Self-Regulatory Organizations; National Association of Securities Dealers, Inc.; Order Approving a Proposed Rule change to the By-Laws and Rules of Fair Practice Relating to Rule Approval Procedures

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-33737; File No. SR-NASD-93-48]

Self-Regulatory Organizations; National Association of Securities

Dealers, Inc.; Order Approving a Proposed Rule change to the By-Laws

and Rules of Fair Practice Relating to Rule Approval Procedures

March 8, 1994.

I. Introduction

On September 17, 1993, the National Association of Securities

Dealers, Inc. (``NASD'' or ``Association'') filed with the Securities

and Exchange Commission (``SEC'' or ``Commission'') a proposed rule

change pursuant to section 19(b)(1) of the Securities Exchange Act of

1934 (``Act'')\1\ and Rule 19b-4 thereunder.\2\ The rule change amends

the NASD By-Laws and Rules of Fair Practice to make uniform all rule

approval and amendment procedures under the NASD's By-Laws and to

convert certain appendices of Rules of Fair Practice into Rules of Fair

Practice themselves.

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\1\15 U.S.C. 78s(b)(1) (1988).

\2\17 CFR 240.19b-4 (1993).

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Notice of the proposed rule change appeared in the Federal Register

on September 28, 1993.\3\ The Commission received four comment letters

opposing the proposal.\4\ This order approves the rule change.\5\

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\3\Securities Exchange Act Release No. 32942 (Sept. 22, 1993),

58 FR 50609 (Sept. 28, 1993).

\4\Letter from Merle I. Hoch, Executive Director, Securities

Traders Association of New York, to Jonathan G. Katz, Secretary, SEC

(Oct. 15, 1993) (``STANY Comment Letter''); letter from Dennis

Marion, President and Chief Executive Officer, Sherwood Securities,

to Jonathan G. Katz, Secretary, SEC (Oct. 15, 1993) (``Sherwood

Comment Letter''); letter from David E. Rosendahl, Chairman, Federal

Regulation Committee, Securities Industry Association (``SIA''), and

Mark T. Commander, Chairman, Self-Regulatory and Supervisory

Practices Committee, SIA, to Jonathan Katz, Secretary, SEC (Nov. 4,

1993) (``SIA Comment Letter''); and letter from Kenneth S. Spirer,

General Counsel, Private Client Group, Merrill Lynch, to Jonathan G.

Katz, Secretary, SEC (Oct. 25, 1993) (``Merrill Lynch Comment

Letter'').

\5\The rule change was approved for filing with the Commission

at a meeting of the NASD Board of Governors (``Board'') on November

13, 1992. The change was submitted to a vote of the NASD membership

in NASD Notice to Members 93-15 (Mar. 1993), and was approved by the

membership, as required by Article XII, Section 1, and Article XVII,

Section 1 of the NASD By-Laws by a vote of 1,683 in favor, 478

opposed, and 11 not voting out of 2,172 ballots received.

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II. Description of the Rule Change

The NASD is proposing to amend the NASD By-Laws and Rules of Fair

Practice to make all rule approval and amendment procedures under the

NASD's By-Laws uniform\6\ and, thus, eliminate the requirement that

certain rules be submitted to the membership for their approval as part

of the rulemaking process.\7\ The rule change conforms the NASD's

procedure to those of other securities industry self-regulatory

organizations (``SRO''), which do not require member vote for rule

changes.\8\ The rule change is effective immediately and applies only

to proposed rule changes approved by the Board or the Executive

Committee\9\ after the effective date of the rule change.\10\ Thus,

rule changes currently pending before the Commission or approved by the

Board prior to the date of effectiveness of this order will not be

affected by the rule change.

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\6\In addition, the rule change converts certain appendices of

Rules of Fair Practice into Rules of Fair Practice themselves.

\7\Currently, the NASD By-Laws and Rules of Fair Practice

require Board and membership approval to amend Rules of Fair

Practice while amendment to other NASD rules only requires Board

approval. Thus, the NASD By-Laws currently provide that the Board

may adopt Rules of Fair Practice for submission to NASD members.

NASD Manual, By-Laws, Art. XII, Sec. 1 (CCH)  1251. Certain Rules

of Fair Practice adopted by the Board and approved by the

membership, however, authorize the Board to establish rules,

regulations and/or procedures concerning NASD members without

recourse to the membership for approval. NASD Manual, Rule of Fair

Practice, Art. III, Secs. 30(b) (Margin accounts), 31 (Securities

``failed to receive'' and ``failed to deliver''), 32(b) (Fidelity

bonds), 33(c) (Options), 34(c) (Direct participation programs) & 37

(Operating rules for ITS/CAES and CAES), (CCH)  2180, 2181, 2182,

2183, 2191 & 2197.

\8\See, e.g., Amex, Const., Art. II, Sec. 2; Chicago Stock

Exchange, Const., Art. XI, Sec. 2; Midwest Clearing Corp., By-Laws,

Art. VII, Sec. 1; NYSE, Const., Art. VIII, Sec. 1.

\9\Between Board meetings, the Executive Committee has authority

to act on behalf of the Board during emergency or extraordinary

market conditions. NASD Manual, By-Laws, Art. VII, Sec. 3, (CCH) 

1182A.

\10\Letter from Suzanne Rothwell, Associate General Counsel,

NASD, to Selwyn Notelovitz, Branch Chief, SEC (Jan. 27, 1994).

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A. Amendments to the By-Laws

Article VII, Section 1(a) of the By-Laws sets forth certain

authority of the Board. The rule change amends this section with

respect to the Board's authority to amend the NASD rules; to amend its

Certificate of Incorporation or By-Laws, the NASD will continue to be

required to obtain membership approval. To reflect this distinction,

Article VII, section 1(a)(1) of the By-Laws has been divided into two

subsections. Amended section 1(a)(1) provides that amendments to the

By-Laws require membership approval and new section 1(a)(2) specifies

that the Board has the authority to adopt and amend Rules of Fair

Practice. This new section also provides that the Board may, in its

discretion, still choose to submit certain rule changes or additions to

Rules of Fair Practice to the membership for consideration.

Redesigned section 1(a)(3) (formerly section 1(a)(9)) generally

provides broad authority to the Board to exercise the action necessary

or appropriate to implement the provisions of the Act. The rule change

deletes from redesignated section 1(a)(3) language referencing the

Government Securities Act of 1986 because the pertinent provisions of

the Government Securities Act of 1986 are incorporated in the Act, as

amended.\11\

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\11\The rule change also amends redesignated sections 1(a) (5),

(6) and (8) (formerly sections 1(a) (3), (4) and (6)) because the

language in these sections specifying that no member vote is needed

is now superfluous. In addition, redesignated sections 1(a) (9) and

(10) (formerly sections 1(a) (7) and (8)) have been amended

stylistically, with no substantive implications.

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Article XII, Section 1 of the By-Laws is also amended to delete the

reference to the member vote procedure for adoption and amendment of

Rules of Fair Practice, and to remove references to emergency rules.

Because the NASD may now amend Rules of Fair Practice without

membership vote, the procedures for member vote and references to

emergency rules are no longer.

B. Amendments to Rules of Fair Practice

Currently, the text of Rules of Fair Practice, Article III,

Sections 30 through 34 contain general Rules of Fair Practice and set

forth the procedures for adopting the specific requirements underlying

these general rules, which procedures include that the Board may adopt

or amend these rules without recourse to the membership.12 The

specific requirements underlying these general rules appear in

appendices to each of these rules, which include a reiteration of the

general rule. As noted above, the rule change amends Article VII of the

By-Laws to provide the Board authorization to and the procedure for

amending all Rules of Fair Practice without recourse to the membership.

Accordingly, the rule change deletes the text of Sections 30 through

34, which are now superfluous, and converts the substantive provisions

found in the appendices to each of these rules into their respective

sections. To conform the former appendices to the format of Rules of

Fair Practice, the appropriate numbering, lettering and cross

referencing, changes have been made.13

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\1\2NASD Manual, Rule of Fair Practice, Art. III, Secs. 30(b),

31, 32(b), 33(c), 34(c) & 37, (CCH)  2180, 2181, 2182, 2183, 2191

& 2197.

\1\3The numbering convention for former Appendix A, however, is

not changed at this time because, as explained in SR-NASD-92-35, the

NASD's new margin rule is based on rules of the NYSE and, for

purposes of comparison, the NASD considers using the same numbering

scheme for the NASD's and NYSE's rules useful. See Securities

Exchange Act Release No. 31918 (Feb. 24, 1993), 58 FR 12286 (Mar. 3,

1993) (order approving File No. SR-NASD-92-35).

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Finally, the rule change deletes Rules of Fair Practice, Section

37, which provided the Board authority to adopt and amend CAES

Operating Rules and ITS/CAES Operating Rules without seeking membership

approval. As amended, redesignated Sections 1(a) (3), (8) and (9)

(formerly sections 1(a) (9), (6) and (7)) generally provide the Board

authority to adopt rules and operate systems such as CAES and ITS/CAES

without membership approval; thus, section 37 is unnecessary.

III. Comment Letters

The Commission received four comment letters opposing the rule

change. Commentators noted, among other things, that it violated the

traditionally democratic process of the NASD14 and is unnecessary

given the Board's authority to adopt rules in the event of an

emergency.15 One commenter opposed the NASD's rule change because

it believed that member vote provides a mechanism for NASD members to

give careful consideration to rule changes.16 In addition, this

commenter argued that the NASD should establish a uniform comment

period for all rule changes.

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\1\4STANY and Sherwood Comment Letters.

\1\5STANY and SIA Comment Letters.

\1\6Merrill Lynch Comment Letter.

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In response, the NASD noted that its members have access to the

NASD's rulemaking process through means other than membership

vote.17 In particular, the NASD noted, members participate in this

process through their representatives on Standing and District

committees and through the election of a Board member from their

district. In addition, the NASD noted, the Board has reserved the

option of submitting to its members for consideration proposed changes

to Rules of Fair Practice. Moreover, the NASD reiterated its

representation that it will continue to notify its members of proposed

rule changes through regular publication of Notice to Members and

periodic summaries of Board meetings and noted that it will still

respond to member comments.

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\1\7Letter from T. Grant Callery, Vice President and General

Counsel, NASD, to Selwyn Notelovitz, Branch Chief, SEC (Nov. 29,

1993).

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IV. Discussion

The Commission believes that the NASD's rule change is consistent

with the requirements of the Act and the rules and regulations

thereunder applicable to the NASD and, therefore, has determined to

approve the rule change. Specifically, the Commission believes that the

rule change is consistent with the provisions of sections 15A(b)(4) and

(6) of the Act.18 These sections require, in part, that the NASD's

rules assure fair representation in the selection of its directors and

the administration of its affairs and be designed to foster cooperation

and coordination of securities transactions, to remove impediments to a

free and open market, and to protect investors and the public interest.

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\1\815 U.S.C. 78o-3(b)(4) and (6).

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By eliminating the need for member vote prior to amending certain

of the Rules of Fair Practice, the rule change simplifies the NASD's

ability to amend its rules. With the change, the NASD's procedures for

amending its rules will be consistent with those of other SROs in the

securities industry, which do not require member vote for rule changes.

According to the NASD, the change will not only reduce delays in making

rule changes effective, but will also result in administrative cost

savings. A member vote will, however, continue to be required for

amendments to the NASD's By-Laws. Further, the Board has specifically

provided that it may seek a member vote on any rule change if it

considers such a vote appropriate.

The rule change does not alter the substance of the NASD's Rules of

Fair Practice. Rather, it simplifies the NASD's ability to amend its

rules by eliminating the requirement for member vote. Nonetheless,

mechanisms for members to participate in the formulation of and comment

on NASD proposed rule changes remain. As noted above, members will

continue to be able to participate in this process through the election

of a Board member from their district and through representation on

more than twenty Standing and District committees.19 Each Standing

committee consists of at least one Board member and of members from

across the country with expertise in the committee's business. In

addition, section 19(b) of the Act provides NASD members the mechanism

to comment in writing directly to the Commission on all NASD rule

changes.20

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\1\9NASD Manual, By-Laws, Sec. 4(a), (CCH) 1183; By-Laws, Art.

III., Secs. 1-12, (CCH) 1191-1202; By-Laws, Art. XI, Secs. 1-4,

(CCH) 1241-44.

\2\015 U.S.C. 78s(b)(1).

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To facilitate access to its committees, in addition to publishing

the names and titles of all its officers, the NASD provides in the

front of its manual a list of its committees and the names of the

committee members. Each committee has a mission statement which

provides it authority to make recommendations to the Board concerning

specific areas of concentration. When the jurisdiction for an issue

overlaps, all the relevant committees are presented an opportunity to

provide input before a final recommendation is presented to the Board.

The NASD's current process of electing Board members and selecting

committee members provides fair representation of local, regional and

national firms on the Board and on committees. To provide greater

representation to each board member, in 1990, the NASD decreased the

size of the Board.21 Finally, the Commission notes that an

overwhelming majority (77%) of the members voting on the NASD's

proposal voted to approve the rule change.

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\2\1Securities Exchange Act Release No. 28406 (Sept. 4, 1990),

55 FR 37782 (Sept. 13, 1990).

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Recognizing that some rule changes will engender more debate than

others, the Board has reserved the option of submitting to its members

for consideration proposed changes to Rules of Fair Practice.

Furthermore, the NASD has reiterated its representation that it will

continue to notify its members of proposed rule changes through regular

publication of Notice to Members and periodic summaries of Board

meetings.

Section 15A(b)(4) requires the NASD's rules assure fair

representation of its members in the selection of its directors and

administration of its affairs. This can be accomplished in several

ways, not just by requiring member votes on specific rules.

Accordingly, the Commission encourages the NASD not to underestimate

the benefits derived from membership comment. In the Commission's

experience, this provides members the opportunity to review proposals

carefully, and often members provide useful comments which may lead to

changes in the proposal.\22\ Committee members, therefore, should be

encouraged to obtain the views of all interested members and committee

chairman should be reminded of the NASD's obligation to provide fair

representation to a cross-section of members pursuant to section

15A(b)(4) of the Act.

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\22\See, e.g., SR-NASD-93-3 (amendment to Section 34, Appendix

F, Rules of Fair Practice to limit member participation in unfair

roll-up transactions); SR-NASD-92-46 (amendment to Schedule E,

Schedule to the By-Laws concerning conflicts of interest).

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V. Conclusion

For the reasons stated above, the Commission believes the rule

change is consistent with the Act and, therefore, has determined to

approve it. The rule change will provide the NASD greater flexibility

to amend its rules. This will enable the NASD to respond quickly to the

needs of its members and to protect investors and the public interest

in this era of rapidly changing market conditions.

The Commission does not believe that the rule change will result in

any burden on competition that is not necessary or appropriate in

furtherance of the purposes of the Act, as amended.

It is therefore ordered, Pursuant to section 19(b)(2) of the Act,

that the rule change SR-NASD-93-48 be, and hereby is, approved.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\23\

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\23\17 CFR 200.30-3(a)(12).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 94-5920 Filed 3-14-94; 8:45 am]

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