Special Studies
Report on the Status of the Recommendations From the Large Firm Project Report
Sept. 4, 1994
REPORT ON
THE STATUS OF THE RECOMMENDATIONS
FROM
THE LARGE FIRM PROJECT REPORT
Division of Market Regulation
Division of Enforcement
United States Securities and Exchange Commission
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.
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I. INTRODUCTION
On May 19, 1994, the Securities and Exchange Commission ("SEC"
or "Commission") announced the findings of a review undertaken by
the SEC, 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, particularly those moving from firm to firm.
As part of this review (referred to as the "Large Firm
Project" or "Project"), Commission, NYSE, and NASD staff conducted
170 examinations covering home offices of the nine firms and 161
branch offices. The Project also focused on 268 registered
representatives ("selected registered representatives") who had
been the subject of sales practice-related customer complaints,
named as defendants or respondents in customer-initiated litigation
or arbitration proceedings, or otherwise had been the subject of
an enforcement or disciplinary action by a state or federal
governmental entity or self-regulatory organization ("SRO").
The Large Firm Project Report ("Report") contained the
following six specific findings:
1. More than one-third of the selected registered
representatives were no longer in the securities
industry.
2. Approximately 25 % of the examinations resulted in
enforcement referrals. [Although one-quarter of the
examinations resulted in enforcement referrals, this was
not surprising. The branch offices were selected on the
basis of, among other things, large numbers of customer
complaints as reported to the NYSE. The selections were
made with the intention of following up with enforcement
action, whenever appropriate.]
3. Three of the nine firms accounted for 88% of the
enforcement referrals.
4. Some branch office managers were not enforcing
supervisory and compliance systems.
5. Registered representatives were able to move when
customer complaints existed.
6. The largest revenue producing registered representatives
generally were not the subject of investor complaints.
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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 enforcement of sales
practice rules and detection of violations need improvement. In
particular, the Commission Staff ("Staff") 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. -[1]- 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.
II. RECOMMENDATIONS
The Report proposed a series of recommendations that the Staff
believes will strengthen broker-dealer compliance mechanisms,
enhance SRO efforts in detecting sales practice abuses and
enforcing compliance with applicable rules, and reinforce the
Commission's principal mandate of investor protection. What
follows is a plan for implementing those recommendations, as well
as a summary of what has been accomplished already. Additionally,
on August 4,1994, the Division of Market Regulation and Division
of Enforcement sent a letter ("August Letter") to the SROs
suggesting a number of changes and requesting a timetable for
implementation of those recommendations directed to the SROs. -
[2]-
See Appendix A for a sample of the letters. The responses we have
received thus far generally agree with and support the overall
findings and recommendations of the Large Firm Project. We have
addressed the recommendations sequentially, as set out in the
Report, below.
1. Increased Examination Efforts and Sanctions in all Sales
Practice Matters
Over the past five years, the SROs have increased
substantially their staff resources devoted to enforcement matters,
have brought an increased number of sales practice and failure to
supervise cases, and have increased sanctions for violative
conduct. Nevertheless, based on the results of the Project, stepped
up examination efforts are necessary, existing supervisory and
compliance systems designed to detect problem registered
representatives need improvement, and existing sanctions for sales
practice violations at both the SRO and Commission level need to
be strengthened.
a. Examination Efforts
The Staff has increased its focus, and has encouraged the SROs
to do likewise, on registered representatives with large numbers
of customer complaints, arbitration awards or settlements, or
disciplinary actions, and we will continue to step up our oversight
efforts with respect to sales practice examinations conducted by
the SROs. Focusing our attention and increasing the visibility of
our presence in this arena will convey a strong message that
violative behavior will not be tolerated by the Commission or by
the SROs. The Staff is exploring different methods of utilizing
NYSE Rule 351 data in its regular examination program. -[3]- The
Staff also is developing a program for the systematic review of
allegations made in arbitration cases filed with the NASD and
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other SROs. This will enable the Staff to review allegations of
sales practice abuses on a more timely basis, and should aid in
the earlier identification of problem registered representatives.
We are continuing our efforts to bring to the SROs' attention
those areas we feel need improvement. The Division of Market
Regulation, in the past ten years, has increased its oversight of
the SROs' sales practice compliance and enforcement programs. This
oversight includes increased compliance inspections, and regular
meetings with senior staff of the NYSE and NASD to discuss the
importance of effective sales practice compliance and overall
enforcement programs. It also has contributed to an increased SRO
commitment to identifying and disciplining sales practice abuses.
The August Letter requested that the NYSE, NASD, and other
SROs work on developing better tools for identifying sales practice
problems at an earlier stage. Specifically, we have asked the SROs
to enhance their efforts in the review of sales practice
allegations made in arbitration cases. By utilizing information
concerning allegations of sales practice abuses in a more timely
manner, the SROs will enhance their ability to detect patterns of
fraud and supervisory deficiencies, and to identify problem
registered representatives. We also requested that the NYSE make
greater use of the complaint information available from NYSE Rule
351 data to detect trends and patterns of complaints.
The NYSE already has taken steps to enhance and increase its
examination efforts in sales practice matters. Specifically, the
NYSE has increased the resources in its Sales Practice Review Unit
("SPRU") by hiring an additional five examiners. This will enable
the NYSE to conduct full sales practice reviews of all NYSE firms
on a more frequent basis. Those NYSE firms that are not subject to
a yearly full sales practice review are still subject to a
financial and operation examination ("FINOP"). The FINOP
examination had previously included a limited sales practice
review. The NYSE has revised the FINOP examination procedures to
include more focused sales practice analysis in order to facilitate
the review for abusive sales practices. Additionally, the NYSE has
instituted a program to conduct a risk analysis using NYSE Rule 351
data to identify problem registered representatives and, where
appropriate, follow up with a special cause examination. The NYSE
also will utilize this information in connection with its routine
examination program.
The NASD has been developing a program using information from
the Central Registration Depository ("CRD") database relating to
registered representatives with frequent customer complaints,
settled arbitrations, and frequent employment changes. The NASD
will provide this information to the SEC, and will distribute the
information to the 14 NASD District Offices to utilize in the
NASD's regular examination programs. The NASD also has instructed
its District staff to conduct examinations of broker-dealer main
and branch offices, as well as individuals associated with those
offices, in cases where the broker-dealers or individuals pose a
regulatory concern because of past conduct.
B. b. Sanctions
In the August Letter, we asked the SROs to devote additional
resources to prosecuting sales practice cases against problem
registered representatives who have
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violated SRO rules. We also asked the SROs to review and, if
necessary, revise their policies concerning remedial sanctions for
sales practice violations. We strongly believe that disciplinary
sanctions against broker-dealers and registered representatives
engaging in abusive sales and trading practices should be severe.
We also intend to devote additional resources to prosecuting
sales practice cases against problem registered representatives who
have violated Commission rules, and to reviewing the policies
regarding remedial sanctions for sales practice violations. One
area that has been acted upon already deals with the Commission's
policy on bar orders. The Division of Market Regulation and
Division of Enforcement recently sent a letter to the SROs
announcing Commission policy regarding the consequences of an
unqualified bar (i.e., one that does not contain a proviso allowing
for re-application after a specified time period). -[4]- The
imposition of an unqualified bar evidences the Commission's
conclusion that the public interest is served by permanently
excluding the barred person from the securities industry. This is
viewed as a particularly severe sanction and is reserved for
egregious cases. -[5]- Accordingly, absent extraordinary
circumstances, a person subject to an unqualified bar will be
unable to establish that it is in the public interest to permit re-
entry to the securities industry. See Appendix B for a copy of the
letter.
2. Improved Broker-Dealer Compliance Systems for Identifying
Problem Registered Representatives
While the Large Firm Project generally found adequate home
office procedures and supervisory structures at most of the firms
examined, the Staff believes that firms need to strengthen their
procedures used to identify registered representatives generating
large numbers of sales practice-related customer complaints, and
arbitration awards and settlements. We recommend that firms
utilize, to a greater extent, the information contained in the NYSE
Rule 351 data in order to detect trends and patterns of complaints
within their own branch offices. Additionally, we ask that firms
improve compliance systems designed to oversee and review employee
conduct, and review their data processing and computer capabilities
to better assist branch office managers m performing their
supervisory functions.
On June 21,1994, the Commission received a letter from the
SIA regarding the creation of an Ad Hoc Committee on Regulatory
Reporting and Disclosure ("Ad Hoc Committee"). The SIA created the
Ad Hoc Committee to work toward the resolution of issues relating
to the reporting and disclosure of sales practice complaints and
disciplinary actions. The SIA letter affirmed the need for
effective and fair systems for the reporting, retention and
analysis of data on regulatory actions, complaint resolutions and
allegations of improper sales practices. While there are concerns
regarding the current systems and requirements, as well as issues
regarding questions of privacy and fairness, we intend to work with
the Ad Hoc Committee toward a resolution of these concerns and
issues.
3. Enhanced Compliance by Firms and Registered
Representatives with all SRO Reporting Requirements
Historically, a highly fruitful source for the identification
of possible sales practice problems has been reports that broker-
dealers and registered representatives are
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required to file with SROs. -[6]- These required filings form the
backbone of the SRO systems for the early detection of problem
registered representatives. The August Letter requested that the
SROs closely monitor the timeliness of required filings, such as
the Forms U-4, U-5 and RE-3, through examinations and otherwise.
The SROs also were asked to increase sanctions against both firms
and individuals where instances of noncompliance with SRO reporting
requirements are discovered. In this regard, the NASD responded
that one possible approach would be the adoption of a minor rule
violation plan to ensure that late and deficient filers are dealt
with promptly.
We have requested that all other SROs consider adopting a rule
based on NYSE Rule 351 requiring members to report customer
complaints on a quarterly basis. The NASD is currently in the
process of drafting customer complaint reporting rules calling for
the submission by members of quarterly summary information of
customer complaints received, and hopes to propose the rules to its
appropriate committees before the end of the year.
4. Qualified Immunity for Firms on Form U-5
The Staff is aware of the concerns of firms and supervisory
personnel about civil liability for disclosing disciplinary
problems on Form U-5. Such concerns may inhibit full and adequate
disclosure of the facts and circumstances surrounding the reason
for termination of registered representatives. The Staff is
exploring with the SROs means of affording qualified immunity to
firms that make good faith disclosure on Form U-5. Nevertheless,
broker-dealers have an obligation to file Form U-5 in a timely
manner, and to make complete and accurate disclosure on such forms
in order to prevent recurrent sales practice abuses. Disciplinary
action may be necessary in instances where it appears that a
broker-dealer inadequately disclosed the reasons for the
termination of a problem registered representative who subsequently
commits additional sales practice abuses.
5. Enhanced Role for Legal and Compliance Departments
A firm's compliance department is an important means for
assuring adherence by its employees to the federal securities laws.
-[7]- Firms should have procedures that enable compliance personnel
to ensure that firm supervisory procedures are being properly
implemented. These procedures should specifically address the role
of compliance personnel in ensuring that salespersons who
previously have been involved in abusive sales practices are
subject to reasonable supervision. The Staff believes that the
hiring procedures adopted by broker-dealers with respect to problem
salespersons should include significant involvement by senior
management, and firm compliance or legal personnel.
In general, the Staff believes that the determination whether
to hire problem salespersons is most appropriately made by a firm's
legal or compliance personnel. Firm procedures should include a
requirement that management provide written justification for a
decision to hire or retain an individual that is taken in the
absence of, or against the express recommendation of, legal or
compliance staff. In some instances, the Commission has entered
into settlements requiring broker-dealers to develop standards to
identify problem sales personnel and require the written approval
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by compliance personnel of the hiring of any associated person with
a significant disciplinary history or who has been the subject of
significant customer complaints. -[8]-
The August letter asked the SROs to consider whether rules
requiring broker-dealers to have specific procedures regarding the
role of legal and compliance departments in hiring and supervisory
decisions should be implemented.
6. Firm Responsibility for Recidivist Registered
Representatives
The Staff will consider whether additional regulatory action
is needed to address the problem of registered representatives with
a disciplinary history of sales practice abuses who become employed
by a broker-dealer and subsequently commit a sales practice
violation. Broker-dealers and supervisors that have not devoted
increased attention with respect to the hiring and supervision of
problem salespersons may be subject to sanctions where problem
salespersons subsequently engage in additional instances of abusive
sales practices. The Staff believes that broker-dealers and their
supervisory personnel have an obligation to reasonably apprise
themselves of the disciplinary and employment history of sales
personnel, and that the existence of prior sales practice problems
should serve as a red flag signaling the need for heightened
scrutiny with respect to the hiring or supervision of a particular
employee. The Staff has asked the SROs in the August letter to
review their rules and consider increasing sanctions against firms
for hiring problem registered representatives who continue to
commit sales practice violations.
7. Continuing Education
Another crucial method of improving registered representative
compliance with sales practice rules and procedures is to enhance
registered representative education. In April 1994, Chairman Levitt
wrote to the Chief Executive Officers of approximately seventy NYSE
and NASD member firms emphasizing that mandatory continuing
education of securities industry professionals should be one of the
industry's highest priorities. Following the issuance of the
Chairman's letter, both the NYSE and the NASD issued information
bulletins to their membership to inform them of a continuing
education program being developed by the Council on Continuing
Education ("Council"), an organization composed of a cross-section
of broker-dealer firms, representatives of six SROs, and liaisons
from the SEC and the North American Securities Administrators
Association ("NASAA").
The program being developed by the Council has two principal
elements: (a) a "Firm" element mandating that every broker-dealer
provide annual continuing education on its products and services
to all registered employees who engage in sales, trading and
investment banking, and their first-line supervisors; and (b) a
"Regulatory" element generally requiring registered personnel to
receive training in compliance, regulatory, ethics, and sales
practice issues, on a two, five and ten year cycle following their
initial registration.
The Council has organized two working committees to develop
the Regulatory and Firm elements of the program. These committees
have prepared proposed draft rules for adoption by the SROs. The
Regulatory Element Committee has developed an initial listing of
standardized subject matter for a computer-based training program.
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The Firm Element Committee has developed standards that firms must
adhere to in developing and implementing their training programs.
The SROs anticipate submitting proposed rule changes to the
Commission in November 1994 that would put into place a mandatory
continuing education program for all registered securities
professionals. See Appendix C. The Council is working towards a
July 1995 implementation date of the SRO rules.
Chairman Levitt supports the efforts of the Council and has
emphasized his belief that a continuing education program must be
one of the industry's highest priorities.
8. Development and Implementation of Tracking Systems for
SRO Handling of Investigations Relating to Form U-4 and
U-5 Filings
The August Letter asks the SROs to review their existing
coordination protocols and, if necessary, implement a system for
tracking which SRO is investigating a registered representative's
termination for cause or amendment to Form U-4 and U-5, and the
current status of such investigations. An important element of the
SROs responsibility to govern the conduct of their member firms is
the ability to ensure that matters are fully investigated and that
there is no duplication of effort.
The NASD currently is embarked on a multi-million dollar
rewrite of the CRD system. The first phase of the new CRD system,
which is scheduled to be operational as a pilot program in the fall
of 1995, focuses on member filing functions in the new CRD
environment relating to individuals and organizations, and
encompasses full electronic filings by the membership. When
completed in 1996, 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 registered
representatives, to flag problem registered representatives 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 updated system will
continue to provide firms and investors, through the toll free hot-
line operated by the NASD ("800 number"), with easier access to
disciplinary records. The Staff has been working closely with the
NASD redesign team and views the new CRD system as an important
means of identifying problem registered representatives.
9. Disclosures When Opening New Accounts
Providing investors with information concerning the
disciplinary history of registered representatives is another means
of protecting investors from abusive sales practices. The Staff
believes that information concerning a registered representative's
disciplinary history is particularly important to investors at the
time they open an account or establish a relationship with a
registered representative. The selection of a reliable registered
representative is a critically important decision. 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 800 number.
Accordingly, the August Letter asked the SROs to consider the
submission of rules requiring member firms to disclose to
investors, prior to effecting any transaction in a new account,
information relating to the availability of the 800 number.
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10. Public Disclosure by All SROs of Initiated Disciplinary
Actions
The final recommendation of the Large Firm Project involved
the issue of public disclosure, by the SROs, of the filing of
charges against member firms or registered representatives when
actions are initiated. The Staff believes that the lack of
disclosure with respect to SRO disciplinary proceedings is
inconsistent with the public interest. While the NASD and the NYSE
already have instituted procedures to disclose initiated
disciplinary actions, the August Letter asked the remaining SROs
to make public disciplinary actions against member firms and
individuals when the SRO initiates the disciplinary action by
filing formal charges.
III. OTHER INITIATIVES
In addition to the recommendations noted in the Large Firm
Project, there are several other initiatives underway to address
and curb abusive sales practices.
1. Joint Regulatory Examination Effort
A joint regulatory examination effort is currently in the
planning stages and will be conducted with the NASD, NYSE, and
NASAA. The Large Firm Project focused on nine of the largest
broker-dealers in the United States and on registered
representatives who were or had been employed at one of the firms.
This joint effort will focus on so-called "rogue brokers" employed
throughout the industry. The NASD has developed a program designed
to profile and analyze the current registered representative
population using, among other things, the regulatory information
that resides in the CRD.
The planning process includes coordinating the selection of
registered representatives using information from the CRD,
including customer complaints, arbitrations, patterns of frequent
employment changes and disciplinary actions previously taken by a
regulatory entity. By working with the SROs and NASAA in this
cooperative venture, we are increasing the level of protection
afforded to investors from abusive, fraudulent and manipulative
activities.
2. Cold-Calling
A practice that is widely used in the industry, yet holds the
potential for abuse, is cold-calling. Some securities firms have
procedures in place to govern the cold-calling practices of their
registered representatives, and are able to use cold-calling as a
legitimate method to develop customer relationships. However, when
a registered representative uses abusive cold-calling to convince
a customer to make inappropriate or excessive securities trades,
the standards of conduct expected of a securities professional are
wholly violated.
Broker-dealers, like all firms engaged in telemarketing, are
subject to the Telephone Consumer Protection Act of 1991 ("TCPA")
and a Federal Communications Commission ("FCC") rule promulgated
thereunder. -[9]- Pursuant to the FCC rule, firms must: adhere to
time-of-day restrictions; establish "do-not-call" lists; and
establish training requirements, supervisory procedures and
identification requirements for cold-callers.
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The Commission intends to take action to adopt a cold-calling
rule. Last month, Congress passed and the President signed new
cold-calling legislation, entitled the Telemarketing and Consumer
Fraud and Abuse Prevention Act. -[10]- The Act directs the
Commission to promulgate rules to prohibit deceptive and other
abusive telemarketing practices. The Act requires, however, that
the Federal Trade Commission ("FTC") adopt cold-calling rules
within a year of the legislation and that the SEC adopt
substantially similar rules within six months of the FTC rule. The
Commission intends to work in cooperation with the FTC to
coordinate the rulemaking efforts.
3. Compensation Practices
The public's trust and confidence in the securities industry
are strongly affected by registered representative compensation.
Investors develop confidence in a registered representative based
on their interactions with that individual. When a registered
representative recommends a security, the investor should not have
to wonder whether the investment is in his or her interest or
whether the registered representative is simply trying to make a
quick buck. Investors should feel that their registered
representatives are looking out for their best interest.
The Chairman has asked a committee of distinguished
individuals to examine compensation practices in the brokerage
industry ("the Committee"). The Committee is chaired by Dan Tully,
Chairman and CEO of Merrill Lynch, and includes: Warren Buffett,
Chairman and CEO of Berkshire Hathaway, and former Chairman of
Salomon Brothers; Jack Welch, Chairman and CEO of General Electric;
Raymond Mason, Chairman and CEO of Legg Mason; Sam Hayes, a noted
Harvard Business School professor; and Tom O'Hara, President of the
National Association of Investors Corp. and a member of the SEC's
Consumer Affairs Advisory Committee. The Committee's mission is to
identify industry practices that raise significant conflicts of
interest between a registered representative and his or her
customers, and to suggest ways to eliminate or reduce these
conflicts. The Committee will focus specifically on the factors
that influence a registered representative when he is attempting
to make a sale. In August, the Committee released an open letter
to the financial services industry asking for widespread comment
from all parts of the industry and public. See Appendix D. Over the
next few months, the Committee plans to draft a discussion paper
that will address industry compensation practices, identify actual
and perceived conflicts of interest, and identify the "best
practices" in the industry -- those compensation practices that
pose the least conflict between investors and registered
representatives.
IV. CONCLUSION
The Staff believes that the cooperative working partnership
between the Commission, the SROs and the securities industry should
increase the early detection and prosecution of problem registered
representatives. The Commission, the SROs, and most firms are
committed to removing problem registered representatives. Together,
we have implemented or are in the process of implementing a variety
of recommendations and programs. Our highest aim is to protect the
investing public and improve investor confidence in the integrity
of this nation's capital markets.
--------------------------- ENDNOTES -------------------------
-[1]- See Article IV, Section 3 of the NASD By-Laws and NYSE
Rule 345. These rules require the registration of
representatives and associated persons. The rules require
that specific relevant information be disclosed during
the registration and termination process. This
information is disclosed on Form U-4 ("Uniform
Application for Securities Industry Registration or
Transfer Form") and Form U-5 ("Uniform Termination Notice
for Securities Industry Registration").
-[2]- The August letter was sent to the NYSE, NASD, American
Stock Exchange ("AMEX"), Boston Stock Exchange ("BSE"),
Chicago Board Options Exchange ("CBOE"), Chicago Stock
Exchange ("CHX"), Cincinnati Stock Exchange ("CSE"),
Pacific Stock Exchange ("PSE") and the Philadelphia Stock
Exchange ("PHLX").
-[3]- NYSE Rule 351, among other things, requires a member firm
to submit to the NYSE, on a quarterly basis, summary
information concerning all written customer complaints
the member firm received during the quarter.
-[4]- Individuals subject to an unqualified bar are subject to
a statutory disqualification under Section 3(a) (39) of
the Securities Exchange Act of 1934 ("Exchange Act") and,
as such, are required to undergo a special review process
before becoming associated with a member of a SRO in
addition to obtaining the Commission's consent.
-[5]- See e.g. Lester Kuznetz, Securities Exchange Act Release
No. 23525 (Aug. 12, 1986), 36 SEC Docket 466, 470;
Stephanie J. Hibler, Securities Exchange Act Release No.
22067 (May 23, 1985), 33 SEC Docket 205, 208.
-[6]- 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 any of its associated persons,
judgements, awards or settlements involving customer-
initiated litigation and arbitration, and written
customer complaints involving allegations of theft,
misappropriation of funds or securities, or forgery.
-[7]- See Prudential Bache Securities. Inc., Exchange Act
Release No. 22755 (January 2, 1966)(noting that, for
purposes of supervision, a broker-dealer should not rely
solely on its branch managers).
-[8]- Prudential Securities Incorporated, Exchange Act Release
No. 33082 (October 21,1993).
-[9]- Telemarketers are subject to the Telephone Consumer
Protection Act of 1991 and the FCC rule promulgated
thereunder. See Pub. L. No. 102-243, 105 Stat. 2394
(1991)(codified at 47 U.S.C. 227 (1992)); 47 C.F.R.
64.1200 (1992). It should be noted that one federal
district court held that the TCPA, by prohibiting the use
of artificial or pre-recorded voice devices to deliver
commercial messages to residential telephones without
consent of the called party, places an unconstitutional
restriction upon protected commercial speech in violation
of the First Amendment. Moser vs. Federal Communications
Commission, 826 F.Supp. 360 (D. Or. 1993). There are
presently no federal court of appeals or Supreme Court
cases dealing with this issue.
-[10]- See H.R. Rep. No. 868, 103rd Cong., 1st Sess. (1994).
-------------------------- APPENDIX A --------------------------
August 4, 1994
Richard A. Grasso
President
New York Stock Exchange, Inc.
11 Wall Street
New York, New York 10005
Re: Large Firm Report Recommendations
Dear Mr. Grasso:
In May 1994, the Divisions of Market Regulation and
Enforcement ("Divisions") jointly issued The Large Firm Project
Report ("Large Firm Report" or "Report"). The Report announced the
findings of a review undertaken by the Securities and Exchange
Commission ("SEC" or "commission"), working in conjunction with the
New York Stock Exchange ("NYSE") and the National Association of
Securities Dealers ("NASD"), regarding the hiring, retention and
supervisory practices of nine of the largest broker-dealers in the
United States. It recommended several actions to be taken or
considered by self-regulatory organizations ("SROs") in order to
improve the detection of sales practice violations and enforcement
efforts in this area.
Since the issuance of the Large Firm Report, the Divisions
and the SROs have been working together to develop and implement
the Report's recommendations, as well as other proposals to reduce
sales practice problems. At this time, we would like you to review
and report to us the actions your organization has taken, or plans
to take, to address the issues discussed below.
1. Increased Examination Efforts and Sanction in all Sales
Practice Matters
The Large Firm Project concluded that SROs need to increase
examination efforts to ensure that member firms have adequate
supervisory and compliance systems designed to detect problem
registered representatives. It also concluded that sanctions for
sales practice violations should be strengthened at both the SRO
and Commission levels.
a. Examination Efforts
In order to address these findings, we encourage you to devote
additional resources to conducting examinations. In addition to
expanding your examination efforts, we believe that you should
focus additional attention on the review of sales practice
allegations made in arbitration cases. This is an important
resource for identifying sales abuses at an early stage. By
reviewing allegations of sales practice abuses made in arbitration
filings in a timely manner, we believe that you will
--------------- APPENDIX A: BEGINNING OF PAGE #2 ---------------
Richard A. Grasso
Page 2
enhance your ability to detect patterns of fraud and inadequate
supervision and increase your ability to identify problem
registered representatives. We request that you advise us of the
steps you have taken to achieve this objective.
In this regard, we also request that the NYSE make greater
use of Rule 351 information to detect trends and patterns of
complaints. We would appreciate any recommendations you may have
in this regard.
b. Sanctions
We urge you to review and, if necessary, enhance sanctions
against registered representatives and broker dealers who commit
sales practice violations. The Report specifically recommended
that SROs review their rules and by-laws with a view towards
increased sanctions against firms for hiring registered
representatives with a history of sales practice abuses who
continue to commit sales practice violations. Broker-dealers
should have procedures governing the hiring of individuals having
disciplinary or employment histories involving abusive sales
practices that are more stringent than its general hiring
procedures. These procedures should identify the personnel
responsible for making the decision to hire a problem salesperson.
They also should set forth factors relevant to this hiring
decision, and provide for heightened supervision of any prospective
employee with prior disciplinary or employment history involving
sales practice abuses. We believe that these procedures should
also include a requirement that broker dealer management provide
written justification for a decision to hire or retain an
individual that is made in the absence of, or against the express
recommendation of, legal or compliance staff.
We request that you inform us of the status of your review of
your rules and by-laws with regard to ensuring the existence of
adequate broker-dealer hiring procedures and sanctions for hiring
registered representatives with a history of sales practice abuses.
Additionally, we ask that you inform us about what steps you have
taken or intend to take to devote additional resources to
prosecuting sales practice cases against problem registered
representatives who have violated your rules.
2. Enhanced Compliance by Firms and Registered Representatives
with all SRO Reporting Requirements
Historically, Forms U-4, U-5 and NYSE Form RE-3 have been a
fruitful source for identifying possible sales practice problems.
These required filings form the backbone of the SRO systems for
identifying problem registered representatives. The Report
recommended that the SROs monitor the timeliness of these required
filings. In cases of untimely or non-reporting of required
information, SROs should increase their sanctions against both
firms and individuals.
--------------- APPENDIX A: BEGINNING OF PAGE #3 --------------
Richard A. Grasso
Page 3
3. Tracking Systems
When conducting investigations of member firms, SROs must
ensure that matters are fully investigated, without duplication of
effort between the SROs. The Large Firm Report revealed
deficiencies in regulators' existing capability to identify and
track problem registered representatives. The staff identified
instances where investigations by SROs were duplicated, and cases
where the SROs were uncertain as to the status of certain
investigations. The Report recommended that the SROs develop and
implement a system for tracking which SRO is investigating a
particular matter, as well as the current status of the
investigation.
We request that you review your existing procedures for
coordinating information between SROs and if necessary, develop
and implement a joint system for tracking which SRO Is
investigating a case in connection with information contained in
a Form U-4 or U-5 or any amendments thereto, and the current status
of the investigation. Please inform us of the results of your
review and any possible recommendations you may have to improve
tracking systems.
4. Additional Disclosures
Information concerning final disciplinary history of
registered representatives is now available to the public through
the NASD'S toll-free hotline (1-800-289-9999). Customers can
obtain information regarding final disciplinary actions against
registered representatives taken by federal, state and foreign
regulators, as well as criminal indictments and convictions. The
Report recommended that SROs adopt a rule requiring member firms
to disclose to investors opening new accounts, prior to effecting
any transaction in that account, the availability of information
through the NASD's Central Registration Depository ("CRD") system
concerning disciplinary actions against registered representatives,
and the availability of the hotline.
The Staff believes that the information in the CRD database
should be expanded to include notification at the time a regulator
initiates a disciplinary action rather than at the time the action
is completed. Once an SRO has made a determination that there is
probable cause for believing that securities laws have been
violated and has actually initiated a disciplinary action, this
information should be publicly available on the NASD's CRD system.
Making this information available at an earlier stage of the
proceeding will enhance the SROs' ability to detect patterns of
fraud and supervisory negligence. It also will aid in the
detection of problem registered representatives and remove existing
benefits firms receive from dilatory tactics that delay resolution
of the disciplinary proceeding.
----------------- APPENDIX A: BEGINNING OF PAGE #4 -------------
Richard A. Grasso
Page 4
It is the staff's understanding that the NYSE and the NASD
have already initiated procedures to disclose initiated
disciplinary actions to the public. The staff supports this action
and believes that it will aid investors in obtaining the
information they need to know regarding their registered
representatives.
Presently, we request that you inform us regarding the status
of your review of these recommendations.
We appreciate your cooperation and assistance in this matter.
We believe that by coordinating our efforts we can make significant
progress to reduce fraud and abuse and improve overall investor
confidence in the securities markets. Please respond in writing
on or before August 29, 1994, outlining the actions you have taken
or intend to take to address the issues discussed above. If you
have any questions, please call Mark Fitterman at (xxx) xxx-xxxx
or Joseph Goldstein at (xxx) xxx-xxxx.
sincerely, sincerely,
/s/ /s/
Brandon Becker William McLucas
Director Director
Division of Market Regulation Division of Enforcement
cc: Edward Kwalwasser
Sal Pallante
------------------------ APPENDIX B ------------------------
Richard A. Grasso
President
New York Stock Exchange, Inc.
11 Wall Street New York, New York 10005
Re: Unqualified Bar Orders
Dear Mr. Grasso:
In connection with the Commission's initiatives to address
abusive sales practices, we are writing to discuss the Commission's
policy on the reentry into the securities industry of persons who
have been barred by the Commission from association in any capacity
with registered entities, and whose bar orders do not contain any
proviso for re-application for such association after the
expiration of a specified period (i.e., unqualified bars). -[1]-
There apparently has been some confusion about the consequences of
an unqualified bar. Some believe that an unqualified bar
implicitly provides an opportunity for reentry after five years
absent any misconduct during that period. Others do not share that
view.
The purpose of a bar is "to protect the public interest by
preventing [problem sales representatives] from again engaging in
. . fraudulent activity." -[2]- It also "serves the purpose of
general deterrence and should act as a warning to any other
participant in the securities industry who might be tempted to
engage in similar misconduct." -[3]- An unqualified bar is a
particularly severe sanction and is reserved for egregious cases.
-[4]-
Henceforth, the imposition of an unqualified bar evidences
the Commission's conclusion that the public interest is served by
PERMANENTLY excluding the barred person from the securities
industry. Accordingly, absent extraordinary circumstances, a person
subject to an unqualified
-------- FOOTNOTES --------
-[1]- Such persons are subject to a statutory disqualification
under Section 3(a)(39) of the Securities Exchange Act of
1934 ("Exchange Act") and, as such, are required to
undergo a special review process before becoming
associated with a member of the New York Stock Exchange,
Inc., in addition to obtaining the Commission's consent.
-[2]- Lester Kuznetz, Securities Exchange Act Release No. 23525
(August 12, 1986), 36 SEC Docket 466, 470.
-[3]- Id. at 470-71. See also Arthur Lipper Corporation v. SEC,
547 F.2d 171, 184 (2nd Cir. 1976) ("The purpose of such
severe sanctions must be to demonstrate not only to
petitioners but to others that the Commission will deal
harshly with egregious cases.")
-[4]- See, e.g., Lester Kuznetz, supra n.2; Stephanie J.
Hibler, Securities Exchange Act Release No. 22067 (May
23, 1985), 33 SEC Docket 205, 208.
---------------- APPENDIX B: BEGINNING OF PAGE #2 --------------
Richard A. Grasso, President
New York Stock Exchange, Inc.
bar will be unable to establish that it is in the public interest
to permit reentry to the securities industry.
Sincerely,
Brandon Becker, Director William McLucas, Director
Division of Market Regulation Division of Enforcement
cc: Joseph R. Hardiman, President
National Association of Securities Dealers, Inc.
Richard F. Syron, Chairman and Chief Executive Officer
American Stock Exchange
[Heads of all SROs]
-------------------------- APPENDIX C --------------------------
STATUS REPORT ON THE CONTINUING EDUCATION PROGRAM
The Industry Regulatory Council On Continuing Education
August, 1994
BACKGROUND
In March 1993, six self-regulatory organizations (SROs) -[1]-
announced the formation of an industry task force to consider
whether the industry should develop a uniform continuing education
program for registered persons. The task force was composed of
experienced individuals with diverse backgrounds from a broad range
of firms, thus ensuring consideration of the interests and needs
of a wide cross section of the industry. The SROs noted that the
increasing complexity of the securities industry demands that
professionals who deal with the public or are in supervisory
positions maintain minimum standards of competence and
professionalism. The SROs also said that a formal industry-wide
continuing education program to keep professionals up to date on
products, markets, and rules might be needed. By initiating a
broad-based industry effort, the SROs hoped to provide a unified
industry-wide approach acceptable to all segments of the industry.
In September 1993, the industry task force issued a report
calling for a formal two-part continuing education program for
securities professionals that would require uniform periodic
training in regulatory matters (Regulatory Element) and ongoing
programs by firms to keep employees up to date on job and product-
related subjects (Firm Element). The report also recommended the
creation of a permanent Industry/Regulatory Council on Continuing
Education (the Council) -[2]- to recommend to the SROs the specific
content of the uniform Regulatory Element and the minimum core
curriculum for ongoing firm training programs undertaken to satisfy
the requirements of the Firm Element. The task force recommended
further that computer-based training be used as a primary delivery
vehicle for the uniform Regulatory Element of the program. In
November 1993, the SROs endorsed in concept the recommendations of
the industry task force.
Since November 1993, the Council has met monthly and has
formed separate committees to work on the Regulatory and Firm
Elements. The Regulatory and Firm Element committees have prepared
proposed draft rules that would implement the program when approved
by the SROs. The Regulatory Element Committee has also developed
an initial listing of standardized subject matter for the computer-
based training program. The Firm Element Committee has developed
standards that firms must adhere to in developing and implementing
their training programs.
The Council has now submitted these proposed rules to the
various SROs for review with an aggressive schedule to develop and
implement the continuing education program. The current target is
to have the final rules adopted by the SROs by November 1994 and
for the SROs to immediately thereafter file the rules for approval
with the SEC. It is anticipated that the rules will be formally
approved by the SEC in January 1995. The continuing education
program would then be implemented on July 1, 1995.
PROPOSED PROGRAM HIGHLIGHTS
The Regulatory Element proposal requires all registered
persons to participate in a prescribed computer-based training
session on their second, fifth and tenth registration anniversary
-------- FOOTNOTES --------
-[1]- The SROs include the American Stock Exchange (AMEX), the
Chicago Board Options Exchange (CBOE), the Municipal
Securities Rulemaking Board (MSRB), the National
Association of Securities Dealers, Inc. (NASD), the New
York Stock Exchange (NYSE), and the Philadelphia Stock
Exchange (PHLX).
-[2]- The Council includes representatives from 13
broker/dealers and the six SROs. In addition, the
Securities and Exchange Commission (SEC) and the North
American Securities Administrators Association (NASAA)
have each assigned a liaison to the Council. Members of
the Council are listed at the end of this report
(appendix).
---------------- APPENDIX C: BEGINNING OF PAGE #2 -------------
dates. Persons who have been registered for more than 10 years and
have not been subject of a serious disciplinary action (as more
fully described below) during the most recent 10 years are exempt
from the Regulatory Element.
Failure to complete the required Regulatory Element computer-
based training session during the prescribed period would result
in a person's registration becoming inactive. A person whose
registration becomes inactive cannot conduct a securities business
or perform any of the functions of a registered person until such
person meets the requirement.
Any person who would otherwise be exempt from the Regulatory
Element would be required to re-enter the program for another 10
years upon becoming subject to certain disciplinary actions or as
otherwise required by a securities regulatory or self-regulatory
organization. Such re-entry would be occasioned by a person
becoming subject to a statutory disqualification pursuant to the
Securities Exchange Act of 1934; if an individual's registration
is suspended by a securities regulatory or self-regulatory
organization; or if a securities regulatory or self-regulatory
authority imposes a fine of $5,000 or more for a violation of any
securities law, rule or regulation, which is the threshold level
for determining a serious disciplinary action.
The Regulatory Element computer-based training program will
be designed to transmit information broadly applicable to all
registered persons. The content will be recommended by a group of
industry representatives, subject to Council review and SRO
approval. The content will focus on compliance, regulatory,
ethical and sales-practice standards. Because of the general and
broadly applicable nature of this material, the Council determined
to recommend that the Regulatory Element should be initiated with
a "one size fits all" approach to the material transmitted in the
computer-based training program, regardless of the job functions
or registration status, such as Series 6 or Series 7.
While there will be no grading of individual performance on
the Regulatory Element, information feedback will be provided to
individuals and their firms regarding areas of apparent strength
or weakness as indicated by the individual's interaction with the
computer-based training program. In addition, aggregated
information will be provided to their firms on all their covered
registered persons who take the computer-based training program in
a given period. Firms will be expected to consider this
information when formulating their training plans for the Firm
Element, as more fully described below.
Unlike the Regulatory Element, where only those persons
registered for 10 years or less are covered, the Firm Element has
no time limitations. It is applicable to all persons who conduct
business with retail, institutional or investment banking customers
of the firm. The immediate supervisors of such persons are also
covered by the Firm Element.
The Firm Element requires each member to establish a training
process and identifies certain minimum requirements associated with
that process. The firm must prepare a training plan after an
analysis of its training needs. Firms must consider certain
factors when developing their analyses and in developing their
training plans, such as the firm's size, organizational structures,
and scope of business activities, as well as regulatory
developments and the performance of covered registered persons in
the Regulatory Element. The program requires a training plan to
be implemented by a member and requires the member to maintain
records that clearly demonstrate the content of its training
programs and the completion of the programs by the persons
identified in the firm's training plan. Persons who are subject
to the training plan would have an affirmative obligation to
participate in the programs identified by the member.
The Firm Element also establishes certain minimum standards
for the training programs that are used in a member's plan. For
example, such programs, when dealing with investment products and
services, must identify their investment features and associated
risk factors, their suitability in various investment situations
and applicable regulatory requirements that affect the products or
services. The SROs would have the ability to require members,
individually or as part of a group, to provide specific training
to covered registered persons in any area the SROs deem necessary.
Depending on the issue of concern, these requirements could be
directed at specific individuals or portions of a firm, a specific
firm or group of firms, or across the entire industry.
IMPLEMENTATION
The SROs propose to fully implement the Regulatory Element on
July 1, 1995. The Central Registration Depository (CRD) system
will track persons subject to the requirement and notify members
in advance of those individuals approaching their second, fifth
and tenth anniversary dates who are required to participate in a
computer-based training session. Follow-up notices will also be
sent as persons subject to the Regulatory Element requirement
approach the end of the 120 days during which the requirement must
be satisfied. In addition, the CRD system will generate monthly
reports to members identifying those persons approaching or subject
to the Regulatory Element requirement as well as those persons
whose registration have become inactive due to failure to complete
the requirement within the specified time.
The Regulatory Element requirements will apply to all
registered persons whose second, fifth and tenth registration
anniversary dates occur on or after July 1, 1995. Persons who have
completed 10 years of registration before July 1, 1995 will be
exempt. A person's registration anniversary dates will be measured
from his or her first registration with the CRD, regardless of any
subsequent firm changes or changes in registration category.
Persons who have incurred a disciplinary event during the 10-year
period before July 1, 1995, that would require them to re-enter the
program will have the initial registration date that coincides with
the effective date of the final decision in a disciplinary action.
The NASD PROCTOR system will be modified to handle the
delivery of the computer-based training program in the 55-center
PROCTOR network. Future expansion of the network is also being
investigated, including the use of temporary centers that would
operate periodically in areas located at a considerable distance
from a full-time network center. In addition, the Council and the
SROs will in the future consider the feasibility of permitting
members to deliver the computer-based training in their internal
computer systems in certain technical, administrative and
regulatory concerns can be adequately resolved.
The Firm Element of the continuing education program will be
implemented in two stages. By July 1, 1995, members would be
required to complete their training needs analyses and to develop
written training plans that would be available for review upon
request by the SROs, the SEC, and state regulators. Members would
be expected to begin implementing their plans as soon as
practicable but, in any event, no later than January 1, 1996. The
SROs are committed to developing a consistent approach to
examination and enforcement of the Firm Element requirements.
Additionally, the SROs will coordinate their field inspection
efforts to avoid any unnecessary regulatory overlap in the
inspection process for firms that are joint members of two or more
SROs.
The Firm Element provides great flexibility to firms in
designing training programs appropriate to their needs and
consistent with their resources, subject to broad standards defined
in the Firm Element. The Firm Element framework is intended to be
flexible enough to accommodate differences in the size, scope, and
complexity of firm operations. Therefore, the Council and the SROs
believe that the training plan requirements of the proposal are
within the capabilities of all organizations, regardless of size.
The Firm Element also proposes that a member would be
responsible for assuring that training programs for investment
products and services used in its training plan appropriately cover
the investment characteristics and associated risk factors of the
product or service, their suitability for different investment
situations and any regulatory requirements that affect the product
or service. The Council and the SROs realize that a great deal of
the training material and programs will be provided by a variety
of training and education providers. Nevertheless, the proposed
rules place the responsibility on each member to assure that such
training meets the broad content standards included in the rule as
they relate to that particular firm. The SROs do not intend to
pre-approve training materials and programs developed by members
or providers. They will, however, communicate regularly with
members regarding the expectations for the content of training
programs. As the program evolves, it is expected some curricula
content standards will be defined by the SROs for products and
services where heightened regulatory concerns exist.
The Council intends to develop more extensive guidelines to
assist firms in carrying out their responsibilities under the Firm
Element and will recommend to the SROs that these guidelines be
provided to firms when the final continuing education rules are
adopted by the SROs and approved by the SEC.
Industry/Regulatory Council on Continuing Education
William R. Simmons
Council Chairman
Executive Vice President & Director
Dean Witter Reynolds, Inc.
New York, NY
Industry Representatives
Judith Belash
Vice President &
Associate General Counsel
Goldman Sachs
New York, NY
Mary Alice Brophy
First Vice President &
Director of Compliance
Dain Bosworth Inc.
Minneapolis, MN
Ronald E. Buesinger
Corporate Secretary &
Senior Vice President
A.G. Edwards & Sons, Inc.
St. Louis, MO
Elena Dasaro
Compliance Official
H.C. Wainright & Co., Inc.
Boston, MA
David A. DeMuro
Senior Vice President
Associate General Counsel
Lehman Brothers, Inc.
New York, NY
---------------- APPENDIX C: BEGINNING OF PAGE #4 --------------
John P. Gualtieri
Vice President &
Insurance Counsel
Prudential Insurance Co. of America
Newark, NJ
Therese M. Haberle
Associate General Counsel
Charles Schwab & Co., Inc.
San Francisco, CA
James Harrod
General Principal
Investment Representative
Edward D. Jones & Co., Inc.
Maryland Heights, MO
Todd A. Robinson
Chairman & CEO
Linsco/Private Ledger Corp.
Boston, MA
Richard C. Romano
President
Romano Brothers & Co.
Evanston, IL
Lois Towers
Director Institutional Compliance
Fidelity Securities
Boston, MA
O. Ray Vass
First Vice PResident
Merrill Lynch, Pierce, Fenner & Smith, Inc.
New York, NY
SRO Representatives
Diane Anderson
Vice President of Examinations
Philadelphia Stock Exchange
Philadelphia, PA
Howard Baker
Senior Vice President
American Stock Exchange
New York, NY
Darrell Dragoo
Vice President of Compliance
Chicago Board Options Exchange
Chicago, IL
Frank J. McAuliffe
Vice President
NASD
Rockville, MD
Loretta Rollins
Professional Qualifications
Administrator
MSRB
Alexandria, VA
Donald Van Weezel
Managing Director
NYSE
New York, NY
Questions & Answers Regarding The Securities Industry Continuing
Education Proposals
1. What is the Industry/Regulatory Council on Continued Education
(the Council) and what role does it play?
The Council is comprised of 13 representatives of the
securities industry (primarily the former members of the
Securities Industry Task Force on Continuing Education) and
representatives of six self-regulatory organizations (SROs).
2. Why does the program consist of two elements?
The Regulatory Element is applicable to all persons registered
with an SRO within their first 10 years in the business.
Because the Regulatory Element is intended to enhance
education and training in broad-based regulatory, compliance
and ethical issues, a "one-size fits all" approach is
initially contemplated for persons engaged in limited or full-
service aspects of the securities business and in a variety
of jobs.
The Firm Element is designed to ensure that firms provide
ongoing education
--------------- APPENDIX C: BEGINNING OF PAGE #5 --------------
and training to persons who deal directly with individual,
institutional and investment banking customers. This element
will focus on topics tailored specifically to the job
functions and products handled by those people. Accordingly,
the Firm Element has sufficient flexibility to meet the needs
of all firms irrespective of their size or product mix.
3. Who will be covered by the program?
Every person registered for 10 years or less will be covered
by the Regulatory Element and will be required to take the
regulatory portions within 120 days after their second, fifth
and ten anniversaries.
The Firm Element requirements shall apply to all "covered
registered persons (salespeople, traders, investment bankers,
and others who conduct a securities business with customers,
and their first-line immediate supervisors) for as long as
they are considered "covered registered persons." The term
"customer" applies to retail, institutional, and investment
banking customers, but does not include other broker/dealers.
4. Will registered personnel located outside the United States
be covered?
Yes and the Council is considering what special accommodations
may be necessary to deliver the program to such individuals.
5. Will anyone be grandfathered or exempted?
Grandfathering applies to the Regulatory Element only. Those
who have been registered more than 10 years and who have not
been subject of a serious disciplinary action (suspension,
bar, fine of $5,000 or more, or a statutory disqualification)
during the most recent 10 years will be grandfathered from the
Regulatory Element.
6. Are the branch managers "covered registered persons" within
the Firm Element?
Yes. Branch are covered registered persons because they
directly supervise salespeople in the branch. If a branch
manager also has customer accounts, then his/her supervisor
is a "covered registered person" as well.
7. Are research analysts "covered registered persons" within the
Firm Element?
Yes, if they communicate directly with or engage in sales
presentations to customers.
8. Will either element contain pass/fail tests?
No. The Council recommended that the program should focus on
increased education and training rather than on periodic
examinations.
9. How will the program be administered?
The Regulatory Element will be delivered through computer-
based training, in which participants will work through
problems and/or scenarios at computer terminals located in an
NASD PROCTOR center or other specified location.
The Firm Element will be delivered by firms and may include
written material, videos, audio tapes, classroom training,
direct broadcasts or other media.
10. What is the rational behind discontinuing the Regulatory
Element after 10 years?
Because information to be transmitted through the Regulatory
Element is primarily of a compliance, regulatory and ethical
nature, it was perceived that individuals registered for more
than 10 years without a significant disciplinary action would
have adequately absorbed this material and that this would be
reflect in their manner of doing business. In addition, all
registered individuals who are "covered registered persons"
will continue to be subject to the requirements of the Firm
Element throughout their careers.
11. In the Regulatory Element, will there be a way to verify that
individuals have completed the computer-based training?
Yes. The CRD system will track and communicate anniversary
dates and evidence of completion for the Regulatory Element.
The computer-based training systems used to transmit the
training information can also capture, store and analyze data
as to who took the training, when, where and other information
- in a manner similar to that of the industry qualification
testing now conducted through the NASD PROCTOR system.
12. What is the expected fee for each Regulatory Element session
at an NASD PROCTOR center?
--------------- APPENDIX C: BEGINNING OF PAGE #6 --------------
The current estimate is about $75; however, the ultimate fee
will depend on the overall costs of the program, which will
operate on a revenue-neutral basis and be subject to periodic
independent audits.
13. For those firms with internal computer systems and the
capability to interface with the NASD PROCTOR system, will
there be an opportunity to deliver the Regulatory Element
material through these systems?
Initial delivery of the Regulatory Element will be on the
PROCTOR system; however, the potential for internal delivery
on firm computer systems is under discussion. Obviously,
arrangements to permit internal delivery depend on the
development of appropriate safeguards to ensure the integrity
of the program and the ability to capture the necessary
information on feedback.
14. Is the content of the Firm Element left entirely up to the
individual firms?
No. The firms will be required to update training plans
annually to demonstrate that they meet certain prescribed
minimum standards with respect to subject material to be
disseminated to their "covered registered persons" based on
their needs, products, and line of business.
15. Will "covered registered persons" need to participate in
formal Firm Element training programs every year?
Not necessarily. There are no set schedules or required
numbers of hours for the Firm Element, but coverage must be
sufficient to meet the criteria established by SRO rules. For
example, it may not be necessary to include every "covered
registered person" within each calendar year if the firm is
engaged exclusively in limited lines of business.
16. Is the annual compliance meeting required under Section 27 of
the NASD Rules of Fair Practice adequate to demonstrate
compliance with the requirements of the Firm Element?
Not in and of itself. It can certainly be used as an occasion
on which to transmit information or conduct training.
However, firms must address their own needs with regards to
sales practices and product training and carry out effective
programs. In most instances, a significant expansion of
material covered at the annual compliance meeting will
probably be necessary. Also, it may be appropriate to
transmit some material in a more timely manner than waiting
for scheduled annual compliance meetings.
17. Can the requirements of the Firm Element be met through
continuation of the significant internal training and
education programs already at place in some firms?
Possibly. For firms with comprehensive ongoing training
programs in place, the requirements may result primarily in
expanded record keeping, more formalized planning, and the
incorporation of any minimum criteria specified by the SROs.
It is likely, however, that most firms will need to
substantially increase their education and training efforts
to meet or exceed these requirements.
18. Will it be necessary for each "covered registered person" to
meet personally with his/her supervisor annually to determine
the training requirement for that person?
No. However, some firms may elect to conduct such meetings
to ascertain individual needs or to do so during regular
performance reviews.
19. Can firms use training materials or presentations prepared or
delivered by outside entities to satisfy the requirements of
the Firm Element?
Yes, provided that they meet the same standards established
for firms.
20. If firms use materials or presentations prepared or delivered
by outside entities to satisfy the requirements of the Firm
Element, who is responsible for the content?
Individual firms have the ultimate responsibility for the
content and adequacy of material or presentations, regardless
of who prepares or presents the material.
21. How can firms obtain guidance on designing and implementing
internal training programs adequate to meet the requirements
of the Firm Element?
The Council anticipates producing a compilation of guidelines
taking into account comments and questions received while rule
enactment is pending. These guidelines would not be rules but
would offer suggestions intended to help firms devise
appropriate and reasonable programs consistent with their own
unique characteristics and businesses.
--------------- APPENDIX C: BEGINNING OF PAGE #7 ---------------
22. Will sessions devoted exclusively to selling skills or
prospecting fulfill the requirements of the Firm Element?
No.
23. How will materials or presentations used by firms to satisfy
the Firm Element be checked or evaluated?
Training plans, materials, outlines, and other required
documentation must be retained for regulatory examination
(upon request or during routine sales practices examinations)
for conformance with standards prescribed by SRO rules. In
addition, firms will be required to maintain evidence of
participation and completion by their "covered registered
persons."
24. What authority does the Council have to require firms to
transmit specific information or carry out training in
specific areas?
None directly. Explicit authority for the requirements and
enforcement of the continuing education program will be
established in rules promulgated by the SROs.
25. If a "covered registered person" has an insurance license and
fulfills insurance continuing education obligations, can that
serve as a substitute for the Firm Element?
Perhaps it may comprise a portion of the Firm Element
requirements relating to insurance-related securities
products, but it is unlikely that most insurance programs will
meet all minimum standards prescribed under this program.
26. Will study materials be available?
A content outline will be prepared for the Regulatory Element.
Guidelines will be published for the Firm Element and it is
anticipated that additional study materials will be developed
and made available by individual firms, product originators,
and other outside entities.
27. When will the Continuing Education rules be enacted?
It is expected that the rules will receive SEC approval in
January of 1995.
28. When will the Regulatory Element actually go into effect?
The Regulatory Element is slated to begin on July 1, 1995.
Thus, persons with two, five, and 10-year registration
anniversaries on or after July 1, 1995 will be required to
participate in accordance with those dates.
29. When and how will the Firm Element become effective?
The Firm Element will also begin on July 1, 1995, and, for
most firms, will necessitate a two-tier implementation
process. Firms will be required to have completed their
written training plans by July 1, 1995. The Council and the
SROs recognize that firms will likely require additional time
to develop and prepare materials, plan budgeting needs, and
arrange scheduling; however, the actual implementation of the
plan must begin no later than January 1, 1996.
It is anticipated that regulatory examination of the Firm
Element will also proceed in accordance with the preceding
schedule. For example, written training plans are subject to
inspection by July 1, 1995, and firm records should
demonstrate programs in progress as of January 1, 1996.
30. How will people be phased into the program initially?
Individuals will be phased into the Regulatory Element based
on their registration date or, if applicable, based on the
date of the most recent disciplinary action against them. For
example, persons who became registered in October 1990 would
enter the program having been registered for more than four
years and would be required to participate in the Regulatory
Element around October 1995 (within 120 calendar days after
their fifth anniversary of continuous registration). In
October 2000 they would have to participate to complete their
10-year cycle. Thereafter, they will be exempted from the
Regulatory Element, provided they have no serious disciplinary
action within the most recent 10 year period.
The Firm Element will begin for all "covered registered
persons" no later than January 1, 1996, in accordance with
their firms' written plans.
31. How does a serious disciplinary action affect one's status in
the Regulatory Element?
A serious disciplinary action would effectively pre-empt one's
original registration date as a trigger for entry into the
full 10-year cycle of the Regulatory
--------------- APPENDIX C: BEGINNING OF PAGE #8 ---------------
Element. Within 120 days of imposition of the disciplinary action,
that individual will be required to participate in a Regulatory
Element session, followed by additional sessions at the second,
fifth and tenth anniversaries of the date of the disciplinary
action.
32. Is a serious disciplinary action the only factor that might
mandate re-entry into the Regulatory Element?
No. A federal or state regulatory authority or self-
regulatory organization may require re-entry into the
Regulatory Element as part of the sanction in a disciplinary
matter.
33. How will the registration date be calculated for individuals
who have acquired multiple registrations (for example: the
series 6 in 1988 plus the series 7 in 1991)?
The original registration date (1988 in the above example)
will be used, provided that the person has remained
continuously registered since that time.
34. How will temporary lapses in registration be handled?
These will be treated similar to the way in which
qualification testing is handled. If individuals become
unregistered for less than two years, they will maintain their
original registration date, but will first be required to
participate in any Regulatory Element program that may have
been missed during the period in which they were unregistered.
For example, an individual whose registration lapses at four
and a half years who wishes to reactivate at what would be
his/her six-year anniversary must complete the fifth year
Regulatory Element before reactivation of registration.
35. What will be the status of a person who becomes unregistered
for a two-year period or more?
This person would begin the entire registration process anew.
He or she would be required to take the appropriate
qualification examination(s) and would enter the Regulatory
Element at the beginning of its 10-year cycle.
36. What regulatory consequences will result when an individual
does not complete the required continuing education?
Non-compliance with Regulatory Element requirements will
result in an individual's registration being deemed inactive
until he/she fulfills all applicable elements. Firms must
ensure that those deemed inactive are not permitted to engage
in activities requiring registration. Failure to comply with
Firm or Regulatory Element requirements may be subject the
firm and individuals to disciplinary action.
37. Will firms that are members of two or more SROs be subject to
redundant inspections for compliance with the continuing
education requirements?
The SROs will coordinate their field inspection efforts to
avoid any unnecessary regulatory overlap for joint members.
The SROs are especially committed to developing a consistent
approach to examining for and enforcing the Firm Element
Requirements.
-------------- APPENDIX D: BEGINNING OF PAGE #1 ----------------
An Open Letter To Members of the Financial Services
Industry Regarding Compensation of Retail Brokers
And Their Supervisors
From The Committee On Compensation Practices
August 29, 1994
As you may be aware, Securities and Exchange Commission Chairman
Arthur Levitt asked us to serve on a committee to examine the
securities industry's compensation practices and to highlight areas
of potential conflicts of interest as well as examples of
particularly effective procedures for managing the broker-investor
relationship. The Committee is seeking to identify practices that
most effectively eliminate, reduce or mitigate these conflicts of
interest.
Specifically, the Committee's mission is to:
* Review industry compensation practices
* Identify actual and perceived conflicts of interest for
both brokers and managers.
* Identify the "best practices" used in the industry to
eliminate, reduce or mitigate such conflicts.
The Committee is particularly interested in any conflicts that
exist at the time of sale. Simply stated: when a responsible
broker can choose among a large number of reasonable investments,
what influences his/her recommendation? Does the broker place the
investor's interest first? To what extent do compensation practices
influence a broker's recommendation?
We hope that this Committee's work will initiate a dialogue within
the industry about the best compensation practices and encourage
firms to compete on the basis of how they manage these real and
perceived conflicts.
As part of the Committee's process, we would like your help and
your views on these issues. We are not seeking information about
any specific compensation program at any particular firm. Rather,
we are seeking examples of how current compensation practices
affect sales behavior, as well as examples of practices that
eliminate or reduce conflicts.
The Committee would like your thoughts on what impact, if any, the
following compensation practices have on sales behavior:
differentiating compensation by product; flat fees versus
transactional commissions; recruitment practices (e.g., up-front
payments and increased payouts); compensation for fixed income
products (e.g., credits); sales contests or other incentive
programs; and supervisor compensation.
Similarly, many in the industry have developed practices designed
to align closely the broker's interest with that of the client.
The Committee is interested in your observations regarding such
practices, including supervision and other management techniques,
compliance and training programs, and disclosure.
-------------- APPENDIX D: BEGINNING OF PAGE #2 ----------------
We want to emphasize that the above are only examples of the kinds
of practices that we are interested in examining; they are in no
way intended to limit any observations or comments you may have on
this subject. The Committee welcomes any insights you may with to
provide, including those based on your experiences with
experimental or pilot programs.
We hope you will take the time to respond and share your views with
us. Please forward your comments to:
Professor Samuel L. Hayes III
Jacob H. Schiff Professor of Investment Banking
Harvard Business School, Morgan 375
Soldiers Field Road
Boston, MA 02163
Fax: (617) 496-6592
Please respond by October 14, 1994. Thank you in advance for your
assistance.
Sincerely,
Daniel P. Tully
Chairman, Committee on Compensation Practices
Chairman and Chief Executive Officer
Merrill Lynch & Co., Inc.
Warren Buffett
Chairman and Chief Executive Officer
Berkshire Hathaway Inc.
Samuel L. Hayes III
Jacob H. Schiff Professor of Investment Banking
Harvard University, Graduate School of Business Administration
Raymond A. Mason
Chairman and Chief Executive Officer
Legg Mason, Inc.
Thomas O'Hara
Chairman of the Board
National Association of Investors Corp.
John F. Welch, Jr.
Chairman and Chief Executive Officer
General Electric Company
# # #Last Reviewed or Updated: March 18, 2026