuance of the Large Firm Report in May 1994. Appendix A
to this report discusses the recommendations made in the Large
Firm Report and the status of those recommendations.
Because the Large Firm Report revealed a number of
supervisory weaknesses and areas where improvements were needed,
this Sweep was commenced as a follow-up to the Large Firm
Project. Like the Large Firm Project, the Sweep focused on
problem registered representatives and the firms employing them,
and involved a review of the sales practices of selected
individuals and the hiring, retention, and supervisory practices
of the firms employing those individuals. Unlike the Large Firm
Project, the Sweep focused on registered representatives that met
the specific criteria developed by the Working Group. These
individuals were primarily employed by small- and medium-sized
brokerage firms. As described in more detail below, the
registered representatives selected for review were identified
based on specific criteria formulated by the Working Group and,
therefore, the findings of this project should not be viewed as
representative of all small- and medium-sized brokerage firms.
II. THE EXAMINATION PROCESS
A. Selection of Registered Representatives
At the end of 1994, approximately 485,000 registered
representatives were associated with registered broker-dealers
doing business with the public. Out of this population, the
Working Group selected, based on the criteria described below,
347 registered representatives (the profiled registered
representatives or "PRRs") for special examination.
The Working Group attempted in the selection process to
identify individuals who, based on their disciplinary, customer
complaint, and employment histories, may engage in sales practice
misconduct. The firms and branch offices selected for
examination during the Sweep were identified because they
employed at least two individuals who met the profile. The
criteria for identifying PRRs was continuously refined and
resulted in a combination of four different criteria being
employed. Three out of the four criteria used a single measure
to identify a PRR while the last criterion included a combination
==========================================START OF PAGE 3======
of four different criteria. Out of a universe of approximately
485,000 registered individuals, 50,000 individuals were initially
selected because they had reportable incidents noted on their
Form U-4. Applying the four criteria to the list of 50,000
individuals resulted in a total of 1,018 individuals that met one
or more of the four criteria:
1. The person:
a. had been the subject of two or more NASD
cause examinations-[12]- between January 1,
1992 and August 15, 1994, or
b. had been the subject of one or more selected
reported CRD pending actions between February
15, 1994 and August 15, 1994 (see Appendix
B), or
c. had been the subject of one or more selected
reported CRD final actions between January 1,
1992 and August 15, 1994 (see Appendix C),
and
d. had been employed by three or more firms
since January 1992; or
2. The person had been involved in two or more
pending disciplinary actions during the period of
January 1, 1992 through August 15, 1994; or
3. The person had been the subject of five or more
NYSE Rule 351(d)-[13]- customer complaints
during the period from April 1, 1992 to March 31,
1994; or
4. The person had been identified by the SEC, the
NASD, the NYSE, or any state securities commission
as needing special attention.
Then, in order to reduce the universe of registered
representatives to a manageable size, the following factors were
applied to extract registered representatives from the initially
identified list of registered representatives. Extracted from
the list were:
1. All registered representatives employed at one of
the nine firms examined during the Large Firm
Project: 294.
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2. All registered representatives who were the only
profiled registered representative identified at
their firm: 227.
3. All registered representatives who were under
investigation by the NASD, NYSE, or SEC at the
time of the selection process: 104.
4. All registered representatives who were
preliminarily screened and designated as
inappropriate candidates by the Working Group
(e.g., customer complaints did not relate to
retail transactions): 46.
After extracting these registered representatives from the
initial universe of potential PRRs, 347 PRRs at 117 different
firms remained. These 347 PRRs were assigned among the NASD, the
NYSE, the SEC, and certain state securities regulators for
examination.-[14]- Due to movements by PRRs and the
unavailability of others to be interviewed,-[15]- Working
Group examiners interviewed 230 PRRs during 179 branch
examinations. The SEC, the NASD, the NYSE, and the states
conducted 43, 58, 40, and 38 examinations, respectively.
B. Scheduling, Objectives and Scope
The examinations, which began in December 1994 and generally
were completed by November 1995, were conducted at 101 different
(primarily small- and medium-sized) firms. The Sweep involved
both on-site examinations and a CRD review to ensure that the PRR
was still employed by the broker-dealer. The objectives of the
Sweep were to identify possible problem registered
representatives, to review their sales practices, and to assess
whether adequate hiring, retention, and supervisory mechanisms
are in place. Where appropriate, the Sweep would result in
enforcement action against these registered representatives
and/or the firms employing them.
The examination field work consisted of (1) branch office
examinations where the PRRs were employed and, where necessary,
follow-up examinations where a PRR moved to a new branch or firm,
(2) PRR interviews, and (3) branch office manager (and sometimes
other compliance personnel) interviews. In order to ensure
uniformity in examination methodology and scope, all Sweep
examiners were furnished with procedures designed to provide a
standard minimum review of the activities of the branch office,
with interview modules designed specifically for the branch
office manager/compliance officer and PRR interviews, and with
instructions and guidance on the format and contents of the
examination reports.
==========================================START OF PAGE 5======
III. THE SWEEP FINDINGS
A. Some Firms Are Willing to Employ Registered
Representatives With a History of Disciplinary Actions
or Customer Complaints
The Working Group reviewed the employment patterns of the
347 PRRs from December 1994 to November 1995 to identify any
possible trends. Of the 347 PRRs, 114 PRRs (33%) had moved to at
least one new brokerage firm during that time period.-[16]-
Twenty-two registered representatives (or 9% of the 347 PRRs) had
changed firms between two and six times. These findings show
that some firms are willing to employ individuals with a history
of disciplinary actions involving sales practice abuse or
customer complaints.
B. Many of the Branches Examined Utilize Only Minimum
Hiring Procedures
A review of hiring procedures revealed that while many firms
go beyond the minimum steps required by law, approximately 42 of
the 179 branches examined (24%) appeared to conduct, before
hiring, only the minimum review required by NASD and NYSE rules
of a registered representative applicant's background, including
those with a disciplinary history or history of customer
complaints.-[17]- Such review is generally limited to
examining the individual's Forms U-4 and U-5 (or reviewing the
applicant's history on CRD), and contacting the applicant's
previous employers for the past three years.-[18]- A small
number of branches did not conduct even the minimum background
checks required by NASD and NYSE rules. As discussed above, the
significant movement of PRRs within the securities industry may
be attributable, at least in part, to the less than effective
hiring procedures in place at some brokerage firms. The Working
Group believes that many firms need to consider adopting more
stringent hiring procedures.
C. One-Fifth of the Examinations Resulted in Enforcement
Referrals and an Additional One-Fourth of the
Examinations Resulted Primarily in the Issuance of
Letters of Caution or Deficiency Letters
The Sweep established that sales practice abuses by
registered representatives continue to be a problem that requires
attention. As mentioned above, 104 registered representatives
were eliminated from the Sweep because they were already under
ongoing investigation by the SEC or an SRO. Moreover, 38 of the
Sweep's 179 examinations (21%) resulted in referrals for
enforcement investigation. This figure is roughly equivalent to
==========================================START OF PAGE 6======
the findings in the Large Firm Report, in which approximately 25%
of the examinations resulted in enforcement
referrals.-[19]- These enforcement referrals involved 28
of the 101 firms examined, and 23 of the 230 PRRs interviewed.
The potentially violative activity identified during the
examinations included, among other things, excessive trading,
unauthorized trading, failure to supervise, and improper
registered representative registration or failure to update
registration forms.
In addition, 52 of the Sweep's 179 examinations (29%)
resulted in the issuance of a letter of caution or a deficiency
letter. The letters noted violations or deficiencies not rising
to the level of seriousness warranting enforcement investigation.
These letters noted a significant number of minor or less serious
violations and deficiencies including, among other things,
inadequate supervision, deficient written supervisory procedures,
books and records deficiencies, problems with the filing or
completion of registration forms, and advertising issues.
Together with the enforcement referrals, almost half of the
examinations resulted in either an enforcement referral, a letter
of caution, or a deficiency letter.
Inadequate supervision and deficient written supervisory
procedures accounted for many of the apparent violations and
deficiencies found. There appeared to be deficient supervision
in various respects and in varying degrees of seriousness in 51
of the 179 examinations (28%), and deficient written supervisory
procedures in 24 (13%) of the 179 examinations. Inadequate
supervision and deficient written supervisory procedures were
also the most common apparent violations underlying the
enforcement referrals. Only nine of the 179 examinations (5%),
however, revealed very poor supervision or particularly deficient
written supervisory procedures. Nonetheless, these findings
suggest that many firms' supervisory and compliance systems
should be strengthened.
D. Supervisors in Many of the Branches Examined Conduct
Inadequate or No Routine Review of Registered
Representatives' Customer Securities Transactions to
Detect Sales Practice Abuses
It appeared from the examinations conducted that at 47 of
the 179 branches examined (26%), supervisors conduct inadequate
or no routine review of customer securities transactions effected
by registered representatives employed at the branch.
Supervisors should review registered representatives' securities
transactions in order to detect, among other things, sales
practice abuses.-[20]- Trading reviews were generally determined
to be inadequate if supervisors within the branch reviewed too
==========================================START OF PAGE 7======
few reports or other documents over a period of time that
appeared to be insufficient to detect a pattern of trading abuses
vis-a-vis the size and business mix of the firm.-[21]- In
addition, some branch office manager interviews disclosed
practices that present significant concerns. For example, one
branch was found to employ two PRRs who are co-managers (and also
husband and wife) who approve each other's trades. Another
branch employs only one PRR (who was also the branch manager) but
whose activities did not appear to be supervised. Of particular
concern is a statement by yet another branch manager that the
registered representatives in the branch supervise their own
activities. Although these types of findings were isolated,
they require that supervision of sales practice activity be
improved to aid in the detection and prevention of sales practice
abuses.
E. Almost One-Half of the Branches That Engage in Some
Type of Cold Calling Evidenced Cold-Calling Violations
or Deficiencies
The examination interviews revealed that 103 of the 179
branches examined (representing 71, or 70%, of the 101 firms
examined) engage in some type of cold-calling activity. Of the
103 branches that engage in cold calling, 46 (45%) did not fully
comply with the Telephone Consumer Protection Act.-[22]-
For example, the Sweep revealed that 12 of the 103 branches that
engage in cold calling (12%) do not maintain a "do-not-call"
list. In 17 of the 103 branches (17%), registered
representatives who engage in cold calling indicated that they
had not received training regarding the provisions of applicable
cold-calling rules although the firms represented that they
provide such training.-[23]- Finally, sixteen of the 103
branches that engage in cold calling (16%) provide no training
regarding cold-calling requirements.
IV. RECOMMENDATIONS
The Working Group believes that the examination findings
demonstrate a need to continue to devote additional attention and
resources to the prevention and detection of sales practice and
supervisory problems. Consequently, the Working Group proposes
the recommendations discussed below. These recommendations have
been developed to place the responsibility on broker-dealers to
strengthen the compliance mechanisms in place within firms and to
enhance the efforts of the Commission, the SROs, and the state
securities regulators in the prevention and detection of sales
practice abuses.
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A. More Stringent Hiring Procedures for Registered
Representatives
The Working Group believes that more effective pre-hiring
screening of all registered representatives will aid in efforts
to eliminate problem registered representatives from the
securities industry. To this end, firms and their branch offices
should adopt stringent hiring procedures when considering all
registered representative applicants for employment. In addition
to reviewing an applicant's Form U-4 and Form U-5, reviewing CRD,
and contacting the applicant's previous employers, as is now
required under SRO rules, the Working Group strongly recommends
as a "best hiring practice" that firms (or branches) also (1)
discuss with the applicant the nature of the applicant's prior
customers, business mix, and investment philosophy; (2) conduct a
credit and financial check of the applicant; and (3) obtain from
the applicant, orally or in writing, explanations regarding any
customer complaints and regulatory actions to determine the
merit, to the extent practicable, of each prior to hiring. Firms
also should consider asking applicants about the existence and
nature of any pending proceedings, customer complaints, or
arbitrations not listed in CRD. The firm's specific hiring
policies and procedures should be adopted by the firm in writing.
Consistent with the recommendations made in the Large Firm
Report and the "Best Compliance Practices" endorsed by the
Securities Industry Association ("SIA"),-[24]- the Working
Group also recommends that broker-dealers involve compliance and
legal staff in the hiring process and designate (above the branch
office manager level) an individual or committee to approve the
hiring of any registered representative with a history of
compliance problems. The Sweep disclosed that almost 25% of the
branches examined follow such a practice, by requiring that
senior management (above the branch office manager level),
compliance staff, outside counsel, or a special committee review
registered representative applicants before hiring. In addition,
SROs and state securities regulators should remind firms about
their existing responsibilities under SRO rules and regulations
and applicable state securities laws to investigate adequately
each applicant's character, business repute, qualifications, and
experience before hiring and to maintain documentation of the
hiring steps taken (including the "best practices" discussed
above). Firms' documentation of the steps taken in the hiring
process should then be subject to regulatory review during
examinations.
B. Special Supervision for Registered Representatives With
a Disciplinary History
The Working Group strongly believes that it is important for
firms to exercise close supervision over registered
==========================================START OF PAGE 9======
representatives who have engaged in misconduct in the past. If a
firm hires a registered representative with a recent disciplinary
history involving sales practice abuse or other customer harm,
the firm should place the newly hired registered representative
under special supervision. This special supervision should
include a heightened level of scrutiny of the registered
representative's activities by the registered representative's
supervisor. "Normal" supervision is simply not enough; firms
must craft special supervisory procedures tailored to the
individual representative. If firms fail to establish such
special supervisory procedures, SROs will consider revising their
rules to specifically require that registered representatives
with a recent history of disciplinary actions involving sales
practice abuse or other customer harm be placed under special
supervision by the firm for a period of time.-[25]- While
the firm should be responsible for monitoring such a registered
representative's special supervision, the SROs should evaluate
the firm's special supervision of problem registered
representatives during their routine examinations. Moreover, if
such an employee commits a sales practice violation during the
period of special supervision, firms should recognize that
securities regulators do and will continue to closely evaluate
whether the firm itself should be subject to disciplinary action
for failure to supervise the registered representative.
In addition, the Working Group recommends that firms'
compliance or legal personnel immediately perform a thorough
review of a registered representative's customer account activity
when the registered representative is named, during a one-year
period, in three customer complaints alleging sales practice
abuse. The customer account activity of persons with fewer
customer complaints or customer complaints over a longer period
of time also should be reviewed as a matter of course.
C. Branch Manager Compensation
The Working Group is concerned that some branch office
managers are neither devoting sufficient time nor employing
adequate supervisory tools in overseeing the sales activities of
registered representatives. With now over 505,000 registered
representatives and approximately 60,000 branch offices, it is
critical that supervision be effective at every level. As the
first line supervisor, however, the role performed by the branch
office manager, or other first-line supervisor, is critical in
preventing, detecting, reporting, and correcting problems. In
order to encourage and enhance supervisory vigilance, the Working
Group recommends that firms consider adopting a policy of tying a
component of the branch office manager's compensation to the
manager's effective supervision of registered
representatives.-[26]- The Working Group believes that it
==========================================START OF PAGE 10======
would be a good practice for managers to be compensated, at least
in part, for effective supervision and compliance efforts based
on preventing, detecting, reporting, and correcting sales
practice abuses and other customer harm. These efforts may be
evidenced by, for example, internal audit review of the branch,
external regulatory review, and an assessment of arbitrations and
customer complaints within the branch. Firms implementing this
recommendation should also provide branch office managers with
adequate support (both in terms of technical assistance and
support) to enable them to conduct their supervisory
responsibilities adequately.
D. Firm Supervisory Obligations
In light of the deficiencies and weaknesses found in firms'
supervision and written supervisory procedures, the Working Group
believes that firms must ensure that they are fulfilling their
supervisory obligations under SRO rules. It is firms themselves
that are responsible for deterring, detecting, and correcting
weaknesses, deficiencies, and apparent violations of relevant
laws, rules, and regulations. In order to focus firms on this
endeavor, the SROs should remind members of their supervisory
obligations under SRO rules through the use of notices to members
or information memoranda to members. For example:
1. The NASD will remind its members of the following
obligations:
a. Firms must designate one or more
appropriately registered principals in each
office of supervisory jurisdiction ("OSJ"),
including the main office, and one or more
appropriately registered representatives or
principals in each non-OSJ branch office with
authority to carry out the supervisory
responsibilities assigned to each
office.-[27]-
b. At least annually, firms must conduct a
review of the businesses in which they
engage, which review must be reasonably
designed to assist in detecting and
preventing violations of and achieving
compliance with applicable securities laws
and regulations and with the rules of the
NASD.
c. Firms must conduct an annual inspection of
their OSJs.
==========================================START OF PAGE 11======
d. Firms must conduct inspections of non-OSJs
according to the schedule set forth in the
firm's written supervisory procedures.
e. Firms must retain a written record of the
dates upon which each review and inspection
was conducted.-[28]-
2. The NYSE will remind its members of the following
obligations:
a. Firms must supervise each office, department,
or business activity.-[29]-
b. Firms must delegate to qualified principals
or employees responsibility and authority for
the supervision and control of each office,
department, or business activity, and provide
for appropriate procedures of supervision and
control.-[30]-
c. Firms must establish a separate system of
follow-up and review to determine that the
delegated authority and responsibility is
being properly exercised.-[31]-
3. In addition, the other SROs and the state
securities regulators should remind firms about
their respective responsibilities to supervise
branch offices and the importance of designating
appropriately registered principals to carry out
supervisory responsibilities.-[32]-
Moreover, as part of the increased regulatory emphasis on
evaluating the adequacy of supervision and supervisory
procedures, the Working Group believes that regulators should
place increased emphasis during regulatory examinations on
whether firms have met these requirements.
E. Cold-Calling Training and Supervision and Increased
Regulatory Review and Enforcement
Cold calling plays an important role in many firms' efforts
to generate revenue. Because of the abuses that can be, and have
been, perpetrated by cold callers, both Congress and regulatory
authorities have prescribed restrictions to protect the public
from unwanted solicitations and fraudulent conduct by
salespersons and telemarketers.-[33]- The Working Group
believes that many cold-calling violations can be prevented (at
least to a significant degree) through training and more
effective supervision. However, the examinations revealed that a
==========================================START OF PAGE 12======
significant number of firms that engage in cold calling of some
type are unaware of all of their responsibilities, particularly
those under the Telephone Consumer Protection Act.-[34]-
Accordingly, firms must ensure that they adequately train and
supervise all telemarketers and registered representatives who
engage in cold calling on the provisions of FCC rules and SRO
rules on cold calling. Firms that employ cold callers or whose
registered representatives engage in cold calling must ensure
that the Firm Element of the newly implemented continuing
education program incorporates a cold-calling component and that
employees are trained appropriately. In addition, firms must
ensure that they maintain a "do-not-call" list, establish
procedures to add names to the list upon request, and provide a
"do-not-call" list to all persons who engage in cold calling (or
ensure that such persons have access to a copy of the list).
Moreover, in order to ensure that firms fulfill their
obligations under applicable laws and rules, the Commission and
the regulators that conduct examinations will increase their
focus on their regulatory review of cold-calling practices during
sales practice examinations and on bringing appropriate
disciplinary actions for violations in this area. To this end,
the Commission and SROs and state securities regulators that do
not already have a cold-calling component in their modules to
incorporate such a review. SROs should also consider whether it
is appropriate to add to their minor rule violation plans minor
violations of the cold-calling rules.-[35]-
F. Increased Review During Examinations for Inadequate
Supervision and Deficient Written Supervisory
Procedures
Effective supervision and sound written supervisory
procedures are the first line of defense in guarding against
sales practice abuses, detecting those problems that do arise and
taking prompt corrective action. However, the Sweep examinations
found supervisory breakdowns at a number of branches.
Accordingly, members must take steps to improve their performance
in these important areas. The Working Group recommends that
during regulatory examinations, the Commission, the SROs, and
those state securities regulators that conduct examinations
increase their emphasis on evaluating firms' supervision of
registered representatives. In particular, where a weakness,
deficiency, or apparent violation is detected by examiners,
examiners should determine whether supervisors reasonably carried
out their responsibilities; whether such weakness, deficiency, or
apparent violation is indicative of a defect in the firm's system
of supervision, including its written supervisory procedures; and
whether remedial measures are required. This recommendation is a
corollary to the recommendation in the Large Firm Report that
==========================================START OF PAGE 13======
examination staff increase the emphasis during examinations on
sales practice abuses. The Working Group believes that an
increased focus during examinations on supervision and
supervisory procedures applicable to sales practices would
improve firms' efforts to prevent and detect sales practice
abuses by helping to identify weaknesses in the firms' systems of
supervision.
G. Follow-Up Review of Firms That Were the Subject of
Enforcement Actions
Firms that have engaged in sales practice abuse and have
been the subject of disciplinary action must take necessary steps
to remedy the problems within the firm. To ensure that firms
that have had sales practice problems do not repeat the offense
and to quickly detect those that do, the Working Group recommends
that the SEC and the appropriate SROs include in their annual
examination priorities follow-up examinations of firms that have
been the subject (or whose management have been the subject) of
SEC or SRO enforcement actions involving serious sales practice
abuses, supervisory breakdowns, or other egregious activity that
harms customers within one year of the enforcement action. The
Working Group also recommends that, as part of the overall
sanctions imposed in enforcement actions, firms be required to
prepare and submit to the appropriate regulator a report of the
steps taken by the firm to address the abusive practices,
including a follow-up review by the firm regarding its
supervisory improvements following such actions. The
improvements contained in this report will then be closely
reviewed during follow-up regulatory examinations. Enhanced
regulatory oversight of firms with a history of serious
deficiencies or violations through increased SRO examinations
should cause such firms to take remedial actions in a more timely
fashion, and should allow SROs to detect and halt sales practice
abuse at the earliest point.
V. CONCLUSION
The protection of customers from sales practice abuses or
other financial harm is critical to maintaining a healthy
securities industry. As such, it is an objective shared by the
Commission, the SROs, state securities regulators, and the
securities industry. Like the Large Firm Project, the Sweep
disclosed that the efforts to prevent and combat sales practice
abuses can be improved and strengthened by both regulators and
the securities industry.
The Sweep involved a sampling of registered representatives
with histories of disciplinary actions and customer complaints
==========================================START OF PAGE 14======
and the firms employing such individuals. As a result, it is not
possible to draw general conclusions regarding the securities
industry as a whole with respect to its hiring, retention and
supervisory practices. However, in the small sample selected for
examination, the Sweep's findings suggest that existing
supervisory and compliance systems at many firms could and should
be improved.
The Working Group believes that the Commission, the SROs,
the state securities regulators, and the securities industry
should work together to identify problem registered
representatives at an early stage. Once identified, steps should
be taken to reduce the potential for future sales practice abuse
through examination oversight and, where appropriate, aggressive
enforcement action. Even more important, however, is the need to
prevent sales practice abuses through the establishment and
implementation of firm policies and procedures designed to
prevent and detect such abuses, and through effective
supervision. In addition, firms must improve substantially their
pre-screening of registered representative applicants in order to
preclude problem registered representatives from re-entering the
securities industry or remaining in the industry by moving from
firm to firm. Reducing the number problem registered
representatives in the securities industry is a pivotal step in
effectively reducing potential harm to the investing public.
The Working Group recommends that the Commission, the SROs,
the state securities regulators, and the securities industry
consider prompt implementation of the recommendations contained
in this report, which are designed to build on and improve
existing supervisory and regulatory systems, and most
importantly, to protect the integrity of the U.S. securities
markets and the well-being of public investors.
==========================================START OF PAGE 15======
=========ENDNOTES=========
-[1]- The term "Working Group" refers to the staffs of
the SEC, the NASD, the NYSE, and NASAA.
-[2]- The firms examined include both clearing and
introducing firms (mostly introducing firms),
employ anywhere from approximately 10 to several
thousand registered representatives, are located
throughout the United States, and generally offer
a wide variety of securities products.
-[3]- For purposes of this report, the main and branch
offices of firms examined during the Sweep are
collectively referred to as branches.
-[4]- The review also revealed that almost one-fourth of
the 347 PRRs were not working in the securities
industry at the conclusion of the Sweep in
November 1995.
-[5]- An applicant for registration with an NASD member
firm must complete a Uniform Application for
Securities Industry Registration or Transfer Form
(Form U-4), pursuant to Article IV, Section 2 of
the NASD's By-Laws. Similarly, NYSE Rule 345.12
requires persons preparing to become associated
with NYSE firms to file and keep current Form U-4.
Form U-4 requires that firms and individuals
report personal data, residential history,
employment, and personal history for the past ten
years, as well as findings and adjudications by
domestic and foreign courts, the SEC, the
Commodity Futures Trading Commission ("CFTC"),
federal, state, and foreign regulatory agencies,
self-regulatory organizations ("SROs"), and
commodities exchanges involving felony
convictions, certain misdemeanors, false
statements and omissions and violations of
applicable rules. Applicants must also report
customer-initiated complaints involving
allegations of fraud or wrongful taking of
property, allegations of compensatory damages of
$10,000 or more, awards of damages of $5,000 or
more, or settlements of $5,000 or more. Form U-4
also requires disclosure of unsatisfied judgments
or liens, petitions in bankruptcy and any
discharges or resignations from employment
resulting from accusations involving investment-
related rules, regulations or statutes, wrongful
==========================================START OF PAGE 16=====
taking of property or failure to supervise in an
investment context.
-[6]- Under Article IV, Section 3 of the NASD By-Laws
and NYSE Rule 345.17, members must provide the
NASD and NYSE, respectively, with written notice
of termination of any registered person. In
addition to notifying the SROs of the termination
of association between the broker-dealer and
registered representative, the Uniform Termination
Notice for Securities Industry Registration (Form
U-5) requires that firms report any disciplinary
action, investigation, or proceeding by a domestic
or foreign governmental body or SRO with
jurisdiction over investment-related business;
convictions or guilty pleas in a foreign or
domestic court involving felonies or certain
misdemeanors; internal investigations involving
fraud or wrongful taking of property or violations
of investment-related statutes or regulations; and
investment-related consumer initiated complaints
that allege compensatory damages of $10,000 or
more, allege fraud or the wrongful taking of
property, were settled or decided against the
individual for $5,000 or more, or where the
broker-dealer found fraud in the wrongful taking
of property. Members must file an amended Form U-
5 in the event that the member learns of facts or
circumstances causing information in the Form U-5
termination notice to be inaccurate or incomplete.
One purpose of the timely filing of the
termination notice is to provide the SROs with a
mechanism for reviewing past conduct of terminated
registered representatives before the SROs lose
jurisdiction over the registered representatives
that may have violated federal, state, or SRO
rules and regulations.
-[7]- Developed jointly by NASAA and the NASD in 1981,
the CRD, which the NASD operates, is an on-line
database containing information pertaining to
broker-dealers and their associated persons.
Information contained in the CRD is provided by
the NASD, SEC, some exchanges, the CFTC, the
National Futures Association, state securities
regulators and the Federal Bureau of
Investigation. Information is also provided to
the NASD for input into CRD by broker-dealers
through their submissions of amendments to Form BD
(the firm's registration form) and Forms U-4 and
==========================================START OF PAGE 17======
U-5. The CRD database includes information on
approximately 5,500 broker-dealers and 505,000
active registered persons.
-[8]- An enforcement referral occurs when findings
discovered during an examination are deemed by the
staff to be of sufficient concern to warrant
further investigation and possible enforcement
action. The fact that an examination has been
referred to enforcement staff does not necessarily
mean that a violation of the sales practice rules
or the antifraud provisions of the securities laws
has occurred, or that an enforcement case will be
brought involving the branch or registered
representative whose conduct is the subject of the
referral. Some of these examinations also
resulted in other actions, such as a letter of
caution or a deficiency letter. See infra note 9
(definitions of letter of caution and deficiency
letter).
-[9]- A letter of caution is a letter sent to a broker-
dealer by an SRO or state securities regulator
describing a violation by the broker-dealer or its
associated persons of one or more securities laws,
rules or regulations. A letter of caution is
typically issued for violations that are less
serious than those warranting an enforcement
referral. If further similar violations occur,
the broker-dealer may be subject to more formal
disciplinary action, such as a disciplinary
proceeding seeking a fine or bar. A deficiency or
exception letter is issued to a broker-dealer by
an SRO, state securities regulator, or Commission
staff describing deficiencies and sometimes
violations in the broker-dealer's operations found
during a broker-dealer examination. A deficiency
letter is not viewed as a disciplinary action; it
apprises the broker-dealer of areas that need
improvement, requests that corrective steps be
taken to rectify the problems specified, and
generally requires the broker-dealer to provide
within a specified time a response identifying any
remedial actions taken or proposed to be taken.
-[10]- Broker-dealers, like all firms engaged in
telemarketing, are subject to the Telephone
Consumer Protection Act and a Federal
Communications Commission ("FCC") rule promulgated
thereunder. See Pub. L. No. 102-243, 105 Stat.
==========================================START OF PAGE 18======
2394 (1991) (codified at 47 U.S.C. 227(1992));
47 CFR 64.1200 (1992). Pursuant to the FCC's
cold-calling rule, telemarketers must abide by
specified time-of-day restrictions, maintain "do-
not-call" lists and add names to such lists upon
request, train personnel and adopt a written
policy with respect thereto, and follow certain
identification requirements. In August 1994,
Congress passed and the President signed new cold-
calling legislation, entitled the Telemarketing
and Consumer Fraud and Abuse Prevention Act. See
H.R. Rep. 686, 103rd Cong., 1st Sess. (1994).
This Act required the Federal Trade Commission
("FTC") to enact cold-calling rules with respect
to most telemarketers, except those regulated by
the SEC, within a year of the legislation, and
directed that the SEC adopt, or cause SROs to
adopt, substantially similar rules for broker-
dealers and other SEC-regulated entities within
six months of the effective date of the FTC rules,
unless the Commission determines that such rules
are unnecessary or inappropriate. See infra note
34. The FTC approved rules under the Act in
August 1995, which rules became effective on
December 31, 1995. See 60 Fed. Reg. 43842 (Aug.
23, 1995).
-[11]- The Securities Industry/Regulatory Council on
Continuing Education, composed of representatives
from SROs, a cross-section of firms, and liaisons
from NASAA and the SEC, has developed a continuing
education curriculum to improve practices
throughout the securities industry. Under the
program, every broker-dealer is required to
provide its registered representatives and first-
line supervisors with annual continuing education
relating to its products and services. In
addition, all registered representatives who have
been registered less than ten years or who have
been the subject of serious disciplinary action
must receive compliance, ethics and sales practice
training.
-[12]- NASD cause examinations generally are conducted as
a result of a customer complaint alleging
violation of the NASD rules and/or federal
securities laws or disclosure of certain
information on Form U-5 regarding the termination
for cause of a registered representative.
==========================================START OF PAGE 19======
-[13]- NYSE Rule 351(d) requires that member firms submit
to the NYSE, on a quarterly basis, summary
information concerning all customer complaints the
member firm received during that quarter. In
addition, NYSE Rule 351(a) specifically identifies
ten different circumstances where broker-dealers
must file a report with the NYSE. See Appendix D
(text of Rule 351(a)).
-[14]- The following state securities regulators
participated in the Sweep examinations discussed
in this Report: Alaska, Arizona, California,
Colorado, Connecticut, District of Columbia,
Florida, Idaho, Illinois, Iowa, Kansas, Maine,
Maryland, Michigan, Montana, New Jersey, New
Mexico, Nevada, North Carolina, North Dakota,
Oklahoma, Oregon, Pennsylvania, Puerto Rico,
Texas, Utah, Virginia, Washington, and Wisconsin.
-[15]- One hundred and seventeen PRRs were not
interviewed because, among other things, they were
either out of the industry at the time of the
examination, determined (on-site or immediately
prior to the scheduled examination) to be
inappropriate interview candidates because they
did not conduct retail securities business or
conducted an insignificant number of trades per
month, or were subject to an enforcement
investigation that began after the examinations
occurred.
-[16]- The review of the 347 PRRs revealed that 75 of the
347 PRRs (22%) were not working in the securities
industry at the conclusion of the Sweep in
November 1995. Of these PRRs, four (5%) have been
the subject of a disciplinary action involving
sales practice abuse during the Sweep and 11 PRRs
(15%) were, as of January 1996, the subject of an
ongoing, non-public investigation involving sales
practice abuse.
-[17]- See Article III, Section 27(e) of the NASD's Rules
of Fair Practice and NYSE Rule 345.11. Some state
securities regulatory authorities have adopted
similar requirements.
==========================================START OF PAGE 20======
-[18]- An applicant is frequently offered a position
before the broker-dealer contacts the person's
employers for the past three years as required by
Form U-4. However, that person is not permitted
to act as a registered representative until the
Form U-4 has been filed with and received by the
NASD (or other SRO as required).
-[19]- The number of Sweep examinations that resulted in
enforcement referrals was roughly consistent with
the number of referrals typically resulting from
the SEC's examination program. In fiscal year
1995, approximately 21% of the SEC's examinations
(excluding those related to the Sweep) resulted in
referrals for possible enforcement investigation.
-[20]- The types of reviews conducted vary from firm to
firm, or branch to branch, based on the size of
the firm or branch, and the business mix. Reviews
include the examination of, among other things,
order tickets and customer accounts. In addition,
some firms or branches may utilize exception
reports (i.e., computerized reports designed to
highlight activities that trigger certain
parameter breaks), while others (usually smaller
firms or branches) may rely primarily on manually
generated reports.
-[21]- For a branch with few registered representatives,
for example, a daily check of order tickets and a
review of monthly statements by the branch office
manager may be adequate because the branch manager
should be familiar with all of the accounts. For
a larger firm with many registered
representatives, such a trading review should
include the use of exception reports, which enable
a firm to tailor reports to detect specific types
of sales practice abuses based on parameter
breaks.
-[22]- See supra note 10.
-[23]- Two branch managers believed that training is not
required or given if the salesperson is a
registered representative.
-[24]- See Appendix A, Section A.5. (discussion of SIA
endorsement of best compliance practices).
==========================================START OF PAGE 21======
-[25]- Registered representatives who are subject to a
statutory disqualification and seek to become
associated with a registered broker-dealer
typically are required by the SRO to be placed
under enhanced supervision as a condition of such
person's employment at the broker-dealer.
Generally, a person is subject to a statutory
disqualification if that person has been convicted
of any felony or certain enumerated misdemeanors
within the last ten years; is enjoined temporarily
or permanently from violating the securities laws
by a court of competent jurisdiction; or has been
and is barred from associating with a broker-
dealer by the SEC, the CFTC, an SRO, or the
foreign equivalent thereof. See Section 3(a)(39)
of the Securities Exchange Act of 1934 ("Exchange
Act"). The recommendation to place registered
representatives with a history of disciplinary
actions under special supervision is not limited
to statutorily disqualified persons.
-[26]- Compensating a branch office manager based on,
among other things, the compliance record of the
branch was reflected as a "best practice" in an
April 1995 report by the Committee on Compensation
Practices. See Report of the Committee on
Compensation Practices (April 10, 1995) (also
discussed in Section B.1. of Appendix A).
-[27]- See Article III, Section 27(a)(4) of the NASD's
Rules of Fair Practice.
-[28]- See Article III, Section 27(c) of the NASD's Rules
of Fair Practice.
-[29]- See NYSE Rule 342(a).
-[30]- See NYSE Rule 342(b)(1).
-[31]- See NYSE Rule 342(b)(2).
-[32]- See Section III.D. for examples of highly
questionable supervisory practices by principals.
-[33]- The permitted activities of telemarketers who are
not registered representatives are extremely
limited. See generally Article II, Section 2 and
Article IV, Section 1 of the NASD's By-Laws.
==========================================START OF PAGE 22======
-[34]- See supra note 10 and accompanying text
(discussion of cold-calling requirements and
examination findings). To date, several SROs have
promulgated cold-calling rules that require
members that engage in telephone solicitations to
offer and sell securities to create and maintain a
centralized do-not-call list. Exch. Act Rel. No.
35821 (June 7, 1995) (NYSE rule); Exch. Act Rel.
No. 35831 (June 9, 1995) (NASD rule); Exch. Act
Rel. No. 36588 (Dec. 13, 1995) (CBOE rule); and
Exch. Act Rel. No. 36748 (Jan. 19, 1996) (Amex
rule).
-[35]- Many SROs have minor rule violation plans that
enable them to discipline members and registered
representatives for minor violations without
having to follow the more formal procedures
required for enforcement actions (see, e.g., Art.
II, Sec. 10 of the NASD's Code of Procedure, NYSE
Rule 476A).
==========================================START OF PAGE 1======
APPENDIX A
STATUS OF LARGE FIRM PROJECT RECOMMENDATIONS
AND OTHER INITIATIVES
The Large Firm Report contained a number of recommendations
to strengthen broker-dealer compliance systems, enhance SRO
efforts in detecting sales practice abuses and enforcing
compliance with their rules, and increase investor protection.
In addition to these recommendations, the SEC's Divisions of
Market Regulation and Enforcement requested other actions in an
August 4, 1994 letter to all SROs ("August Letter"). Other
initiatives have also been taken to address and curb sales
practice abuses. A discussion of the status of the
recommendations made in the Large Firm Report and subsequent
initiatives taken follows.
A. Large Firm Report Recommendations
1. Increased Examination Efforts and Sanctions in
Sales Practice Matters
Based on the results of the Large Firm Project, the
Commission recognized that stepped-up examination efforts were
necessary, existing systems designed to detect problem registered
representatives needed improvement, and sanctions for sales
practice violations at both the SRO and Commission levels needed
to be severe.
a. Examination Efforts
The Commission has increased its examination efforts in
detecting sales practice abuses. Since 1992, the Commission has
increased the number of annual broker-dealer examinations by over
20%, each of which included a review of sales practices. Since
1994, Commission examination staff has been directed to increase
the focus on sales practice activities during examinations. In
addition, in April 1995 the Commission reorganized and
consolidated its inspection and examination programs into one
office, the Office of Compliance Inspections and Examinations
("OCIE"). OCIE streamlines the examination process by
consolidating the management of the programs and improving
coordination with the regional office examination staff and with
other regulatory agencies. In addition, a new office was created
within OCIE specifically dedicated to the broker-dealer
examination program. The Office of Broker-Dealer Examinations
and Oversight was created to give greater focus to, and expand
the activities of, the broker-dealer examination program.
Finally, the Commission staff is reviewing customer complaint
information to focus examinations, which should aid in the
earlier identification of problem registered representatives.
==========================================START OF PAGE 2======
The NASD has instructed its District staff to conduct
examinations of broker-dealer main and branch offices, as well as
individuals associated with those offices, where the broker-
dealers or associated individuals pose a regulatory concern
because of past conduct, and to view customer complaints
collectively so that patterns or trends regarding a particular
firm, individual, or product can be readily identified.
Moreover, on October 1, 1995, the NASD Rules of Fair Practice
incorporated Section 50 of Article III, which requires members to
report to the NASD ten specified events, termed "disclosure
events," and the quarterly reporting of summary statistics
regarding customer complaints. The rule exempts any firm subject
to a similar reporting requirement of another SRO. This rule is
designed as an early warning mechanism for potential sales
practice problems in which registered persons and members are
engaged.
In addition, the NASD initiated a comprehensive overhaul of
the CRD system to expand the use of the CRD system as a tool for
broker-dealer regulation. As a result of the NASD's efforts, the
redesigned CRD system ultimately is expected to provide the
Commission, the SROs, and state securities regulators with: (i)
streamlined capture and display of data, (ii) better access to
registration and disciplinary information through the use of
standardized and specialized computer searches, (iii) electronic
filing of Forms U-4 and U-5, and (iv) computerized ad hoc reports
that provide various profiles and information for regulatory
use.1/ The NASD also developed a program to identify PRRs for
not only this Sweep, but also in conjunction with NASD sales
practice examinations that focus on individuals that fit the PRR
profile.
Further, in 1996, as part of its newly adopted CornerStone
examiner training and support system, the NASD introduced its
Automated Examination Modules ("AEM") to all of its District
examiners to replace its paper examination modules. Utilizing
AEM, examiners have all of the NASD's examination modules and
related procedures on a lap top computer for use in the field,
which greatly facilitates the focusing, recording, and finalizing
of examination reports.
Finally, the NASD has developed a National Regulatory Plan
that is designed to ensure that high risk firms, individuals,
practices, and products are timely and effectively identified on
a nationwide basis, and an appropriate regulatory response
developed and implemented in a manner that cuts across individual
District and departmental boundaries. In concept, the National
Regulatory Plan is both a strategic and centralized planning
initiative that draws on existing district and departmental
==========================================START OF PAGE 3======
manpower and expertise to inspect and investigate or otherwise
consider identified areas of focus.
The NYSE, over the last several years, has substantially
increased the number of sales practice examiners and
substantially increased the number of firms receiving a
specialized sales practice examination. Currently, NYSE firms
receive specialized sales practice examinations in addition to
their annual financial and operations examinations. The sales
practice program has been expanded so that the top 16 firms
dealing with the public receive an annual specialized sales
practice examination. In addition, the NYSE established a sales
practice cycle for all other firms dealing with the public and as
a result, these firms now receive a specialized sales practice
examination at least once every four years. When NYSE examiners
do not conduct specialized examinations, the member firms receive
a sales practice review by the NYSE's financial and operations
examiners during the annual examination. Accordingly, all NYSE
firms dealing with the public receive an annual review for sales
practices. Moreover, the NYSE has instituted a program to
conduct risk analysis using NYSE Rule 351 data to identify
problem registered representatives and, where appropriate, follow
up with a special cause examination.
The NYSE has also built a tracking system for registered
individuals who receive five or more sales practice complaints.
These individuals are targeted for review by NYSE examiners
during routine sales practice examinations. Furthermore, in
1996, the NYSE plans to rewrite its sales practice program and
manual. Also, with the advent of the new CRD system, the NYSE is
looking forward to linking its system so that it can both track
problem registered representatives, as well as build the NYSE's
matrix to assist in examination planning.
b. Sanctions
In September 1994, in keeping with its commitment to review
its policies regarding sanctions for sales practice violations,
the Commission's staff sent a letter to the SROs clarifying the
Commission's policy regarding the re-entry of individuals who
have been barred by the Commission from the securities industry
without any provision for re-application after the expiration of
some period.2/ The letter stated that the imposition of an
unqualified bar against an individual "evidences the Commission's
conclusion that the public interest is served by permanently
excluding the barred person from the securities industry."3/
Accordingly, absent extraordinary circumstances, a person subject
to an unqualified bar will be unable to establish that it is in
the public interest to permit a re-entry to the securities
industry.
==========================================START OF PAGE 4======
In addition, the Commission has heightened its focus on
broker-dealer misconduct and supervisory breakdowns in
enforcement actions. Since 1992, the number of enforcement
actions brought by the Commission against broker-dealers and/or
their employees involving fraud against customers has increased
(from at least 41 cases in 1992 to at least 66 cases in 1995),
and the number of defendants in these cases has more than doubled
(from at least 53 in 1992 to at least 108 in 1995). The number
of failure to supervise cases brought by the Commission during
the same period has also doubled (from at least 9 in 1992 to at
least 19 in 1995).
Further, as a result of the examinations completed as part
of the Large Firm Project, a number of referrals were made to the
Commission's enforcement staff for their review and
consideration. While some of these matters are still under
investigation, these referrals played a role in a number of
enforcement actions, as described below.
The Commission recently brought action against PaineWebber
Inc. for violations of the antifraud and recordkeeping provisions
of the federal securities laws in the marketing and sale of
limited partnership interests and other "direct investments" from
1986 to 1992.4/ The firm was also charged with failing
reasonably to supervise ten registered representatives (two of
whom were branch managers) who engaged in fraudulent sales
practices in connection with both direct investments and other
securities. A number of the enforcement referrals played a role
in this proceeding. Without admitting or denying the findings
contained therein, the firm consented to the entry of a
Commission order to comply with its representation that it has
paid or will pay a total of $292.5 million to defrauded
investors.
In another case, an enforcement referral of a branch office
examined during the Large Firm Project formed a part of the basis
of a larger Commission action. Prudential Securities, Inc.
("Prudential") was charged with wide-ranging violations of law,
including sales practice violations arising from the firm's sales
of various investment vehicles from 1980 to 1990.5/ Without
admitting or denying the allegations, Prudential consented to the
entry of a final order of the federal district court requiring it
to pay all valid claims presented through a court supervised
claims resolution process. As a result of this case, Prudential
has paid, as of March 1, 1996, $900 million to resolve
approximately 140,000 claims.
In another enforcement action based on a referral from the
Large Firm Project, the Commission instituted an administrative
proceeding against Daniel Zessinger, a registered representative
==========================================START OF PAGE 5======
employed by Prudential, for various violations of the antifraud
provisions of the federal securities laws.6/ The registered
representative is alleged to have engaged in, among other things,
undisclosed margin trading, unsuitable transactions, and provided
customers with fictitious account statements. Other enforcement
referrals arising out of the Large Firm Project are under
investigation.
2. Improved Broker-Dealer Compliance Systems for
Identifying Problem Registered Representatives
The Large Firm Report recommended that firms strengthen
their procedures to identify registered representatives
generating large numbers of sales practice-related customer
complaints, arbitration awards, and settlements. To facilitate
this, the Large Firm Report recommended that all SROs adopt a
rule similar to NYSE Rule 351, which requires, among other
things, that NYSE member firms submit to the NYSE (on a quarterly
basis), summary information concerning all customer complaints
the member firm received during that quarter. In response, the
Commission approved an NASD rule proposal that requires its
members to report to the NASD the occurrence of certain specified
events, called disclosure events, and quarterly summary
statistics concerning customer complaints, as discussed in
Section A.1.a. above.7/ Firms now can and should use this
information internally to identify and deal with problem
registered representatives or branch offices.
3. Enhanced Compliance by Firms and Registered
Representatives with All SRO Reporting
Requirements
The Large Firm Project found that a fruitful source for the
identification of possible sales practice problems was the
required reports that registered representatives file with SROs.
In its August Letter, the Commission staff requested that the
SROs closely monitor the timeliness of required filings, such as
the Forms U-4 and U-5, through examinations and otherwise. The
SROs also were asked to increase sanctions against both firms and
individuals where instances of noncompliance with SRO
requirements were discovered. In this regard, the NASD has
indicated that it believes that late and deficient filing
violations should be added to the NASD's minor rule violation
plan; a proposed rule change to the NASD's minor rule violation
plan is anticipated to be submitted to the Commission in the near
future. In addition, the NASD's redesigned CRD will provide for
greater detection of late, deficient, or missed filings; and
thus, regulatory follow-up will be enhanced.
In addition, during 1994 and 1995, the NYSE completed
numerous enforcement actions against firms for late reporting of
==========================================START OF PAGE 6======
Forms U-4, Forms U-5, and/or NYSE Forms RE-3. Also during that
same time period, the NYSE issued summary fines to ten firms for
late Form U-4, Form U-5, and/or NYSE Form RE-3 reporting. These
types of actions have resulted in a significant increase in
reports and filings with the NYSE, from approximately 4,000 in
1988 to 11,200 in 1995.
4. Qualified Immunity for Firms on Form U-5
In the Large Firm Report, the SEC staff acknowledged that,
because of perceived concerns about liability based on claims of
defamation by terminated associated persons, firms may not be
fully candid on Form U-5 about the reasons for terminations. To
eliminate such concerns, and to ensure the continued integrity
and value of the Form U-5 as a regulatory tool, the SEC staff
recommended that a uniform policy of qualified immunity be
established for statements made by firms and their personnel on
Forms U-5.
Judicial decisions have uniformly afforded firms at least
qualified immunity for statements on Forms U-5. Since the
issuance of the Large Firm Report, there have been several
federal court decisions addressing the issue. In Baravati v.
Josephthal, Lyon & Ross, Inc.,8/ the Seventh Circuit, applying
Illinois law, concluded that qualified, but not absolute,
privilege existed for statements made on Form U-5. In Culver v.
Merrill Lynch & Co.,9/ a district court, applying New York law,
held that such statements are absolutely privileged. Given these
decisions, it is less clear that firms believe that Commission
action to address concerns about potential liability is desirable
at this time. The Working Group reiterates the importance of
firms preparing complete and accurate Forms U-5, especially in
light of its recommendation today regarding the need for more
stringent hiring practices for registered representatives. The
Commission intends to discuss the best course of action with
securities industry representatives, as well as the principal
end-users of Forms U-5 -- the NASD, the NYSE, and state
securities regulators.
5. Enhanced Role for Legal and Compliance Departments
The Large Firm Report specifically recommended that firms
adopt procedures that enable legal and compliance personnel to
have a role in decisions relating to hiring and retaining
registered representatives, particularly when the registered
representative meets criteria indicating a history of regulatory
problems or customer complaints. (In the current Sweep, the
Working Group found that nearly 25% of the firms examined had
adopted such a practice.) In November 1995, the Board of
Governors of the Securities Industry Association ("SIA"), a trade
association that represents broker-dealers, endorsed a set of
==========================================START OF PAGE 7======
"Best Compliance Practices" for voluntary adoption by SIA member
firms.10/ The SIA's Board of Directors made recommendations
with regard to the role of compliance professionals, internal
firm policies, and relationships with investors and regulators.
The best compliance practices include, among others, that member
firms: (a) involve compliance personnel in the decision-making
process for the hiring and termination of employees and in the
firms' internal disciplinary process; (b) require managers and
supervisors to conduct reasonable inquiries and background
reviews before finalizing hiring decisions; (c) have internal
polices that provide that internal disciplinary actions may be
taken against registered representatives for specified types of
misconduct; (d) maintain written records of supervisory
responsibility for each business unit in the organization; and
(e) identify individuals who are the subject of special
supervision and have the manager or supervisor acknowledge his or
her understanding of the special supervisory procedures.
6. Additional Regulatory Action
The Large Firm Report recommended that the Commission
consider whether additional regulatory action is needed to
address the problem of registered representatives with a history
of regulatory problems. As discussed above, the Working Group
recommends that firms should designate, above the branch office
manager level, an individual or committee to approve the hiring
of any registered representative with a history of compliance
problems. The Working Group recommends that firms be required to
place registered representatives with a disciplinary history
under special supervision. In addition, since the Large Firm
Report, SROs have reviewed their examination programs to ensure
that firms and individuals who may pose regulatory concerns are
identified and examined. Both the NASD and the NYSE, for
example, have stated that the supervision of high risk brokers
has been an increasing focus of sales practice examinations, and
that it has improved its surveillance system to flag potential
problem registered representatives. The NYSE has recently
brought several enforcement cases against branch office managers
who failed to supervise adequately a registered representative
where the facts indicate that the branch office manager was on
notice of past complaints or regulatory problems of the
registered representative at previous employers. In addition,
the American Stock Exchange, Inc. ("Amex") removed the ceiling
for fines for sales practice related sanctions, and noted an
increase in the severity of their sanctions over the past several
years.
7. Continuing Education
==========================================START OF PAGE 8======
In May 1993, an industry task force was established to study
the issue of continuing education for securities industry
personnel. This task force issued a report calling for a formal
two-part Securities Industry Continuing Education Program
("Program") for securities industry professionals that would
require uniform periodic training in regulatory matters and on-
going programs by firms to keep registered representatives up to
date on job- and product-related subjects. The report also
recommended the creation of a permanent Securities
Industry/Regulatory Council on Continuing Education ("Council")
to recommend to the SROs the specific content of the curriculum
to improve practices in the industry. On February 8, 1995, the
Commission approved the SROs' proposed uniform rules to implement
the Program based on the Council's recommendation, which became
effective July 1, 1995. As a result, thousands of securities
industry professionals will receive ongoing training in their
profession, enhancing their knowledge, abilities, and
professionalism. Implementation of the continuing education
program is a critical element in preventing sales practice
abuses, protecting individual investors, and enhancing the
professionalism of the industry. The Commission, the NASD, the
NYSE, and certain state securities regulators conduct reviews for
compliance with the new continuing education rules in their
routine examination programs.
8. Development and Implementation of Tracking Systems
for SRO Handling of Investigations Relating to
Form U-4 and U-5 Filings
The Large Firm Report recommended that the SROs continue to
monitor the timeliness of required filings, such as Forms U-4 and
U-5 and NYSE Form RE-3, through examinations and otherwise, and
to sanction firms for failure to make filings promptly and
accurately. In addition, the August Letter asked the SROs to
review their existing coordination protocols and, if necessary,
implement a tracking system for investigations relating to a
registered representative's termination for cause or amendment to
Forms U-4 and U-5, and for the current status of such
investigations. As discussed above, the NASD has initiated a
comprehensive overhaul of the CRD system that is expected to help
in this regard. Once completed, NASD member firms will be
required to file electronically file with the new CRD system all
Forms U-4, U-5, and BD (and amendments thereto), and their
corresponding Disclosure Reporting Pages ("DRPs"), and Form BDW
(for broker-dealer withdrawals). As part of the CRD redesign,
the NASD is developing a tracking program that will alert it to
filing deficiencies and instances of failure to file required
forms.
==========================================START OF PAGE 9======
While electronic filing of Forms U-4 and U-5 and other
uniform registration forms promises to streamline and modernize
broker-dealer filing procedures, electronic filing also raises
various legal and regulatory issues. For instance, the
implementation of electronic, "paperless" filing raises
evidentiary issues, and may implicate existing broker-dealer
recordkeeping requirements. The Commission staff currently is
working with the SROs and the states on a proposal that would
address concerns in these and other areas. With respect to
regulatory concerns raised by electronic filing, broker-dealers
should develop written supervisory procedures governing the
electronic filing of uniform forms using the redesigned CRD to
ensure that they are in compliance with their supervisory
responsibilities.
9. Disclosures When Opening New Accounts
In order to provide investors with information about their
registered representatives before opening an account, the Large
Firm Report recommended that the SROs adopt rules that require
broker-dealers to disclose to investors opening new accounts the
availability of information concerning the disciplinary history
of registered representatives through the NASD's toll-free number
(1-800-289-9999). In response, the NASD, the SEC, and other SROs
have published and widely disseminated to the investing public
the "Invest Wisely" brochure which discloses the availability of
the NASD toll-free number. The NASD has also published "The NASD
Customer Complaint Program," a brochure that describes how the
NASD processes complaints received from investors and describes
the availability of the NASD's toll-free number. As a result,
the public is using the toll-free number more frequently.11/
The NASD will also promote its toll-free number on its home page
on the Internet's World Wide Web, which should be on-line by mid-
1996. Investors may also obtain disciplinary history regarding
registered representatives by contacting their local state
securities agency. Like the NASD, many of these jurisdictions
also have toll-free numbers that consumers may call. (See
Appendix E for a list of these numbers.)
10. Public Disclosure by All SROs of Initiated
Disciplinary Actions
In the Large Firm Report, the SEC staff noted that investors
need more information about formal regulatory actions taken
against broker-dealers. While the NASD and the NYSE already have
instituted procedures to disclose initiated disciplinary actions
through the NASD hot-line, the August Letter asked the remaining
SROs to report to the CRD (for disclosure to the public) SRO-
initiated formal disciplinary actions, as well as completed
==========================================START OF PAGE 10======
disciplinary actions, against member firms and individuals.
On August 4, 1994, the Commission approved a new Chicago Stock
Exchange rule to disclose pending disciplinary proceedings to the
CRD for dissemination to the public.12/ In addition, the Amex
also instituted procedures to disclose pending Amex charges on
the CRD system. Finally, the Commission approved a CBOE rule
change which reports an investigation to CRD at the time that
CBOE's Business Conduct Committee issues a Statement of
Charges.13/ Despite these actions, the Sweep revealed that not
all CRD reportable disciplinary actions (e.g., formal
investigations) by SROs have been reported to CRD. Accordingly,
SROs should ensure that disciplinary actions, pending and final,
are promptly reported to CRD.
B. Other Initiatives
In addition to the recommendations noted in the Large Firm
Report, the Commission, the SROs, and NASAA have taken several
other steps to address and curb abusive sales practices and
generally enhance the effectiveness of the examination process.
1. Compensation Practices
In order to focus industry attention on compensation
practices and the conflicts that certain practices might impose,
Chairman Levitt convened the Committee on Compensation Practices
("Committee"), chaired by Daniel P. Tully, Chairman and Chief
Executive Officer of Merrill Lynch Co., Inc. On April 10, 1995,
the Committee issued its report, which examined the conflicts of
interest between a broker and an investor presented by current
compensation practices and highlighted the industry's best
practices that eliminate, reduce, or mitigate those
conflicts.14/
Since the issuance of the report, many retail firms have
eliminated higher commissions for sales of proprietary products,
eliminated product-specific sales contests, eliminated
accelerated commissions for newly recruited brokers, and reduced
the use of up-front money in recruiting brokers.
2. Cold-Calling Rules
In August 1994, Congress passed and the President signed new
cold-calling legislation, entitled the Telemarketing and Consumer
Fraud and Abuse Prevention Act.15/ This Act required the FTC
to enact cold-calling rules with respect to most telemarketers,
except those regulated by the SEC, within a year of the
legislation, and directed that the SEC adopt, or cause SROs to
adopt, substantially similar rules for broker-dealers and other
SEC-regulated entities within six months of the FTC rules if the
Commission determines that such rules are necessary. To date,
==========================================START OF PAGE 11======
the Commission has approved NYSE, NASD, CBOE, and Amex rules that
require members that engage in telephone solicitations to offer
and sell securities to create and maintain a centralized do-not-
call list.16/
3. Investor Education and Assistance
In 1994, the Commission's Office of Investor Education and
Assistance, formerly the Office of Consumer Affairs,17/ was
created. Since that time, the office has expanded its functions
to include actively educating investors on the importance of
investing wisely by avoiding securities fraud and abuse. To this
end, it has instituted numerous public outreach and educational
programs. In October 1994, the office established a toll-free
investor information line that provides investors with the
opportunity to order investor education materials and other
documents. Since its inception, the SEC has received
approximately 87,000 calls on this investor information
line.18/ The office has also helped to develop the joint
SEC/SRO Invest Wisely brochures designed to give investors the
tools they need to protect themselves. To date, approximately
227,000 copies of the brochures have been distributed to the
public. In addition, SEC staff has participated in or sponsored
12 investor meetings to educate investors and to hear what is on
the minds of the investing public, and has conducted three pilot
seminars on investors' rights and responsibilities. The office
will be expanding the seminar program significantly in 1996.
NASAA has also been active with proactive consumer education and
awareness programs. Most notably, NASAA regularly issues
"Investor Alerts" to the public that identifies new trends and
issues.
4. Memorandum of Understanding
On November 28, 1995, a Memorandum of Understanding ("MOU")
was signed by officials of the Commission, the Amex, the CBOE,
the NASD, the NYSE, and NASAA. The purpose of the MOU is to
promote cooperation and coordination among the examining
authorities as well as to eliminate unnecessary duplication in
the examination process. The key provisions of the MOU include:
(a) annual national and regional planning summits; (b) a
coordinated computerized tracking system for all broker-dealer
examinations conducted by the Commission and the SROs, to be
maintained by the Commission; (c) coordination of broker-dealer
examinations by the SROs through information sharing and, to the
extent possible, simultaneous on-site examinations when requested
by each broker-dealer; and (d) encouragement by NASAA to state
examination authorities to utilize examination resources where
they are most needed, particularly with respect to broker-dealer
branch offices and smaller investment advisers.
==========================================START OF PAGE 12======
5. Criminal Enforcement Actions
On November 30, 1995, the Justice Department and the
Commission announced the criminal indictment of eleven former
registered representatives.19/ The registered representatives
were charged with a range of illegal activity, including forgery
of investor checks, unauthorized transfer of client funds, sale
of non-existent securities, and providing false account
statements. All these former registered representatives have
been censured by the NASD and barred from the securities
industry. The criminal charges are the result of a concerted
federal government effort to criminally prosecute securities
salespersons for engaging in fraudulent schemes involving their
clients. The joint effort between the Commission and the Justice
Department signals that such problem registered representatives
will face not just fines and administrative sanctions, but
possibly prison sentences, as well.
In addition, the NASD has continued to work cooperatively
with state and federal law enforcement agencies, including the
Federal Bureau of Investigation, the Internal Revenue Service,
and various U.S. Attorney Generals around the country, which have
led to criminal prosecutions, convictions, and imprisonment for
serious sales practice and fraudulent abuses.
==========================================START OF PAGE 13======
ENDNOTES
1/ The implementation of the redesigned CRD is expected to be
conducted by the NASD in three phases. The NASD plans to
conduct a two-month pilot of the redesigned CRD to test the
software that will enable broker-dealers to file uniform
forms electronically and to carry out other quality
assurance testing. Following completion of the two-month
pilot, the NASD plans to implement Phase I of the transition
to the redesigned CRD. During Phase I, the NASD will
convert existing registration information about broker-
dealers and their associated persons now contained in the
old CRD system to the redesigned CRD system. After the
existing registration information has been converted to the
redesigned CRD system, broker-dealers will be required to
file electronically with the redesigned CRD all registration
information.
During Phase II of the implementation process, the
Commission, the SROs, and state securities regulators will
be provided direct access to broker-dealer registration
information contained in the redesigned CRD system. The
NASD anticipates that Phase III of the implementation
process, will among other things, facilitate mass
transactions relating to mergers and acquisitions of NASD
member firms, and a new annual registration and renewal
process for associated persons of member firms.
2/ See, e.g., Letter from Brandon Becker, Director of the SEC's
Division of Market Regulation, and William McLucas, Director
of the SEC's Division of Enforcement, to Joseph Hardiman,
President of the NASD (Sept. 13, 1994).
3/ Id.
4/ SEC v. PaineWebber Inc., 96 Civ. 0331 (SHS), S.D.N.Y.,(Jan.
18, 1996); In the Matter of PaineWebber Incorporated, Sec.
Act Rel. No. 7257, Exch. Act Rel. No. 36724, (Jan. 17,
1996).
5/ In the Matter of Prudential Securities, Inc., Exch. Act.
Rel. No. 33082 (Oct. 21, 1993).
6/ In the Matter of Daniel L. Zessinger, Exch. Act. Rel. No.
36291 (Sept. 28, 1995).
7/ Exch. Act Rel. No. 36211 (Sept. 8, 1995).
8/ Baravati v. Josephthal, Lyon & Ross, Inc., 28 F.3d 704 (7th
Cir. 1994), aff'g, 834 F. Supp. 1023 (N.D. Ill. 1993).
==========================================START OF PAGE 14======
9/ Culver v. Merrill Lynch & Co. [Current Transfer Binder] Fed.
Sec. Rep. (CCH) 98,811, at 92,885 (S.D.N.Y. July 17, 1995).
10/ See Legal Alert No. 95-10 (Nov. 10, 1995).
11/ When the NASD first introduced the toll-free number, it
received approximately 140 calls per day. In January 1993,
when the NASD announced that it was expanding the
information disclosed through the toll-free service, the
average daily call volume was approximately 200 calls per
day. The NASD now receives approximately 300 to 400 such
calls each day.
12/ Exch. Act Rel. No. 34516 (Aug. 10, 1994).
13/ Exch. Act Rel. No. 34984 (Nov. 18, 1994).
14/ Report of the Committee on Compensation Practices (April 10,
1995).
15/ See H.R. Rep. 686, 103rd Cong., 1st Sess. (1994).
16/ Exch. Act Rel. No. 35821 (June 7, 1995) (NYSE rule); Exch.
Act Rel. No. 35831 (June 9, 1995) (NASD rule); Exch. Act
Rel. No. 36588 (Dec. 13, 1995) (CBOE rule); and Exch. Act
Rel. No. (36748) (Jan. 19, 1996).
17/ The Office of Consumer Affairs was established in 1976.
18/ SEC information is also available 24 hours a day on a
computerized bulletin board subsystem located on the Fed
World Electronic Marketplace and a new World Wide Web site
at www.sec.gov. Investors can find on-line brochures,
disclosure documents filed with the SEC, SEC rule proposals,
the SEC News Digest, and speeches.
19/ Robert D. Hershey, Jr., U.S. Indicts 11 Brokers on Criminal
Fraud With Investors, N. Y. Times, December 1, 1995, at D1.
==========================================START OF PAGE 1======
APPENDIX B
LISTING OF ITEMS - PENDING ACTIONS
Form U-4 Disclosure
Question 22:
H1 Disclosure of an investment-related, consumer-initiated
complaint or proceeding that alleged compensatory
damages of $10,000 or more, fraud, or wrongful taking
of property.
I Disclosure of any complaint, investigation, or
proceeding that could result in a "yes" answer to any
final actions (see Appendix C).
Disclosure of the RR being discharged or permitted to resign
as a result of being accused of:
N1 Violating investment-related statutes, regulations,
rules, or industry standards of conduct.
N2 Fraud or the wrongful taking of property.
N3 Failure to supervise in connection with investment-
related statutes, regulations, rules or industry
standards of conduct.
CRD Action Code
ARP Arbitration Decision (Pending)
==========================================START OF PAGE 1======
APPENDIX C
LISTING OF ITEMS - FINAL ACTIONS
Form U-5 Disclosure
Question
Number
13A Disclosure of disciplinary action by domestic or foreign
government or SRO.
Form U-4 Disclosure
Question
Number
Disclosure of domestic or foreign court:
22C1 Enjoined RR in connection with any investment-related
activity.
22C2 Found RR involved in a violation of investment-related
statutes or regulations.
Disclosure of U.S. Securities and Exchange Commission (SEC)
or Commodity Futures Trading Commission (CFTC):
22D1 Found RR to have made a false statement or omission.
22D2 Found RR to have been involved in a violation of investment-
related regulations or statutes.
22D3 Found RR to have been a cause of an investment-related
business having its authorization to do business denied,
suspended, revoked, or restricted.
22D4 Entered an order denying, suspending or revoking RR's
registration or disciplined RR by restricting RR's
activities.
22D5 Imposed a civil money penalty on RR, or ordered RR to cease
and desist from any activity.
Disclosure of Federal or State Regulatory Agency or Foreign
Financial Regulatory Authority:
22E1 Found RR to have made a false statement or omission or been
dishonest, unfair or unethical.
22E2 Found RR to have been involved in a violation of investment
regulations or statutes.
22E3 Found RR to have been a cause of an investment-related
business having its authorization to do business denied,
suspended, revoked, or restricted.
==========================================START OF PAGE 2======
22E4 Entered an order against RR in connection with investment-
related activity.
22E5 Denied, suspended, or revoked RR's registration or license
or otherwise prevented RR from associating with an
investment-related business, or disciplined RR by
restricting RR's activities.
22E6 Revoked or suspended RR's license as an attorney, accountant
or federal contractor.
Disclosure of any self-regulatory organization or
commodities exchange:
22F1 Found RR to have made a false statement or omission.
22F2 Found RR to have been involved in a violation of rules.
22F3 Found RR to have been the cause of an investment-related
business having its authorization to do business denied,
suspended, revoked or restricted.
22F4 Disciplined RR by expelling or suspending RR from
membership, barring or suspending RR's association with its
members, or restricting RR's activities.
22G Disclosure of any foreign government order related to
investments or fraud.
22H2 Disclosure of investment-related, consumer-initiated
complaint or proceeding that was settled or decided for
$5,000 or more, or found fraud or the wrongful taking of
property.
CRD Action Code
ARB Arbitration Decision (Final)
BAR Barred (prohibited) from registration
CAF Censured and Fined
CDO Cease and Desist Order issued
CEN Censured
DOR Order of Denial or Registration issued
EXP Expelled from Membership
FIN Fine
OOP Order of Prohibition
OPI Order of Permanent Injunction
OTI Order of Temporary Injunction
RES Restricted Registration Capacity (Statutory Disqualification)
REV Revoked
RNP Revoked for Non-Payment of Fines
RRO Order of Restitution, Rescission, Damages, Penalties or
Disgorgement
SUS Suspended from Registration (Capacity specified)==========================================START OF PAGE 1======
APPENDIX D
NYSE RULE 351(a)
Rule 351. (a) Each member not associated with a member
organization and each member organization shall promptly report
to the Exchange whenever such member or member organization, or
any member, allied member or registered or non-registered
employee associated with such member or member organization:
(1) has violated any provision of any securities law or
regulation, or any agreement with or rule or standards of
conduct of any governmental agency, SRO, or business or
professional organization, or engaged in conduct which is
inconsistent with just and equitable principles of trade or
detrimental to the interest or welfare of the Exchange;
(2) is the subject of any written customer complaint
involving allegations of theft or misappropriation of funds
or securities or of forgery;
(3) is named as a defendant or respondent in any
proceeding brought by a regulatory or self-regulatory body,
alleging violation of any provision of the Securities
Exchange Act of 1934, or of any other Federal or state
securities, insurance, or commodities statute, or of any
rule or regulation thereunder, or of any agreement with, or
of any provision of the constitution, rules or similar
governing instruments of, any securities, insurance or
commodities regulatory or self-regulatory organization;
(4) is denied registration or is expelled, enjoined,
directed to cease and desist, suspended or otherwise
disciplined by any securities, insurance or commodities
industry regulatory or SRO or is denied membership or
continued membership in any such SRO; or is barred from
becoming associated with any member or member organization
of any such SRO;
(5) is arrested, arraigned, indicted or convicted of,
or pleads guilty to, or pleads no contest to, any criminal
offense (other than minor traffic violations);
(6) is a director, controlling stockholder, partner,
officer or sole proprietor of, or an associated person with,
a broker, dealer, investment company, investment advisor,
underwriter or insurance company which is suspended,
expelled or had its registration denied or revoked by any
agency, jurisdiction or organization or is associated in
such a capacity with a bank, trust company or other
==========================================START OF PAGE 2======
financial institution which was convicted of, or pleaded no
contest to, any felony or misdemeanor;
(7) is a defendant or respondent in any securities or
commodities-related civil litigation or arbitration which
has been disposed of by judgment, award or settlement for an
amount exceeding $15,000. However, when a member
organization is the defendant or respondent, then the
reporting to the Exchange shall be required only when such
judgment, award or settlement is for an amount exceeding
$25,000;
(8) is the subject of any claim for damages by a
customer, broker or dealer which is settled for an amount
exceeding $15,000. However, when the claim for damages is
against a member organization, then the reporting to the
Exchange shall be required only when such claim is settled
for an amount exceeding $25,000;
(9) is, or learns that he is associated in any business
or financial activity with any person who is, subject to a
"statutory disqualification" as that term is defined in the
Securities Exchange Act of 1934;
(10) is the subject of any disciplinary action taken by
the member or member organization against any of its
associated persons involving suspension, termination, the
withholding of commissions or imposition of fines in excess
of $2,500, or any other significant limitation on
activities. ==========================================START OF PAGE 1======
APPENDIX E
U.S. NASAA JURISDICTIONS' TELEPHONE NUMBER LISTINGS
Alabama (334) 242-2984 (800) 222-1253
Alaska (907) 465-2521
Arizona (602) 542-4242
Arkansas (501) 324-9260
California (213) 736-2741
Colorado (303) 894-2320
Connecticut (203) 566-4560
Delaware (302) 577-2515
District of Columbia (202) 625-5105
Florida (904) 488-9805 (800) 848-3792
Georgia (404) 656-2894
Hawaii (808) 586-2744
Idaho (208) 332-8004
Illinois (217) 782-2256 (800) 628-7937
Indiana (317) 232-6681 (800) 223-8791
Iowa (515) 281-4441
Kansas (913) 296-3307 (800) 232-9580
Kentucky (502) 573-3390
Louisiana (504) 568-5515
Maine (207) 528-8760
Maryland (410) 576-6362
Massachusetts (617) 727-3548 (800) 268-5428
Michigan (517) 334-6212
Minnesota (612) 296-9431
Mississippi (601) 359-6364 (800) 804-6364
Missouri (314) 751-4136 (800) 721-7996
Montana (406) 444-2040 (800) 332-6148
Nebraska (402) 471-3445
Nevada (702) 486-2440 (800) 758-6440
New Hampshire (603) 271-1463
New Jersey (201) 504-3677
New Mexico (505) 827-7140 (800) 704-5533
New York (212) 416-8200
North Carolina (919) 733-3924 (800) 688-4507
North Dakota (701) 328-2910 (800) 297-5124
Ohio (614) 644-7381 (800) 788-1194
Oklahoma (405) 235-0230
Oregon (503) 378-4387
Pennsylvania (717) 787-8061
Puerto Rico (809) 723-3131
==========================================START OF PAGE 2======
Rhode Island (401) 277-3048
South Carolina (803) 734-1091
South Dakota (605) 773-4823
Tennessee (615) 741-2947 (800) 863-9117
Texas (512) 305-8300
Utah (801) 530-6600
Vermont (802) 828-3420
Virginia (804) 371-9280 (800) 552-7945
Washington (360) 902-8760 (800) 372-8300
West Virginia (304) 558-2257
Wisconsin (608) 266-3431 (800) 472-4325
Wyoming (307) 777-7370Last Reviewed or Updated: March 24, 2026