Special Studies
The Large Firm Project
May 1, 1994
THE LARGE FIRM PROJECT
A Review of Hiring, Retention and Supervisory Practices
Division of Market Regulation
Division of Enforcement
United States Securities and Exchange Commission
May 1994
This is a report of the Division of Market Regulation and the
Division of Enforcement. The Commission has expressed no view
regarding the analysis, findings or conclusions herein.
*****
EXECUTIVE SUMMARY
This report announces the findings of a review undertaken by
the Securities and Exchange Commission ("SEC" or "Commission"),
working in conjunction with the New York Stock Exchange, Inc.
("NYSE") and the National Association of Securities Dealers, Inc.
("NASD"), of the hiring, retention and supervisory practices of
nine of the largest broker-dealers in the United States. This
review was commenced because of increased concerns on the part of
the Commission and others regarding the frequency and severity of
sales practice abuses perpetrated by some registered
representatives employed by broker-dealers doing business with
the public.
The nine firms involved in this review (referred to as the
"Large Firm Project " or "Project") were selected because these
firms account for approximately 49% of all public customer
accounts in the United States. As part of this Project,
Commission, NYSE and NASD staff conducted 170 examinations in 32
states. The examinations, which began in August 1992 and
generally were completed in September 1993, covered the home
offices of the nine firms and 161 branch offices. The Project
also focussed on 268 registered representatives ("Selected
registered representatives") who have been the subject of sales
practice related customer complaints, named as defendants or
respondents in customer initiated litigation or arbitration, or
otherwise been the subject of an enforcement or disciplinary
action by a state or federal governmental entity or self-
regulatory organization ("SRO").
FINDINGS
* More Than One Third of Selected Registered Representatives
Are No Longer in the Securities Industry
The review of the Selected registered representatives
revealed that as of December 1993, 97 (36%) of the 268 registered
representatives identified were not working in the securities
industry ("previously registered individuals"). Furthermore, 31
of these previously registered individuals have been barred by
either the SEC or an SRO, or have been the subject of a criminal
proceeding resulting in incarceration. An additional 52 of the
previously registered individuals have been or are currently the
subject of regulatory review or enforcement action.
* Approximately 25% of the Examinations Resulted in
Enforcement Referrals
While many registered representatives already have been
identified by the regulatory systems currently in place, the
Project's examinations have resulted in approximately 40
referrals for further investigation and possible enforcement
action. -[1]- These referrals include 14 of the 268 Selected
registered representatives. Additional referrals related to sales
practice problems involving other registered representatives and
branch offices. Among the types of problems identified were
indications of excessive trading, unsuitable recommendations,
unauthorized trading, improper mutual fund switching and failure
to supervise.
* Three of the Nine Firms Accounted for 88% of the Enforcement
Referrals
The Project disclosed that 88 % of the examinations referred
for further investigation and possible enforcement action
involved three of the nine firms reviewed. These three firms also
accounted for over half of the examinations conducted, and had
employed 71 (73 %) of the 97 previously registered individuals
during the time period reviewed. These findings indicate that
some firms, at the time of the examinations, were not as diligent
in the implementation of their recruitment and hiring practices,
and in carrying out their supervisory and compliance procedures
on an individual branch office basis.
* Some Branch Office Managers Are Not Enforcing Supervisory
and Compliance Systems
The supervisory and compliance systems in place at most of
the nine firms were found to be adequate. The examinations found
that the diligence with which individuals with direct
responsibility for the supervision of registered representatives
pursued their responsibilities had a significant effect on the
overall quality of each firm's compliance and supervisory system.
The examinations indicated that some branch office managers were
not implementing firm procedures adequately.
* Registered Representatives Able to Move When Customer
Complaints Exist
Of the 97 individuals who are no longer in the securities
industry, 42 (43%) had changed firms one time before becoming
non-registered. For the 171 registered representatives currently
employed by a broker dealer, 111 (65 %) had changed jobs, at
least once, from one of the nine firms. Thirty-two of those 111
registered representatives had changed employment between two and
five times. Significantly, 17 (56%) of these 32 individuals had
two or more complaints at the time of their first employment
change and all 32 individuals had at least three complaints by
the time of their second employment change. Although there did
not appear to be any pattern of movement between the nine firms,
the frequency of employment changes of these 32 registered
representatives suggests that some firms are willing to employ
individuals with a past history of customer complaints, but where
no formal disciplinary measures have been taken.
* Largest Revenue Producing Brokers Generally Not the Subject
of Investor Complaints
The examinations revealed that the Selected registered
representatives generally were NOT among the 50 largest revenue
producers at these firms. -[2]- Examiners found that only 15 (6%)
of the 268 Selected registered representatives were identified by
the firms as being among such producers.
RECOMMENDATIONS
The Project reviewed a small portion of the branch offices
and registered representatives from the nine firms, and yet a
disproportionate number of referrals for further investigation
and enforcement consideration were made. These findings suggest,
in our view, that there is a need to devote additional resources
at the firm, SRO and Commission level to the detection and
prosecution of registered representatives who have a history of
sales practice problems or who commit sales practice violations.
In addition, based on the results of the Project as well as
the Commission's oversight examination program generally, a
number of areas relating to the detection and enforcement of
sales practice violations are in need of improvement. In
particular, the Commission Staff ("Staff") has found deficiencies
with respect to (a) compliance with SRO reporting requirements,
(b) tracking systems for SRO handling of investigations relating
to Form U-4 and U-5 filings, and (c) the level of disclosure by
firms on Form U-5. -[3]- Moreover, based on the results of our
overall sales practice examination efforts, the Staff is
concerned that the present level of sanctions may not provide
sufficient deterrence against sales practice misconduct by
registered representatives, and that existing disclosure
regarding SRO disciplinary actions is inadequate.
Based on these factors, the Staff proposes the following
recommendations.
1. Increased Examination Efforts and Sanctions in all Sales
Practice Matters
Sanctions against registered representatives who engage in
serious sales practice abuses should be significant (e.g.,
permanent bars without a right of re-entry, extended suspensions
and increased fines, re-training and probationary programs, re-
qualification, and limitations on sales activities).
Additionally, SROs should increase the emphasis on sales practice
abuses in their examination programs. The Division of Market
Regulation likewise will commit resources to the examination of
sales practice abuses.
2. Improved Broker-Dealer Compliance Systems for
Identifying Problem Brokers
Firms should be required to improve compliance systems
designed to oversee and review employee conduct. Improvements
would include the ability to identify individuals, before hiring,
whose disciplinary history indicates a pattern of sales practice
abuse. Additionally, firms should be able to identify registered
representatives generating large numbers of sales practice
related customer complaints, arbitrations and settlements, and
develop the technical capability in the main office to conduct
account reviews for suitability on a regular basis.
3. Enhanced Compliance by Firms and Registered
Representatives with all SRO Reporting Requirements
The SROs should continue their efforts to monitor the
timeliness of required filings, such as the Forms U-4, U-5 and
RE-3, through examinations and otherwise. The SROs should
increase the sanctions against both firms and individuals where
instances of noncompliance with SRO reporting requirements are
discovered. The NASD should require member firms to report to it
customer complaint data on a quarterly basis similar to the
requirements of NYSE Rule 351. -[4]-
4. Qualified Immunity for Firms on Form U-5
The Commission should consider rule-making or, if necessary,
legislative changes, to implement uniform policies governing the
liability and immunity of broker-dealers and their associated
persons with respect to state law defamation actions in
connection with statements made in regulatory filings required by
the Commission and SROs (e.g., statements in a Form U-5 setting
forth the basis for termination of a registered representative).
5. Enhanced Role for Legal and Compliance Departments
Broker-dealers should increase involvement of their
compliance and legal staff in registered representative hiring,
retention and termination decisions, and branch office visit
programs.
6. Additional Regulatory Action
The Commission should consider whether additional regulatory
action is needed to address the problem of registered
representatives with a history of customer complaints,
arbitration awards, judgements in private litigation, and
disciplinary actions and fines. The Staff recommends that a firm
should be required to designate, above the branch office manager
level, an individual or committee 10 approve the hiring of any
registered representative with a history of compliance problems.
7. Continuing Education
The Staff believes that continuing education requirements
for the securities industry act as a preventive device to avoid
customer complaints and recommends that the Commission continue
to emphasize the need to expand investor protection through
increased knowledge and heightened awareness of regulatory and
ethical standards among securities industry professionals.
8. Development and Implementation of Tracking Systems for
SRO Handling of Investigations Relating to Form U-4 and
U-5 Filings
The SROs should develop and implement a system for tracking
which SRO is investigating a registered representative's
termination for cause or amendments to Form U-4 and U-5, and the
current status of such investigations.
9. Disclosures When Opening New Accounts
The SROs should adopt a rule requiring their member firms to
disclose to investors opening new accounts, prior to effecting
any transaction in that account, the availability of information
concerning the disciplinary history of registered representatives
through the NASD's toll free number.
10. Public Disclosure by All SROs of Initiated Disciplinary
Actions
The SROs should make available to the public all formal
disciplinary proceedings when initiated against member firms and
registered representatives.
CONCLUSION
Ultimately the question of how to deal effectively with
problem, or "rogue," brokers is only one of many issues
confronting the Commission and the SROs in the area of sales
practices. Completion of this Project, therefore, is only one
part of an overall program to increase the emphasis on
identifying and prosecuting sales practice violations. The Staff
intends to continue to identify and target so-called "rogue
brokers" in its examination and enforcement programs.
The recommendations contained in this report deal primarily
with the issues relating to uncovering abusive sales practices
and dealing with them once they occur. Equally important, in our
view is the need to develop means to reduce the likelihood of
violative conduct in the first place through appropriate training
and incentives. To that end, consideration should be given to,
among other things, redefining the role of branch managers and
how they are compensated, and educating consumers so that they
can better protect themselves from sales practice abuse.
Similarly, the industry needs to develop a comprehensive
continuing education program to increase the knowledge and
professionalism of the sales force thereby deterring sales
practice abuse. Finally, prevention of sales practice problems
can be greatly enhanced through effective supervisory systems at
all levels of the firm.
#####
REPORT ON THE LARGE FIRM PROJECT
Prepared By The Staff of
The U.S. Securities and Exchange Commission
TABLE OF CONTENTS
I. BACKGROUND ON THE LARGE FIRM PROJECT
A. Special August 1992 Sales Practice Examination
B. Joint SEC, NYSE, NASD Meeting
II. THE EXAMINATION PROCESS
A. Compilation of Information from Letters
B. Utilization of NYSE Rule 351 Data
C. Objectives and Scheduling
III. THE EXAMINATION FINDINGS
A. Summary Findings
1. More Than One Third of Selected Registered
Representatives Are No Longer In The Securities
Industry
2. Approximately 25% of the Examinations Resulted In
Enforcement Referrals
3. Three of the Nine Firms Accounted For 88% of the
Enforcement Referrals
4. Some Branch Office Managers Are Not Enforcing
Supervisory and Compliance Systems
5. Registered Representatives Are Able To Move When
Customer Complaints Exist
6. Largest Revenue Producing Brokers Generally Not The
Subject of Investor Complaints
B. Enforcement Matters
1. Enforcement Referrals Generally Did Not Involve The
Selected Registered Representatives or Previously
Known Types of Sales Abuses
2. Commission Brings Sales Practice Action Against
Prudential
IV. RECOMMENDATIONS
V. CONCLUSION
APPENDIX A
REPORT ON THE LARGE FIRM PROJECT
Federal securities regulation of broker-dealers rests on the
principle of self-regulation. First and foremost, effective self-
regulation requires broker-dealers to monitor the trading and
sales activities of their associated persons and to establish
effective compliance and supervisory procedures to detect
possible violations of firm policies, SRO rules and federal and
state securities laws. At the next level of the regulatory
structure, the SROs, which are membership organizations overseen
by the Commission, must establish rules that govern the conduct
of member firms and enforce compliance with those rules and with
the federal securities laws. To accomplish these
responsibilities, which are mandated by statute, the SROs examine
their member firms on a routine basis, and initiate disciplinary
actions where member firms or their associated persons violate
SRO rules or the federal securities laws.
Recognizing the inherent limitations and conflicts
associated with any system of self-regulation, Congress gave the
Commission 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 rule-making
authority, its examinations of broker-dealers and inspections of
SROs, and ultimately through enforcement actions against persons
who violate the securities laws.
These statutory purposes are best served when effective
compliance mechanisms are in place within broker-dealers, SROs
routinely examine for and enforce compliance with the securities
laws and their own rules, and, the Commission implements an
effective and comprehensive SRO oversight and enforcement
program.
I. BACKGROUND ON THE LARGE FIRM PROJECT
Concerns regarding the hiring, retention and supervisory
practices of large broker-dealers increased as a result of
Commission examination findings in 1991-92. On July 16, 1992, the
Divisions of Market Regulation and Enforcement ("Divisions")
requested that nine of the largest NYSE member firms provide the
Commission with information concerning their hiring and
termination practices, customer complaints, and arbitration and
civil litigation brought against the firm or its registered
representatives. The letter asked for information regarding
individuals associated with the broker-dealers as registered
representatives who have been disciplined previously by the
Commission (or other federal governmental agency), an SRO or a
state securities agency; or have been or are the subject of
multiple customer complaints, lawsuits or arbitrations alleging
various sales practice abuses, such as churning, unsuitable
recommendations, unauthorized trading, or misappropriation of
funds or securities. -[5]- The Divisions selected these nine
firms because they have approximately 49% of all public customer
accounts in the United States.
A. Special August 1992 Sales Practice Examinations
Before the nine firms responded to the data request of July
16, 1992, the Division of Market Regulation requested that the
Commission's Regional and District offices conduct special sales
practice examinations of 14 branch offices of one of the nine
firms. The branch offices were chosen based on the number of
customer complaints the firm received in 1991 and 1992 (through
June 30). Division staff analyzed the data for purposes of
selecting branch offices where there appeared to be the highest
probability of sales practice and supervisory abuses. The
examinations were conducted between August and November 1992;
enforcement referrals were made regarding eight of these branch
offices.
The examinations revealed multiple potential sales practice
abuses. Registered representatives in several branch offices
appeared to have engaged in numerous instances of excessive and
unsuitable trading, and in mutual fund switching in accounts of
elderly clients to generate substantial commissions for
themselves. These examinations heightened concerns that systemic
supervisory problems existed at this firm.
B. Joint SEC, NYSE, NASD Meeting
On September 10, 1992, senior staff of the Divisions met
with NYSE and NASD staff to discuss the Commission's concerns
about the adequacy of sanctions within the regulatory structure
that currently exists, and a proposed joint SEC and SRO
regulatory effort to analyze the data from the nine firms and to
select the branch offices and individual registered
representatives for examination.
Participants reviewed the current SRO regulatory,
investigative and enforcement programs and discussed the adequacy
of current Commission and SRO sanctions for sales practice
abuses, whether the SEC and SROs should specify stronger
sanctions for serious sales practice abuses, and possible
legislative amendments to protect investors from abusive
registered representatives. Commission and SRO staff also
focused on what SRO regulatory or disciplinary information should
be made available to the general public. Finally, Commission and
SRO staff discussed a joint examination effort in connection with
the Large Firm Project.
II. THE EXAMINATION PROCESS
A. Compilation of Information from Letters
The nine member firms submitted their responses to the
Division of Market Regulation, which reviewed and summarized the
information. The review found that not all the firms were able to
provide a list of 50 registered representatives with the largest
number of complaints for each of the years 1990, 1991, or 1992,
because of the limited number of individuals with large numbers
of complaints. -[6]- Consequently, the Division of Market
Regulation further requested that the firms, in order to provide
a list of 50 registered representatives for each of the requested
years, provide the names of all registered representatives named
in a written sales practice complaint more than once during the
entire three year period.
B. Utilization of NYSE Rule 351 Data
In November 1992, the Division of Market Regulation
requested from the NYSE its Rule 351 computerized database ("351
data") of customer complaints and Form RE-3 information for the
period January 1990 to September 1992. -[7]- The nine firms
reported more than 30,000 sales practice related complaints and
over 60% of those complaints were related to three of the nine
firms. Approximately two-thirds of the complaints were against
registered representatives with less than 3 complaints submitted
during the entire period reviewed. The Staff utilized the 351
data to determine the branch offices and registered
representatives with the largest number of complaints, and
identified the specific allegations associated with each
complaint for the three year period.
The 268 Selected registered representatives were chosen on
the basis of recently filed complaints and the total number of
written sales practice complaints. The Selected registered
representatives had approximately 2,400 complaints. The actual
number of complaints that the 268 registered representatives
incurred individually varied from a low of three to a high of 89,
with an average of 9. Of the Selected registered representatives,
73 % had between 3 and 9 total complaints for the three year
period.
On January 23, 1993, the Division of Market Regulation
provided to the Commission's Northeast Regional Office and
Midwest Regional Office, the NYSE and the NASD, a package of
material for each of the nine firms which they were assigned. The
packages contained (a) a list of branch offices that were the
subject of the most sales practice related customer complaints
during the period January 1990 through September 1992, (b) a list
of Selected registered representatives and a summary of the
specific sales practice complaints and RE-3 information, (c) a
list of Selected registered representatives who had been employed
at one of nine firms involved in this Project before becoming
associated with another of the nine firms, and, (d) complete
copies of the documentation submitted by the nine firms in
response to the July 1992 request.
C. Objectives and Scheduling
The examinations, which began in early February 1993 and
generally were completed in September 1993, involved both the
field work and a review of the firm's initial submission to the
SEC. The primary objectives of the Project were (a) the
identification of sales practice abuses, (b) a review and
assessment of each firm's main office and branch office
supervisory procedures, and (c) a review and assessment of each
firm's hiring and termination procedures.
The examination field work consisted of main office
examinations of the nine firms, branch office examinations of the
nine firms, and, examinations of other broker-dealers where a
Selected registered representative may have become employed. The
objectives of the home office examinations were to review the
data submitted in the responses to the July 16, 1992 letter,
review supervisory and compliance procedures, review the top 50
large producer lists, and review the securities trading and
commission activity of the registered representatives and branch
offices selected for further review. The branch office
examinations were classified into two categories (a) branches
that were examined based on apparent excessive customer
complaints, arbitration and litigation matters and other factors
identified while examining the firm's main office and, (b) branch
offices that were examined because one or more of the Selected
registered representatives were working at the branch office.
III. THE EXAMINATION FINDINGS
A. Summary Findings
I. More Than One Third of Selected Registered
Representatives Are No Longer In the Securities Industry
At the end of 1993, approximately 460,000 registered
representatives were associated with registered broker-
dealers doing business with the public. The nine firms
involved in the Large Firm Project employed 50,762 (11 % of
active) registered representatives at the end of 1993. Out
of the 50,762 registered representatives working for these
firms, the Division of Market Regulation identified 268 (.5
%) for special examination because of the existence of sales
practice-related customer complaints, arbitrations or
litigation. The selection of the registered representatives
was based on information provided by the firms and an
analysis of the Rule 351 data.
The review of the Selected registered representatives
revealed that 97 (36%) of the 268 Selected registered
representatives were not registered with a broker-dealer as
of December 1993. Furthermore, of those 97 registered
representatives who were not employed with a broker-dealer,
31 have been barred by either the SEC, an SRO or were
involved in a criminal proceeding which resulted in a
statutory disqualification. An additional 52 previously
registered individuals have been or are currently the
subject of regulatory review or enforcement action.
2. Approximately 25% of the Examinations Resulted in
Enforcement Referrals
The examinations established that sales practice abuses
by registered representatives continue to be a problem which
requires regulatory attention. Approximately 40 of the 161
branch office examinations conducted in connection with the
Project identified sales practice problems to be referred
for further investigation and possible enforcement action.
These examinations did not find systemic supervisory or
pervasive sales practice problems at the main office level.
However, there were indications of excessive trading,
unsuitable recommendations, unauthorized trading, improper
mutual fund switching and failure to supervise in some of
the branch office examinations.
3. Three of the Nine Firms Accounted for 88% of the
Enforcement Referrals
The Project disclosed that 88 % of the examinations
which were referred for further investigation and possible
enforcement action were from three of the nine firms. These
three firms also accounted for over 50% of the examinations
conducted. Furthermore, 71 of the 97 previously registered
individuals had been employed by one of these three firms
during the time period reviewed. These findings indicate
that, at the time of the examinations, some firms had failed
to adequately implement their recruitment and hiring
practices and their supervisory and compliance procedures on
an individual branch office basis.
4. Some Branch Office Managers Are Not Enforcing
Supervisory and Compliance Systems
The supervisory and compliance systems in most of the
nine firms examined were found to be adequate. The
examinations found, however, that the diligence with which
individuals implemented their systems and policies had a
significant effect on the overall quality of any compliance
and supervisory system. The examinations also revealed that
some branch office managers were not implementing firm
procedures adequately. For example, some branch managers
did not comply with written firm procedures by failing to
contact customers in a timely manner about their account
activity and their satisfaction with a registered
representative's handling of their account, to periodically
review registered representative trading in customer
accounts for suitability, and to obtain authorization
letters from customers in incidents where the customers
switched mutual funds.
5. Registered Representatives Able to Move When Customer
Complaints Exist
The Staff studied the employment patterns of the
Selected registered representatives up to December 1993 to
identify any possible trends. Of the 97 individuals who are
no longer in the securities industry, 42 (43 %) had changed
firms one time before becoming non-registered. For the 171
registered representatives currently employed by a broker
dealer, 111 (65 %) had changed jobs at least once from one
of the nine firms. Thirty-two of those 111 registered
representatives had changed employment between two and five
times.
The Staff reviewed the filing dates of the customer
complaints and compared them to the employment termination
and registration dates. Significantly, 17 (56%) of these 32
individuals had two or more complaints at the time they made
their first employment change from one of the nine firms. By
the time of their second employment change, all 32
individuals had at least three complaints filed against them
at their former firm (total complaints ranged from 3 to 17).
Although there did not appear to be any pattern of
movement between the nine firms, the frequency of employment
changes of the 32 registered representatives who had
multiple employment changes suggests that some firms are
willing to employ individuals with a past history of
customer complaints, but where no formal disciplinary
measures have been taken.
6. Largest Revenue Producing Brokers Generally Not the
Subject of Investor Complaints
The examinations and registered representative reviews
revealed that the registered representatives who were the
subject of sales practice related investor complaints,
arbitration and litigation or SRO disciplinary actions
generally were not the largest revenue producers at these
finds. In fact, examiners found that only 15 (6%) of the 268
Selected registered representatives reviewed in connection
with this Project were identified by the firms as being
among the 50 largest revenue producers.
B. Enforcement Matters
1. Enforcement Referrals Generally Did Not Involve the
Selected Registered Representatives or Previously Known
Types of Sales Abuses
Of the 40 examinations that resulted in enforcement
referrals, only 14 involved a Selected registered
representative. The remaining enforcement referrals involved
firms or other registered representatives whose sales
practice abuses were detected by analysis of firm exception
reports, commission runs and other examination techniques.
In addition, although examiners might have selected a
particular branch office for review because of multiple
customer complaints involving a Selected registered
representative or a particular type of sales abuse such as
excessive trading, examiners often found sales practice
problems involving a registered representative who was not
identified from customer complaint information and which
involved other types of sales abuses including improper
mutual fund switching, unauthorized trading or unsuitable
securities transactions.
2. Commission Brings Sales Practice Action Against
Prudential
During the period in which the Large Firm Project was
underway, the Commission filed civil injunctive and
administrative proceedings against Prudential Securities
Inc. ("Prudential") that, in part, related to the findings
from several examinations conducted as part of the Large
Firm Project. This case, brought on October 21, 1993,
resulted in Prudential agreeing to make an initial payment
of $330 million to a fund for compensatory damages to
customers who had purchased limited partnership interests
from Prudential during the 1980's, and to pay $41 million in
fines to the SEC, NASD and state securities administrators.
Prudential also was required to establish a claim resolution
process, under supervision of a court appointed Claims
Administrator, and to pay compensatory damages to aggrieved
investors without regard to statute of limitations defenses.
In addition, Prudential must review its current compliance
policies and procedures, and any new or revised procedures.
Prudential specifically was required to new policies and
procedures to prohibit excessive trading in customer
accounts, sales of unsuitable securities, the hiring and
retention of registered representatives with significant
disciplinary histories and customer complaints and to review
mutual fund transactions to prevent sales abuses.
The Commission found that Prudential failed to
reasonably supervise ten former registered representatives
in nine separate branch offices whose conduct violated the
anti-fraud provisions of the federal securities laws,
particularly by churning customer accounts and engaging in
unauthorized transactions. The Commission also found that
Prudential failed to reasonably supervise two of the firm's
top producers who were employed in the firm's Dallas branch
office. One registered representative in particular operated
his own department within the Dallas branch office and,
among other things, engaged in unauthorized trading in
customer accounts. Although the resolved all current
Commission investigations involving Prudential, the
Commission stated in its order that the investigation
concerning the matters that were the subject of its
injunctive and administrative actions continues as to
individual liability for the conduct in question.
IV. RECOMMENDATIONS
The examination findings, in our view, demonstrate a need to
devote additional resources at the firm, SRO and Commission level
to the detection and prosecution of registered representatives
who have a history of sales practice problems or who commit
serious sales practice violations. Although the number of
registered representatives who have a significant number of sales
practice complaints is relatively small compared to the industry
in general, continued vigilance by the firms in the
implementation of their supervisory and compliance procedures is
necessary. Over the past five years, the SROs have increased
substantially their staff resources devoted to enforcement
matters, have brought more sales practice and failure to
supervise cases, and have increased sanctions for violative
conduct. Nevertheless, the fact that 25 % of the branch office
examinations conducted in this Project resulted in referrals for
enforcement investigation and possible disciplinary action
suggests that existing supervisory and compliance systems are not
enough to detect problem brokers promptly, and that existing
sanctions for sales practice violations at both the SRO and
Commission level need to be strengthened.
The Staff believes that it is necessary for broker-dealers,
the SROs and the Commission to work together in identifying
problem registered representatives, and once identified, to take
steps to protect the interests of the customers through
aggressive enforcement action or through close supervision of
their conduct. Firms should be more aggressive in scrutinizing
the past history of registered representatives, establishing
policies and procedures designed to prevent and ensure that
registered representatives who have a history of customer
complaints are more closely supervised and that such supervision
is carried out, and responding quickly to indications of sales
practice abuses in their sales force. Additionally, the SROs and
the Commission should develop better means of identifying sales
practice problems at an earlier stage and increase examinations
and enforcement resources devoted to individual sales practice
cases.
The Staff has developed a series of recommendations that it
believes will strengthen the compliance mechanisms in place
within broker-dealers, enhance the efforts by the SROs in the
detection of sales practice abuses and enforcement of compliance
with their rules, and reinforce the Commission's principal
mandate of investor protection. We recommend that the Commission
consider prompt implementation of the following recommendations.
1. Increased Examination Efforts and Sanctions in Sales
Practice Matters
The joint examination sweep by the Commission, the NYSE and
the NASD highlighted the necessity of continuing to emphasize
sales practice matters in on-site examinations. The NASD
routinely reviews sales practice activities through the
regulatory programs administered by its 14 District Offices. The
NYSE conducts a specialized sales practice examination annually
of its largest member firms and in 1994, expanded its program to
review all other firms on a four year cycles. Similarly, the
Commission has focussed significant attention on sales practice
examinations in recent years. The Staff is of the view, however,
that more should be done in targeting examinations and
identifying problem brokers in each sales practice examination.
The SEC, NYSE and NASD must continue to work together to
ensure that registered representatives who are the subject of
sales practice related complaints or named as respondents in
customer initiated arbitration claims are identified promptly.
The Commission has instructed its Regional and District Offices
to give particular emphasis to identifying and targeting problem
brokers in examinations conducted by SEC examiners. In addition,
the Commission plans to conduct additional examination sweeps in
cooperation with other regulators and to focus additional
examination resources on brokers with large numbers of customer
complaints, arbitration awards, and/or disciplinary actions. The
Commission will continue to inspect the regulatory programs of
the SROs, and to conduct oversight with respect to the sales
practice examinations conducted by the SROs.
On the enforcement side, the Staff recommends that
additional resources be devoted, both at the Commission and the
SRO level, to prosecuting sales practice cases against problem
brokers who have violated Commission or SRO rules. Increased
emphasis should be given, in this regard, to developing better
tools for identifying sales practice problems at an earlier
stage. This would include greater use of the customer complaint
information available from NYSE member firms pursuant to Rule 351
and increased efforts to review arbitration cases when they are
filed rather than at completion. As an additional tool to aid in
the identification of problem brokers, the Staff recommends that
the NASD adopt a rule based on NYSE Rule 351 and require its
members to report customer complaints on a quarterly basis.
Disciplinary sanctions against broker-dealers and registered
representatives who engage in abusive sales and trading practices
should be severe. -[8]- The investing public must be assured that
the Commission and SROs are attempting to identify these abuses
and will investigate and quickly prosecute abuses when
discovered. The SROs also must take appropriate disciplinary
action against broker-dealers and their associated persons for
noncompliance with SRO reporting requirements. While the
appropriate sanction in any individual case should depend on the
facts and circumstances of that particular case, the Staff
recommends that for serious sales practice violations or for
recidivists, greater consideration be given to bars (without a
right to reapply) or significant suspensions, such as five years
or more. The Commission may want to consider a policy that,
absent extraordinary circumstances, views negatively reentry
applications from persons that have received permanent bars.
For less serious sales practice violations, consideration
should be given to additional remedial sanctions, such as
extended suspensions, a requirement to complete appropriate
financial courses, minimum six month on-job training on a fixed
salary (with no commissions or bonus), the retaking of all
necessary qualification examinations and a minimum probationary
period during which time a person would be severely restricted in
their sales activities.
2. Improved Broker-Dealer Systems for Identifying Problem
Brokers
Although the examination sweep generally found adequate home
office procedures and supervisory structures at most of the firms
examined, the Staff believes that firms need to do additional
work in terms of reviewing and amending firm procedures to
increase the identification of registered representatives
generating large numbers of sales practice related customer
complaints, arbitrations and settlements. Although the firms
produce quarterly customer complaint information in compliance
with NYSE Rule 351, it is not clear that the firms are using any
of this valuable information internally for purposes of targeting
their own internal audit or branch office visitation programs, or
that the firms are adequately tracking customer complaints by
product, individual or branch office. In addition, some of the
on-site branch office examinations raised questions as to whether
the branch managers were following established supervisory
procedures or whether the home office or regional legal and
compliance departments were fully aware of possible supervisory
deficiencies at the branch office level.
The Staff recommends that securities firms review their data
processing and computer capabilities to better assist branch
office managers in performing their supervisory functions. Firms
should move to develop sophisticated computer systems to provide
branch office managers with automated tools to better monitor
what is happening within a branch, as well as to complete
supervisory tasks and reports. The systems should have the
capability of permitting more effective oversight of the branch
office by the firms senior management and compliance personnel.
3. Enhanced Compliance by Firms and Registered
Representatives with all SRO Reporting Requirements
Historically the most fruitful source for the identification
of possible sales practice problems has been reports that broker-
dealers and registered representatives have been required to file
with SROs. -[9]- Forms U-4 and U-5, which are the uniform forms
for registering and terminating salespersons respectively,
require, among other things disclosure of criminal charges and
convictions. disciplinary actions brought by domestic and foreign
regulators customer complaints that exceed certain thresholds,
and investigations by the firm, an SRO or a foreign or domestic
entity. Separately, the NYSE requires the filing of Form RE-3
which discloses, among other things, disciplinary actions taken
by the member firm against and of its associated persons,
judgements, awards or settlements involving customer initiated
litigation and arbitration, and, written customer complaints
involving allegations of theft or misappropriation of funds or
securities or of forgery.
These required filings form the backbone of the SRO systems
for identifying problem registered representatives. For example,
when the NYSE receives notification on Form RE-3 involving a
registered representative, its procedures require a preliminary
investigation to determine the facts of the matter and whether or
not the conduct appears to be isolated or involves other
customers of the same registered representative. Failure by firms
to make prompt filings of these Forms U-4, U-5 and can impede
substantially the ability of the regulators to address possible
sales practice violations in a timely way. During the Project,
examiners found one firm did not timely file Forms U-4, U-5 and
subsequent amendments.
Registered representatives and their associated firms must
submit on a timely basis all filings and amendments required by
SRO rules in connection with customer complaints, and
adjudicated, resolved or settled disputes. The Staff, therefore,
recommends that the SROs continue their efforts to monitor the
timeliness of required filings through examinations and
otherwise, and to sanction firms for failure to make filings-
promptly and accurately. Similarily, the Staff recommends that
the NASD coordinate with the NYSE to establish a reporting
protocol similar to Form RE-3. The NASD is currently considering
such a proposal.
4. Qualified Immunity for Firms on Form U-5
In addition to the Staff's general concern regarding the
need for timely filing of Forms U-4 and U-5 with respect to
registered personnel, there are additional issues presented in
the case of the Uniform Notice of Termination, Form U-5. These
issues relate to the circumstances under which a registered
representative leaves a particular firm.
Form U-5 requires a firm to disclose whether a termination
is voluntary or not, and whether or not the salesman is the
subject of customer complaints or an investigation. Registered
representatives have complained they have been libeled by
statements made on Form U-5 regarding the characterization of
their termination. Furthermore these complaints, as well as
other disclosures made on the form, have been the subject of
litigation and/or arbitration and substantial awards have been
made in some cases. Regulators have raised concerns that the fear
of litigation has led firms to be less candid in their filings
and has reduced the value of the Form U-5 as a "red flag" in
sales practice cases.
Improved disclosure by firms on Form U-5 could substantially
assist regulators in policing for serious sales practice
violations. Although some states afford some form of immunity
from liability for defamation in these circumstances, the Staff
believes that concerns of firms and supervisory personnel
regarding civil liability for statements made in regulatory
filings required by the Commission or SROs warrant further
examination. Such concerns may inhibit full and adequate
disclosure of the facts and circumstances surrounding the reasons
for termination of registered representatives. The Staff,
however, is also cognizant that false statements by firms about
registered representatives in filings can be professionally
damaging and a source of possible abuse. Accordingly, the Staff
intends to recommend rule-making by the Commission, or if
necessary, legislative changes, to implement uniform policies
governing the liability and immunity of broker-dealers and their
associated persons with respect to state law defamation actions
in connection with statements made in regulatory filings required
by the Commission or SROs.
5. Enhanced Role for Legal and Compliance Departments
The Staff has concerns regarding broker-dealers and managers
who disregard cautionary warnings from the firm's legal and
compliance staffs with respect to decisions to hire individuals
with a history of regulatory problems. Similarly, when a
regulatory problem arises at a firm, the final decision to retain
a particular registered representative rests with the business
interests, who can disregard a recommendation from the legal and
compliance department that the representative be terminated,
disciplined or subjected to special supervision.
Firms should be encouraged to improve their compliance and
supervisory infrastructures and take action so that legal and
compliance officials have a substantial voice in hiring and
retention decisions regarding registered representatives;
particularly where the prospective registered representative, or
the registered representative whose current conduct at the firm
is at issue, has a history of regulatory problems. This will
require greater communication and cooperation among firms
regarding potential hires. Although the Staff does not recommend
that the compliance and legal officials within a firm have veto
power, management should be held responsible for its decisions to
hire or retain a registered representative against the
recommendation of legal and compliance staff and be required to
document the basis for doing so.
In the recent administrative proceedings regarding
Prudential, the Commission sought to address that problem at
Prudential through agreements requiring the firm to justify the
hiring and retention of any salesmen where the legal and
compliance department has recommended that the salesman either
not be hired or be terminated. The Staff believes that the
undertakings with respect to hiring and retention practices
contained in the Prudential administrative proceeding should be
adopted throughout the securities industry.
6. Additional Regulatory Action
The Staff recommends that the Commission consider whether
additional regulatory action is needed to address the problem of
registered representatives with a history of sales-practice
related customer complaints, arbitration awards, judgements in
private litigation, and disciplinary actions and fines. The
Staff's concerns stem from situations in which a broker-dealer,
or its managers and supervisors knows or should have known that a
registered representative presented a serious potential risk to
investors based on a history of regulatory problems.
The Staff believes that a broker-dealer that hires a
registered representative with a history of disciplinary problems
awards or customers complaints could be subject to sanctions if
subsequent to the time the registered representative is hired, he
or she commits a sales practice violation. Moreover, a firm
should be required to 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.
In this regard, the Staff believes it may be appropriate to take
regulatory action to create higher standards, than those
currently existing, which more clearly reflect increased
liability for firms and their managers with respect to hiring and
supervising registered representatives who have a history of
regulatory problems.
7. Continuing Education
In addition to concerns regarding the incidence of
traditional sales practice problems, the Staff is also troubled
by the proliferation of new and exotic investment products
without assurances that the training and knowledge bases of the
securities industry sales force has kept pace. In this regard,
the Staff believes that continuing education requirements for the
securities industry can prevent sales practice abuses from
occurring in the first place. The Staff therefore recommends
that the Commission continue to emphasize the need to expand
investor protection through increased knowledge and heightened
awareness of regulatory and ethical standards among securities
industry professionals.
In May 1993, under the sponsorship of the SROs, an industry
task force was established to study the issue of continuing
education for persons in the securities industry. This task
force, which consisted of twelve individuals from national full
service retail firms, regional firms, investment banks,
investment companies, insurance companies and investment planning
firms, concluded that there should be mandatory continuing
education in the securities industry. The task force was of the
view that there should be a two element structure to such a
program (a regulatory component and a firm component) and that
all registered personnel should participate. A separate standing
Industry/Regulatory Council on Continuing Education ("Council")
was established whose purpose is to (a) determine the specific
content of the regulatory component, and (b) mandate specific
minimum core curriculum for inclusion in the firm component. The
Council is actively pursuing development of a comprehensive
program of continuing education and is working on an accelerated
timetable to adopt and implement SRO rules by year-end.
Adoption of a mandatory continuing education program is, in
our view, a critical element in preventing sales practice abuses
and protecting individual investors. The Staff believes the
Commission should continue to support the efforts of the Council
to work cooperatively with the industry and SROs to implement a
program that accomplishes the goal of assuring more knowledgeable
sales professionals. The Staff also believes that firms should
regularly reassess their own training programs to make sure that
sales professionals are knowledgeable about the products they
sell -- their structure, their pricing, their risk profile and,
most importantly, to what customer base are they suitable.
8. Development and Implementation of Tracking Systems for
SRO Handling of Investigations Relating to Form U-4 and
U-5 Filings
The examination sweep also revealed deficiencies in the
regulators' existing capability to identify and track problem
brokers on an integrated basis. The NYSE's Rule 351 data base,
which contains customer complaint information for NYSE members
going back nearly four years is extremely useful and was of
significant help to the Staff. The Central Registration
Depository ("CRD"), however, which contains records on more than
450,000 individual registered representatives, is capable of
providing detailed information on an individual basis, but is
incapable of the type of regulatory inquiries which are necessary
to target problem brokers as a group. It should be noted that
the CRD originally was designed as a registration system to
facilitate the licensing process with the states and the SROs.
The NASD has recognized this problem and is currently
embarked on a multi-million dollar rewrite of the CRD system When
completed in 1995, the state-of-the-art, user-friendly system
should provide regulators with the ability to search through
hundreds of thousands of records to identify problem brokers, to
flag problem brokers who have left the industry so that they can
be reviewed should they try to return to the business, and to
target firms and branches for examination in a more effective
way. The Staff has been working closely with the NASD redesign
team and fully supports the new CRD as a critical element in the
effort against problem brokers.
The Staff recommends that the SROs should enhance their
coordination and tracking of U-4 and U-5 filings. During the
Project, the Staff had difficulty specifically identifying which
SRO was investigating a certain registered representative or firm
for particular conduct. In some cases, one SRO would initiate all
investigation only to find out that another SRO, already was
reviewing the conduct of that registered representative. In an
effort to avoid unnecessary duplication, the first SRO would
defer the matter to the SRO with the on-going investigation.
Once deferred, however, the conduct giving rise to the deferral
was not always fully investigated, as it might not directly
relate to the scope of the other investigation.
The Staff believes that the NASD's ongoing project to
restructure the CRD system to provide a data base that is more
flexible and useful for regulatory purposes will facilitate this
coordination and tracking. The Staff recommends, meanwhile, that
the SROs review their existing coordination protocols and
tracking systems to ensure that matters are fully investigated
and that there is no duplication of effort. In addition, the
Staff recommends that the Commission's Regional and District
Offices monitor more closely referrals to SROs to ensure that
investigations are proceeding promptly.
9. Disclosures When Opening New Accounts
Information concerning the disciplinary history of
registered representatives is another means of protecting
investors from abusive sales practices. To accomplish this goal,
the NASD has established, in accordance with the requirements of
the Securities Enforcement Remedies and Penny Stock Enforcement
Act of 1990, a toll free telephone number (l -800-289-9999) to
respond to customer inquiries concerning NASD members and their
salespersons. Under this 800 number program, customers can
receive, with respect to any registered representative's
employment history, final disciplinary actions taken by federal,
stale and foreign regulators and by SROs, criminal indictments
and convictions, pending NASD disciplinary actions and
arbitration awards.
The Staff believes that information concerning a broker's
disciplinary history is particularly important to investors at
the time they open an account or establish a relationship with a
particular registered representative. The selection of a
registered representative that meets the financial needs, goals
and objectives of all investor is a critically important
decision. Often an unknown salesperson's pitch is an attempt to
pressure the investor to open an account immediately in order to
take advantage of a "good deal." The Staff believes that to
better protect the interests of investors, customers should be
made aware of the availability of disciplinary history
information regarding the firm and the registered representative
through the toll free hot-line operated by the NASD.
Accordingly, the Staff recommends that the SROs adopt
necessary rules requiring their member firms to disclose to
investors, prior to effecting a transaction in a new account,
information relating to the availability and scope of the NASD
800 number.
10. Public Disclosure by all SROs of Initiated Disciplinary
Actions
Historically, in contrast to the practice at the Commission,
initiated disciplinary actions at the various SROs have not been
made public. The SROs have not made public the filing of charges
against member firms or registered representatives, and
information concerning the disciplinary process is generally not
made public until the process is completed, in the case of a
settled matter, or until administrative appeals at the SRO have
been exhausted.
The Staff believes that the lack of disclosure with respect
to SRO disciplinary proceedings is no longer consistent with the
public interest and should be changed. By not disclosing
disciplinary actions when charges are brought, investors may be
unaware that a registered representative with whom he or she is
dealing, or is planning to deal, is currently charged with a
significant sales practice violation. Moreover, keeping SRO
disciplinary proceedings private encourages proposed respondents
to prolong the proceedings to delay the disclosure of the matter.
In contrast, the Commission's procedures provide for disclosure
of enforcement actions brought in court and administrative
proceedings at their inception, which provides investors with
timely information regarding the disciplinary histories of
brokers.
The Staff recommends that all SROs should make public
disciplinary actions against member firms and individuals when
the SRO initiates the disciplinary action by filing formal
charges. The NASD began disclosing its initiated disciplinary
actions in July 1993. The NYSE's Board of Directors approved a
proposal to make its statements of charges public by having them
available though the CRD. The disciplinary filings to the CRD
from the NYSE commenced on April 25, 1994. Other exchanges,
however, do not publicly disclose their disciplinary actions
until the matter has been resolved or action completed by the
SRO. The Division believes that, once all SRO has made a
determination that there is probable cause for believing the
securities laws or the rules of the SRO have been violated and
has actually initiated a disciplinary action, this information
should be publicly available through inclusion in the CRD
maintained by the NASD on behalf of the states and the SROs. In
addition to the benefits to investors of inclusion of this
information in the CRD, such disclosure will remove existing
benefits firms receive from dilatory tactics that delay
resolution of the disciplinary proceeding.
V. CONCLUSION
The protection of customers from sales practice abuse is
critical to the objectives of the Commission and the SROs. The
Large Firm Project disclosed that the efforts to combat sales
practice abuse need to be improved and strengthened by the
securities industry, the SROs and the Commission.
The Project involved only a small sample of the total number
of securities firms and, of the firms selected, only a small
portion of the branch offices and registered representatives at
those firms. 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, a
disproportionate number of referrals for further investigation
and enforcement consideration were made which suggests that
existing supervisory and compliance systems need improvement and
that existing levels of sanctions for sales practice violations
at both the Commission and SRO level need to be strengthened.
The Staff believes that the Commission, the SROs 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 aggressive enforcement action and close
scrutiny at the time that hiring and retention decisions are
made. The Staff recommends that the Commission and the SROs
consider prompt implementation of the recommendations contained
in this report, which are designed to build on and improve
existing supervisory and regulatory systems.
The Large Firm Project did reveal some encouraging signs
with respect to large firm handling of salespersons with
histories of customer complaints. Approximately 36% of the
registered representatives identified for examination are no
longer employed in the securities industry, and most of the
departures were due to bars, criminal proceedings, or other
regulatory review or enforcement proceedings. This suggests that,
to some extent, brokers who engage in abusive sales practices are
being identified and terminated. Moreover, the fact that most of
the enforcement referrals coming out of the Project involved
three of the nine firms suggests that, at least in that universe
of firms, sales practice problems involving "rogue" brokers are
not systemic.
Ultimately the question of how to deal effectively with
problem, or "rogue," brokers is only one of many issues
confronting the Commission and the SROs in the area of sales
practices. Completion of this Project, therefore, is only one
part of an overall program to increase the emphasis on
identifying and prosecuting sales practice violations. The Staff
intends to continue to identify and target so-called "rogue
brokers" in its examination and enforcement programs. The Staff
also intends to look closely at other sales practice issues, such
as bank-affiliated sales activities, mutual fund sales and
advertising, and "cold calling" practices at broker-dealers.
######
ENDNOTES
-[1]- An enforcement referral is an examination which the
staff deems 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 anti-fraud
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.
-[2]- The July 16, 1992 letter requested that the firm provide
a list of the fifty largest revenue producing registered
representatives in each of the last three years (1990,
1991, 1992 year-to-date) for BOTH options products and
all securities products.
-[3]- See Appendix A for a complete description of Form U-4
and Form U-5, respectively.
-[4]- NYSE Rule 351, among other things, requires its member
firms to submit to the Exchange, on a quarterly basis,
summary information concerning all customer complaints
the member firm received during that quarter.
-[5]- The letter requested information regarding individuals
who were not necessarily subject to a statutory
disqualification. Generally speaking, a person is
subject to a statutory disqualification if that person
has been convicted of any felonies or certain enumerated
misdemeanors within the lash 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 association with a broker-dealer by
the Commission, the Commodity Futures Trading
Commission, an SRO or the foreign equivalent thereof.
SEE Section 3(a)(39) of the Securities Exchange Act of
1934.
-[6]- The July 16, 1992 letter requested that the firms
identify 50 registered representatives with the largest
number of written sales practice related customer
complaints in each of the last three calendar years,
1990, 1991, or 1992 (through June 30).
-[7]- As noted in the discussion contained in Appendix A, NYSE
Rule 351, among other things, requires its member firms
to submit to the Exchange, on a quarterly basis, summary
information concerning all customer complaints the
member firm received during that quarter.
-[8]- Appendix A contains a detailed description of current
SRO investigation and enforcement programs.
-[9]- Appendix A contains a detailed description of current
SRO reporting obligations and the NYSE and NASD
investigative processes that certain of these reports
trigger.
APPENDIX A
This appendix discusses information that the SEC and/or SROs
require broker-dealers and persons seeking to become associated
with broker-dealers to provide to the SEC and/or SROs. The
appendix also discusses the continuing reporting obligations of
firms and their associated persons. Lastly, the appendix
describes the SROs' investigatory process after the SROs receive
the information described above.
I. Current Reporting Requirements
The Securities Exchange of 1934 ("Exchange Act") and SRO
rules -[1]- require that broker-dealers and their associated
persons disclose specific relevant information during the initial
licensing and registration process. Regulators consider this
information in determining whether to register or license a firm
or individual. Individuals and entities seeking broker-dealer
registration must disclose information relating to criminal
convictions, civil litigation and administrative proceedings if
applicable. In addition, after a broker-dealer or associated
person is registered or licensed with the SEC and/or a SRO, the
broker-dealers and their associated persons are required to
report to the SROs if they have been the subject of regulatory or
disciplinary actions, customer complaints or other specifically
identified activities or occurrences. -[2]- Upon submission to
all SRO of such information, SRO staff generally investigate to
determine whether the broker-dealer or associated person has
violated securities laws or SRO rules.
A. The Initial Application
1. Broker-Dealers
Pursuant to SEC Rule 15b1-1, an entity initially registering
with the Commission as a broker-dealer must complete Form BD. In
addition, since January 1993, registrants must file the
application with the NASD's CRD system. -[3]- Applicants must
disclose on Form BD felonies and misdemeanors involving
investments or investment-related business, fraud, false
statements or omissions, wrongful taking of property, bribery,
forgery, counterfeiting or extortion during the past ten years,
and injunctions or findings by a domestic or foreign court in
connection with violations of investment-related statutes or
regulations during the past ten years. Applicants also must
disclose certain sanctions, findings or disciplinary actions by
the SEC, Commodity Futures Trading Commission ("CFTC"), federal,
state or foreign regulatory authorities and any self-regulatory
organization or commodities exchange. After SRO membership is
granted, SEC Rule 15b2-2 requires SROs to conduct examinations of
new members for compliance with applicable financial
responsibility requirements within six months of the effective
date of their SEC broker-dealer registration, and for compliance
with other applicable provisions of the Exchange Act and rules
thereunder within twelve months of the effective date.
2. Registered Representatives
Registered representatives are required to complete a
Uniform Application for Securities Industry Registration or
Transfer Form (Form U-4) before becoming associated with a
broker-dealer. -[4]- Form U-4 requires that firms and individuals
report findings and adjudications by domestic and foreign courts,
the SEC, the CFTC, federal, state and foreign regulatory
agencies, 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 resulting from accusations
involving investment related rules, regulations or statutes,
wrongful taking of property or failure to supervise in an
investment context.
a. Disciplinary History/Criminal Record
The NASD's Qualifications Section and the NYSE's
Qualifications and Registration Section of the Department of
Member Firm Regulation review information contained on Form U-4
as part of the registration process for individuals seeking to
sell securities. The NASD and NYSE also review Form U-4 in
conjunction with reports received from law enforcement officials
for fingerprints submitted pursuant to SEC Rule 17f-2, which
requires that all broker-dealer employees be fingerprinted. The
principal purpose of this review is to identify individuals
subject to statutory disqualification who may be ineligible for
registration or whose applications may require additional levels
of approval under the Exchange Act
b. Statutory Disqualification
Section 3(a)(39) of the Exchange Act defines "statutory
disqualification." Generally speaking, 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 association with a broker-dealer by the
Commission, the CFTC, all SRO or the foreign equivalent thereof.
Any broker-dealer wishing to employ an individual subject
to statutory disqualification must first seek approval of an SRO,
setting forth any terms and conditions under which the individual
would be employed or supervised. The SRO may either deny or
consent to the member's request. Sections 6(c) (2), 15A(g)(2)
and 17A(b) (4) (A) of the Exchange Act require that SROs give
notice to the Commission before admitting to membership any
person subject to statutory disqualification or permitting such
person to become associated with a member. The form and content
of the SROs' notice is prescribed in Rule 19h-1 of the Exchange
Act. Should it disagree with the SRO's recommendation to allow
the proposed association, the Commission may issue an order
directing an SRO to bar the person subject to the
disqualification from becoming associated with the member firm.
Should an SRO deny the member's request to employ an individual
subject to a statutory disqualification, the SRO must notify the
Commission of its decision pursuant to Exchange Act Rule 19d-I.
B. Continuing Reporting Obligations
1. Broker-Dealers\Registered Representatives
Once a broker-dealer has become registered with the
Commission (and presumably with an SRO), certain events
precipitate amended filings of information. Under SEC Rule 15b3-
broker-dealers are required to amend Form BD if information
contained in the application for registration as a broker-dealer
becomes inaccurate for any reason. Broker-dealers must also file
amendments to Form BD with the NASD's CRD system.
NYSE Rule 351 generally provides that a member firm must
report certain occurrences to the Exchange on Form RE-3. Rule
351(a) specifically identifies ten different circumstances where
broker-dealers must file a report with the Exchange. SEE Exhibit
1. These circumstances vary significantly, ranging from
situations where a court, government agency or SRO has determined
there has been a violation of the securities laws, to
circumstances where a firm has received a WRITTEN customer
complaint alleging theft or misappropriation of funds or
securities or of forgery.
The spirit of Rule 351 is premised on the NYSE receiving
notice of certain events involving member firms or their
associated persons so that tIle Exchange, where appropriate, can
investigate. Some of tIle particular subparagraphs of Rule 351
require specific findings of violations made by a governmental
entity or SRO or the initiation of disciplinary action by an SRO
against the firm or its employees. At the same time, however,
other subparagraphs of Rule 351 require reporting of certain
events even though there has been no finding or admission of
guilt or a violation. -[5]- Thus, while Form BD requires that
firms file a report where there has been a finding of some
violation or other improper conduct, the NYSE's RE-3 also
requires firms to file reports in instances where there may not
be a specific finding of a violation. Although NYSE members are
not required to file a Form RE-3 when a written customer
complaint is received alleging damages in excess of $10,000
-[6]-, Rule 351(d) nevertheless requires members to provide the
Exchange, on a quarterly basis, with summary statistics regarding
customer complaints received by the member firms relating to the
firm or any associated person.
Schedule C, Part V of the NASD By-Laws and NYSE Rule 351
require that members promptly notify the NASD and the Exchange of
any disciplinary action taken by any national securities exchange
or association, clearing corporation, commodity futures market or
government regulatory body against itself or its associated
persons. The rules also require that firms notify the NASD of any
disciplinary action taken by the member itself 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.
Article IV, Section 2 of the NASD By-Laws requires that
registered representative applications for registration with the
NASD be kept current at all times by supplemental amendments to
the original application.
C. Terminations
1. Broker-Dealers (Form BDW)
SEC Rule 15b6-l requires that broker-dealers give notice
of withdrawal of registration on Form BDW which, since January
1993, broker-dealers must file with the NASD's CRD system. Form
BDW requires disclosure of any proceedings and unsatisfied
judgments or liens not disclosed on Form BD, as well as
unsatisfied customer claims not disclosed elsewhere on Form BDW.
2. Registered Representatives
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 Form U-5 ("Uniform Termination
Notice for Securities Industry Registration") 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; investment related consumer initiated complaints
that alleged compensatory damages of $10,000 or more, that
alleged fraud or the wrongful taking of property that 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. -[7]- The 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.
II. SRO Investigation and Enforcement Programs
The NYSE and NASD differ in their investigatory and
enforcement processes. These differences, in part, relate to the
NYSE's centralized location in New York City, and the NASD's
eleven district offices. While the NYSE's regulatory and
enforcement programs are located in New York, the NASD primarily
operates its routine examination, investigation and enforcement
programs from its district offices.
A. Enforcement Programs
1. NYSE
The NYSE's Enforcement Division contains a
Preliminary Investigation Unit ("P.I. Unit") whose responsibility
is to conduct a preliminary investigation concerning all matters
that come to the Enforcement Division. For example, the P.I.
Unit will preliminarily investigate Form RE-3 filings, Fond U-5
filings, and referrals from other SROs or the SEC. The P.I.
Unit. handles the initial review of the specific items to
determine if the Enforcement Division should open a formal
investigation. Before making any decisions to proceed further or
to discontinue an investigation, the P.I. Unit gathers certain
information, commonly known as the P.I. protocol, which requires
that the unit obtain certain information before making any
decision to open a formal investigation. For typical allegations
of sales practice abuses, the Enforcement staff generally obtains
statements from the customer, the registered representative and
the firm involved, reviews the customer's new account information
and relevant account statements and reviews other customer
complaints involving the registered representative. -[8]-
The NYSE has increased its enforcement staff from 42 in
1985 to 111 at the end of 1993. Along with this increase in
staffing, the Exchange in recent years has brought many more
disciplinary actions against member firms and their associated
persons. -[9]- Many of these matters, such as the Shearson and
PaineWebber cases, involved significant sales practice abuses and
resulted in significant fines and other sanctions against the
member firms. -[10]- Moreover, because much of the current
regulatory review of abusive sales practices is linked to member
firms and/or their associated persons filing required reports
with an SRO, the NYSE in recent years has taken steps to assure
that member firms and their associated persons follow their
reporting obligations and timely submit reports for regulatory
review. In this regard, the NYSE's ability and commitment to
ensuring that member firms promptly file reports of events such
as settlements of civil lawsuits or arbitrations and terminations
from employment, has improved substantially. The Exchange
notified its membership in early 1990 of the importance of
complying with its reporting requirements, warning that non-
compliance may subject them to "appropriate disciplinary action."
-[11]-
At the same time that the NYSE aggressively attempted to
educate its member firms with regard to their reporting
obligations, it also brought a number of formal and informal
disciplinary actions against member firms for failure to file
required reports or for failing to file such reports in a timely
manner. The appropriate disciplinary actions that the Exchange
can and has taken against member firms for non-compliance ranges
from informal action -[12]- intermediate sanction under NYSE Rule
476A -[13]- and finally, when the member is especially
recalcitrant, the Exchange will bring a formal disciplinary
action against the member. The combination of an effective
educational campaign and aggressive enforcement activity with
regard to the reporting rules has been effective.
2. NASD
The NASD carries out its regulatory and enforcement
responsibilities through several committees reporting to the
NASD's Board of Governors. The general review of sales practice
related problems, whether a customer complaint, termination for
cause, amendment to a Form U-4 or notice of disciplinary action
taken by a member firm against a registered representative,
occurs in the NASD district office where the particular
registered representative is located.
The NASD has increased resources devoted to regulatory and
enforcement programs in its headquarters office and in fourteen
District Offices across the country during the past ten years.
In particular, the two groups most involved in investigating the
types of issues addressed in this Report have both experienced
significant expansions. These are the Enforcement Department and
the fourteen District Offices.
a. Enforcement Department
The NASD's Enforcement Department investigates and
prosecutes many of the NASD's most complex cases, many of which
include market manipulation activities involving member firms or
their employees. The Department's origins date to the mid-1970's
when the Department was then known as the Anti-Fraud Unit. Since
that time, the Anti-Fraud Unit has expanded from four examiners,
each located within a separate district office, to a centralized
enforcement unit of 43 persons within NASD headquarters. Because
of the nature of the alleged violations investigated by the
Enforcement Department, many cases are often considered by the
NASD's Market Surveillance Committee rather than a District
Business Conduct Committee ("DBCC").
b. District Offices
The NASD routinely reviews sales practice activities of
member firms through examination and regulatory programs
administered by the NASD's fourteen District Offices. Possible
material violations of the federal securities laws, Municipal
Securities Rulemaking Board ("MSRB") or NASD rules are presented
to a DBCC for possible formal disciplinary action, if
appropriate. In the last ten years, the NASD District Office
staff has increased from 363 to 578 employees.
B. SRO Investigation Programs
The SRO investigation programs involve the review of
customer complaints, members' notices of disciplinary action,
judgments, awards and settlements, and terminations. In regard
to customer complaints, in cases where SROs directly receive
customer complaints involving the SROs' members and their
employees, the SROs review the complaints as part of the SROs'
regulatory or compliance programs. At the NASD, the district
offices review customer complaints; at the NYSE, the Division of
Member Firm Regulation reviews such complaints. When an initial
investigation reveals evidence of a violation of federal
securities laws or SRO rules, NYSE and NASD staff refer the
customer complaint to the SRO's enforcement program for possible
disciplinary action against the member or its associated persons.
As discussed in the enforcement program section of this
appendix, the NASD and NYSE also routinely review customer
complaints received by member firms and reported on Forms U-4, U-
5 and RE-3. The SROs also utilize customer complaint information
in both the planning and on-site review stages of their broker-
dealer examination programs.
In regard to members' notices of disciplinary actions, the
NASD district offices review such notices. Similarly, the NYSE
Enforcement Division reviews the members' notices filed with the
NYSE on Form RE-3, applying the same preliminary investigation
protocol applied to Form U-5. The NASD Qualifications Section
reviews judgments, awards and settlements, reported on Forms U-4
and U-5, and the NYSE Enforcement Division reviews the same
information reported to that Exchange on Form RE 3 pursuant to
NYSE Rule 351.
Finally, in regard to terminations for cause, the NASD's
qualification Section receives information contained in Form U 5
relating to the termination of registered representatives for
cause. The Qualifications Section refers this information for
investigation to the NASD's district offices. Pursuant to Article
IV, Section 4 of the NASD By-Laws, the Association retains
jurisdiction over a registered representative for two years after
termination of registration with the NASD; the By-Laws, however,
allow additional time for the NASD to begin formal disciplinary
action when actionable conduct is disclosed on an amended Form U-
5 within two years of the original filing.
The NYSE's Enforcement Division reviews information
related to terminations for cause contained on Form U-5 and filed
with the Exchange. This information is subject to the same
preliminary investigation protocol procedures applied to
information contained on Form RE-3. The NYSE retains
jurisdiction over the registered representative for one year
following termination of registration with the NYSE.
III. SRO Reporting & Availability to the Public
A. SEC Rule 19d-1
SEC Rule 19d-l requires that SROs provide to the
Commission notice of final disciplinary action taken against
member firms and associated persons. Decisions in SRO
disciplinary actions are referenced in securities violations
bulletins and are available for review in the Commissions public
reference rooms. In some instances, SROs provide decisions of
formal disciplinary actions directly to public organizations such
as research libraries or the press.
B. Uniform Disciplinary Act Reporting Form (Form U-6)
Form U-6 is a uniform form for reporting, to the
Commission and the NASD, disciplinary actions involving broker-
dealers and associated persons. State and federal law enforcement
and regulatory agencies, securities and commodities exchanges and
self-regulatory organizations in the United States and foreign
countries use this form. It is designed for the reporting of a
broad range of actions such as indictments, criminal convictions,
temporary and permanent injunctions, fines, liquidations and
censures.
C. NASD Public Disclosure Program
In 1988, the Commission approved the implementation of a
Public Disclosure Program by the NASD. -[14]- The purpose of this
program was to permit members of the public to have access to
information to help them to determine whether to conduct, or to
continue to conduct, business with an NASD member or any of the
member's associated persons. Through the Public Disclosure
Program, the NASD released certain information about the
employment and disciplinary history of its members and their
associated persons in response to written inquires from the
public.
In October 1990, Congress enacted the Securities
Enforcement Remedies and Penny Stock Reform Act of 1990 -[15>
("Penny Stock Reform Act"). Among other things, the Penny Stock
Reform Act mandated that the NASD establish a toll-free telephone
number to receive customer inquires concerning the disciplinary
history of its members and their associated persons. -[16]- The
NASD enhanced its Public Disclosure Program with the introduction
of all 800 number service ("800 Service") on October l, 1991.
-[17]- Through this service the NASD reported: (1) past and
present employment history of associated persons of NASD members;
(2) all final disciplinary actions -[18]- taken by federal,
state, or SROs against NASD members and their associated persons
that relate to securities or commodities transactions; and (3)
all criminal convictions reported on Form BD or Form U-4.
In July 1992, the House Subcommittee on Telecommunications
and Finance requested that the General Accounting Office ("GAO")
conduct a review of the rules, procedures, facilities, and
oversight and enforcement activities with respect to the Penny
Stock Reform Act. Congress specifically asked the GAO to review
the operation of the NASD's 800 Service. -[19]- The GAO undertook
a study of the implementation of the Penny Stock Reform Act and
recommended, among other things, that the NASD "provide public
investors who request information via the NASD's toll-free
service with information on final arbitration awards." -[20]-
Both the Commission and the NASD concurred in this
recommendation. -[21]-
On July 1, 1993, the Commission approved all NASD rule
change to permit the NASD to release certain additional
information contained in the CRD system regarding the
disciplinary history of its members and their associated persons
through the 800 Service. The rule change expanded the scope of
the information that is reportable to include: (l) pending formal
disciplinary proceedings initiated by federal or state securities
agencies and SROs -[22]-, as well as pending and final
disciplinary actions taken by foreign governments or foreign
regulatory authorities; (2) criminal indictments or information;
(3) civil judgments; and (4) arbitration decisions in securities
and commodities disputes involving public customers. -[23]- The
NASD discloses final arbitration decisions involving only public
customers that are reported on Form U-4 or that are available
through the NASD's existing arbitration data base. The NASD data
base captures all member and associated person arbitration
decisions issued by the NASD arbitrators after May 10, 1989.
-[24]-
The NASD procedures call for a copy of the information
requested to be sent to the person requesting it and to the
subject of the request, i.e., the member firm or an associated
person. Each NASD member firm receives a monthly print-out with
the number of requests made concerning the firm and its
associated persons, as well as the names of those associated
persons about whom customers have made requests. In addition,
each such associated person receives a report with all the
information that the NASD sent to the requestor. The NASD removes
the name and address of the requestor from these reports and does
not reveal that information to either the member firm or its
associated person. The NASD does not charge a fee for responding
to inquiries from callers planning to use the information for
their personal investments. Callers, however, who are planning to
use the information in their capacity as an agent for an investor
or for other business or commercial uses are charged a $30 fee
per inquiry.
When the NASD first introduced the 800 Service, they
received approximately 140 calls per day. In January 1993, when
the NASD announced the expansion of the information disclosed
through the 800 Service, the average daily call volume was
approximately 200 calls per day. During the first week after the
NASD expanded the 800 Service, the NASD received about 1 ,600
requests for information each day. During July and August 1993,
the NASD received about 800 calls a day and in September 1993,
received about 600 calls a day. Since September the number of
calls to the 800 Service has declined. Between approximately the
end of November 1993 and February 1994, the number of calls to
the NASD's 800 Service has leveled off to about 250 calls a day.
Finally, the Division of Market Regulation has requested
that all SROs operating arbitration programs forward information
concerning arbitration decisions rendered in their forum directly
to the CRD system so that this information is consistently
disclosed to the public regardless of the arbitration forum and
regardless of whether the registered representative timely files
or amends a Form U-4 or RE-3.
#####
ENDNOTES
-[1]- Federal legislation and SRO rules require broker-dealer
registration. See 15 USC 78o. Associated persons of
broker-dealers, including registered representatives, are
required to pass SRO qualification examinations and must
be licensed by the states. The federal government does not
require the licensing and registration of associated
persons. The Commission, however, recently adopted Rule
15b7-1, which makes it a violation of the Exchange Act for
a broker-dealer to have an associated person who has not
complied with SRO registration requirements.
-[2]- See Securities Exchange Act Rule 15b3-l, 17 C.F.R.
240.15b3-1 (requires broker-dealers to amend promptly
their Form BD); NYSE Rule 351 (requires firms to file Form
RE-3 when certain events occur); Article Il, Section 2,
NASD By-Laws (enables the NASD to adopt qualification
requirements for persons associated with member firms,
i.e., Form U-4); Article IV, Section 3, NASD By-Laws
(requires members to notify the NASD if the member
terminates any persons associated with the member).
-[3]- Developed jointly by the North American Securities
Administrators Association ("NASAA") and the NASD in 1981,
the CRD, which the NASD operates, is an on-line data base
containing information pertaining to broker-dealers and
their associated persons. Information contained in the CRD
is provided by the NASD, SEC, some exchanges, the
Commodity Futures Trading Commission, the National Futures
Association, state securities commissions, and the Federal
Bureau of Investigation. The CRD database includes about
5,500 broker-dealers and 460,000 active registered
persons.
-[4]- An applicant for registration with all NASD member firm
must complete Form U-4, pursuant to Article IV, Section 2
of the NASD By-Laws. Similarly, NYSE Rule 345.12 requires
persons preparing to become associated with NYSE firms to
file and keep current Form U-4.
-[5]- For example, the rule requires broker-dealers to report
arrests for other than minor traffic incidents, and
settlements of litigation or arbitration where the member
firm paid a customer an amount in excess of $25,000.
-[6]- The registered representative, however, is still required
to amend the Form UA when the registered representative is
the subject of a written customer complaint alleging
compensatory damages in excess of $10,000 or where the
registered representative settles and is responsible for
any amount in excess of $5,000. SEE NYSE Rule 345.10-12.
-[7]- 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. To be considered timely, members
must file amendments not later than 30 days after the firm
learns the facts or circumstances giving rise to the
amendment. Thus, if the broker-dealer receives a customer
complaint involving a former registered representative,
the broker-dealer is required to file an Amended Form U-
5.
-[8]- There are some matters which are not subject to a P.I.
review but are immediately opened as an enforcement
matter. These matters includes Market Surveillance and
Member Firm Regulation referrals.
-[9]- In 1988 the NYSE completed 58 formal disciplinary actions.
The Exchange completed 119, 191, 212, 194, and 189
enforcement actions in 1989, 1990, 1991, 1992 and 1993,
respectively.
-[10]- Shearson Lehman Bros., HPD 91-59 (May 14, 1991) $750,000
fine; PaineWebber Securities, Inc., HPD 91-192 (November
15, 1991) $900,000 fine.
-[11]- See Information Memo Number 90-17, "Timely and Complete
Filings and Responses to Enforcement Inquiries" (April 30,
1990). Pursuant to NYSE Rule 345, entitled "Employees--
Registration Approval Records", member firms are required
to timely submit to the Exchange notices of termination of
employment with a member (Form U-5). Pursuant to NYSE Rule
351, entitled "Reporting Requirements", members are
required to report certain events to the NYSE on Form RE-
3 such as the initiation or conclusion or settlement of
certain proceedings. For example, members are required to
report settlements of claims against a registered
representative for over $15,000 or against a member for
over $25,000, as well as certain firm, SRO, SEC or other
governmental actions or sanctions.
-[12]- The Exchange may issue letters of caution or letters of
admonition to the offending member for failing to file
certain information with the Exchange in a timely manner.
These letters are considered informal actions.
-[13]- NYSE Rule 476A, entitled "Imposition of Fines for Minor
Violation(s) of Rules," is known as the "traffic ticket"
rule. This rule permits the Exchange to summarily fine a
member up to $5,000 for not timely filing: certain
employee registration or termination information with the
Exchange (Forms U-4 and U-5 respectively); certain types
of pending or final disciplinary proceedings; or pending
customer complaint information. The Exchange is not
required to hold a hearing to issue a traffic ticket and
payment is considered a waiver of any rights to a hearing.
If the firm or individual contests the ticket, then the
matter becomes a disciplinary proceeding.
-[14]- Securities Exchange Act Release No. 25604 (April 20.
1988). 53 FR 14878 (April 26. 1988) (approving File No.
SR-NASD-88-14).
-[15]- Pub. L. No. 101-429, 104 Stat. 931(1990) (codified at 15
U.S.C. 78o-3(i) (1988 & Supp. 1992)).
-[16]- The legislative history of the Penny Stock Reform Act
provides that Congress expects that "the Commission, the
state regulators, and registered securities associations
will consult with one another to try and develop a common
approach to this issue one which fulfills the
informational needs of the customers and assures the
maximum level of investor protection." H.R. Rep. No. 617,
2d Sess. (1990).
-[17]- Securities Exchange Act Release No. 30629 (April 23,
1992), 57 FR 18535 (April 30, 1992) (approving File No.
SR-NASD-91-39).
-[18]- The term disciplinary action as used by the NASD includes,
but is not limited to, the information provided in
response to questions 7 B, C, D, E, and F on Form BD; and
questions 22 C, D, E, F, and G on Form U-4.
-[19]- SEE Letter from Edward J. Markey, Chairman of the
Subcommittee on Telecommunications and Finance, to Charles
A. Bowsher, Comptroller General of the United States (July
17, 1992). Section 510 of the Penny Stock Reform Act
directs the Comptroller General to conduct a review of the
implementation of the Penny Stock Reform Act, and to
submit a report to Congress with any recommendations.
-[20]- SEE GAO "Penny Stocks: Regulatory Actions to Reduce
Potential for Fraud and Abuse" (February 1993) at 48.
("GAO Report").
-[21]- See Letter from William Heyman, Director, Division of
Market Regulation, SEC, to Richard Fogel, Assistant
Comptroller General, General Accounting Office (November
27, 1992); GAO Report at 60 and 65; AND letter from John
E. Pinto, Executive Vice President, Compliance Division,
NASD, to R. Fogel, GAO (November 27, 1992).
-[22> In addition to the information disclosed on Forms BD or U-
4, all pending NASD initiated disciplinary actions,
whether or not disclosed on Forms BD or U-4, are provided
800 Service.
-[23> Securities Exchange Act Release No. 32568 (July 1, 1993),
58 FR 36723 (July 8, 1993) (approving File No. SR-NASD-
93-26).
-[24]- Beginning July 1, 1993, the NASD began disclosing
arbitration awards involving customers rendered in its
forum in two phases. Until September 1, 1993, the NASD
arbitration awards reported on Form U-4 and those awards
in its arbitration data base back to August 6, 1990. On
September 1, 1993, the NASD expanded its disclosure to
arbitration awards in its data base that date back to May
10, 1989.
#####
EXHIBIT I
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 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.
#####Last Reviewed or Updated: March 18, 2026