Self-Regulatory Organizations; Order Granting Approval of Proposed Rule Change, as Amended, and Notice of Filing and Order Granting Accelerated Approval of Amendment No. 2 to the Proposed Rule Change by the National Association of Securities Dealers, Inc. Relating to the Tape Recording of Conversations

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39883; File No. SR-NASD-97-69]

Self-Regulatory Organizations; Order Granting Approval of

Proposed Rule Change, as Amended, and Notice of Filing and Order

Granting Accelerated Approval of Amendment No. 2 to the Proposed Rule

Change by the National Association of Securities Dealers, Inc. Relating

to the Tape Recording of Conversations

April 17, 1998.

I. Introduction

On September 12, 1997, the National Association of Securities

Dealers, Inc. (``NASD''), through its regulatory subsidiary NASD

Regulation, Inc. (``NASD Regulation'') 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\ In this filing, NASD

Regulation proposed amendments to Rule 3010 to require the tape

recording of conversations where members hire more than a specified

percentage of registered persons from certain firms that have been

expelled or that have had their broker/dealer registration revoked for

violations of sales practices rules. The proposed rule change also

includes a conforming rule change to Rule 9610. Notice of this proposed

rule change was published in the Federal Register on December 5, 1997

(as amended, the ``Notice'').\3\ The Commission received one comment

letter, which expressed concerns about using tape recording as a method

of supervision, in response to the Notice.\4\ On March 9, 1998, NASD

Regulation filed Amendment No. 2 with the Commission.\5\ This order

approves the rule change, as amended, and grants accelerated approval

of Amendment No. 2 to the rule change.

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

\2\ 17 CFR 240.19b-4.

\3\ See Securities Exchange Act Release No. 39361 (November 26,

1997), 62 FR 64422 (File No. SR-NASD-97-69). Amendment No. 1 to the

proposed rule filing was filed on November 12, 1997. The changes

contained in this amendment were included in the Notice. See Letter

from Mary N. Revell, Associate General Counsel, NASD Regulation, to

Katherine A. England, Assistant Director, Division of Market

Regulation, Commission (November 17, 1997).

\4\ See Letter from R. Gerald Baker, Securities Industry

Association (``SIA''), to Jonathan G. Katz, Secretary, Commission,

dated February 11, 1998.

\5\ See letter from Mary N. Revell, Associate General Counsel,

NASD Regulation, to Katherine A. England, Assistant Director, Office

of Market Supervision, Division of Market Regulation (March 9,

1998). In Amendment No. 2, NASD Regulation: (1) Applies the proposal

to firms that have a work force comprised of a specified number of

registered persons who were employed by a ``disciplined firm''

within the last three years instead of two years; (2) requires firms

to establish special procedures to supervise the telemarketing

activities of registered persons instead of registered

representatives; (3) amends the definition of registered persons to

include those persons who register as municipal securities

principals or representatives pursuant to Municipal Securities

Rulemaking Board Rule G-3; and (4) provides guidance on what would

constitute ``reasonable procedures for reviewing the tape recordings

made pursuant to the requirements of'' the taping rule in a Notice

to Members announcing approval of the rule.

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II. Background

At its meeting in July 1996, the NASD Regulation Board of Directors

authorized the staff to issue a Notice to Members soliciting comment on

proposed changes to NASD supervisory Rule 3010 to require the tape

recording of telephone conversations of registered representatives in

certain circumstances. The Rule was developed both to respond to

concerns expressed in the Joint Regulatory Sales Practice Sweep

(``Sweep'') Report \6\ regarding the

[[Page 20233]]

need for heightened supervision of certain registered representatives

with troubled regulatory and compliance records and also to address the

particular problems that occur when a firm hires a larger number of

individuals who formerly worked at a firm that has been expelled or has

had its registration revoked (a ``Disciplined Firm'') where they were

inadequately supervised and trained.

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\6\ Staffs of the NASD, New York Stock Exchange (``NYSE''),

North American Securities Administrators Association (``NASAA''),

and the Office of Compliance Inspections and Examinations, SEC,

Joint Regulatory Sales Practice Sweep: A Review of the Sales

Practice Activities of Selected Registered Representatives and the

Hiring, Retention, and Supervisory Practices of the Brokerage Firms

Employing Them (March 1996). The Sweep was an initiative involving

the staffs of the NASD, the SEC, the NYSE, and representatives of

the NASAA (collectively, the ``Working Group'') to review the sales

practice activities of selected registered representatives and the

hiring, retention, and supervisory practices of the brokerage firms

employing them in order to identify possible problem registered

representatives, review their sales practices, and assess whether

adequate hiring, retention, and supervisory mechanisms are in place.

The Sweep Report was released on March 18, 1996.

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NASD Regulation stated in its filing that one of the key findings

of the Sweep Report concerned the willingness of some firms to employ

registered representatives with a history of disciplinary actions or

customer complaints.\7\ Based on this finding, the Working Group

collectively recommended that firms that hire registered

representatives with a recent disciplinary history involving sales

practice abuse or other customer harm should implement special

supervisory procedures tailored to the individual registered

representative, which include a heightened level of scrutiny of the

registered representative's activities by his or her supervisor, for a

period of time.\8\ The Sweep Report recommended that, if firms fail to

establish such special supervisory procedures, the self-regulatory

organizations (``SROs'') should consider revising their rules to

specifically require that registered representatives with a recent

history of disciplinary actions involving sales practice abuse or other

customer harm be placed under special supervision by the firm for a

period of time.

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\7\ The current proposal focuses on the disciplinary history of

the firm that formerly employed the registered representative.

\8\ Id. at ii, iv.

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NASD Regulation and the NYSE have issued a memorandum discussing

the Sweep Report and providing guidance on actions firms could take to

provide heightened supervision of problem registered

representatives.\9\ While the special procedures designed to provide a

heightened level of supervision recommended by the Sweep Report and

described in the NASD/NYSE memorandum may provide adequate supervision

of associated persons in most circumstances, NASD Regulation proposes

to adopt specific procedures in certain situations in order to provide

the level of supervision required by Rule 3010.

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\9\ NASD Notice of Members 97-19 (April 1997); NYSE Information

Memo 97-20 (April 15, 1997).

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NASD Regulation proposes to amend NASD Rule 3010 to require firms

that hire a specified number of individuals from Disciplined Firms to

tape-record telephone conversations between their registered persons

and existing and potential customers. The proposed Rule would apply

when a firm hires a substantial number of registered persons from a

firm or firms that have been expelled or had their registrations

revoked for sales practice abuse. The measures are designed to prevent

a reoccurrence of sales practice abuse or other customer harm that

caused the Disciplined Firm to be expelled or have its registration

revoked. The proposal is similar to an interpretation adopted by the

National Futures Association (``NFA'') in 1993 to combat abusive cold

calling.\10\ The NFA's interpretation is discussed below.

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\10\ See Letter from Lynn K. Gilbert, Deputy Director, Commodity

Futures Trading Commission, to Daniel J. Roth, General Counsel, NFA

(January 19, 1993).

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A. Notice to Members 96-59 and Original Proposal

In its filing with the Commission, NASD Regulation described Notice

to Members 96-59 (``NTM 96-59''), which contained the original proposed

Rule (``original proposal'' or ``original Rule'').\11\ NASD

Regulation's original proposal captured a broader swath of firms. It

would have been triggered whenever a significant portion of a member's

work force was comprised of associated persons who formerly were

employed by a Disciplined Firm or firms or when the firm itself was a

Disciplined Firm. The original proposal defined a Disciplined Firm, for

purposes of the Rule, as one that had been disciplined (e.g., expelled,

suspended, or enjoined) by a regulatory entity, an SRO, or a court

within the previous five years for telemarketing or sales-practice

abuses in connection with the solicitation, offer, or sale of

securities.

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\11\ See Notice to Members 96-59 (September 1996).

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NASD Regulation's original proposal also stated that if more than

20 percent of a member's sales force of associated persons previously

were employed by a Disciplined Firm, the member would have been

required to adopt special written procedures to supervise the

telemarketing activities of its associated persons. Firms that were

themselves Disciplined Firms also would have been required to adopt

these procedures. The procedures would have required, at a minimum,

that the employer member tape record all telephone conversations

between all of its associated persons and both existing and potential

customers, and maintain these procedures for two years. For each firm

that was itself a Disciplined Firm, at the end of the two-year period,

NASD Regulation would have conducted an evaluation to determine

whether, and for how long, the firm would continue to be subject to the

requirements of the Rule. The Rule also would have required firms

subject to the taping requirement to review the tapes periodically to

ensure compliance with securities laws and NASD rules, to submit

reports to NASD Regulation on their supervision of telemarketing

activities, and to retain and index the tapes.

B. Comments and Response on the Original Proposal

NASD Regulation received 42 comment letters in response to its

initial Notice to Members.\12\ Of the 42

[[Page 20234]]

comment letters, 39 were opposed to the proposal, including those filed

by the Securities Industry Association, Lehman Brothers, Merrill Lynch,

Morgan Stanley, and Smith Barney. NASD Regulation stated that most of

the commenters supported the NASD's objective in proposing the taping

Rule and agreed that firms should be discouraged from recruiting groups

of registered persons from a Disciplined Firm, however, they did not

believe that tape recording of conversations was an appropriate

regulatory requirement and feared that regulators will require even

more comprehensive tape recording in the future.

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\12\ NASD Regulation received the following comment letters: (1)

Letter from Brian C. Underwood, A.G. Edwards & Sons, Inc.

(``Edwards''), dated October 31, 1996; (2) Letter from Kevin P.

Howe, American Express Financial Advisors (``AEFA''), dated October

31, 1996; (3) Letter from G. Thomas Mitchell, Aurora Insurance and

Securities, Inc. (``Aurora''), dated October 10, 1996; (4) Letter

from Jerome Snyder, Barington Capital Group, L.P. (``Barington''),

dated October 23, 1996; (5) Letter from Leslie D. Smith, Berthel

Fisher Company (``Berthel''), dated October 25, 1996; (6) Letter

from Walter I. Miller, Capital Growth Planning, Inc. (``Capital''),

dated September 24, 1996; (7) Letter from Sanford D. Greenberg,

Chatfield Dean & Co. (``Chatfield Dean''), dated October 31, 1996;

(8) Letter from Neil Lawrence Lane, Citicorp Investment Services

(``CIS''), dated October 31, 1996; (9) Letter from David J. Master,

Coastal Securities (``Coastal''), dated October 31, 1996; (10)

Letter from John Polanin, Jr., Cowen & Company (``Cowen''), dated

November 7, 1996; (11) Letter from Richard L. Sandow, Cullum &

Sandow Securities, Inc. (``Cullum''), dated October 17, 1996; (12)

Letter from Gregg Thaler, Duke & Company, Inc. (``Duke I''), dated

October 10, 1996; (13) Letter from William Rotholz, Duke & Company,

Inc. (``Duke II''), dated October 29, 1996; (14) Letter from Shannon

Braymen, Duncan-Smith Securities, Inc. (``Duncan-Smith''), dated

October 22, 1996; (15) Letter from James H. Pyle et al., E.E. Powell

& Company, Inc., dated October 21, 1996; (16) Letter from Nancy K.

Port, Equity Services, Inc. (``ESI''), dated October 30, 1996; (17)

Letter from Rick Fetterman, Fetterman Investments, Inc., dated

October 1, 1996; (18) Letter from Herbert O. Sontz, GKN Securities

(``GKN''), dated October 31, 1996; (19) Letter from Lawrence E.

Wesneski, Hoak Breedlove Wesneski & Co. (``Hoak''), dated October

21, 1996; (20) Letter from Cabell B. Birdsong, Investors Security

Company, Inc. (``ISC''), dated October 22, 1996; (21) Letter from

David A. Rich, Jefferies & Company, Inc., dated November 8, 1996;

(22) Letter from Thomas P. Koutris, John Hancock Distributors, Inc.,

dated September 23, 1996; (23) Letter from A.E. Monahan, Keystone

Capital Corporation (``Keystone''), dated October 7, 1996; (24)

Letter from Paul B. Uhlenhop, Lawrence, Kamin, Saunders & Uhlenhop

(``Lawrence, Kamin''), dated October 29, 1996; (25) Letter from

Kathryn S. Reinmann, Lehman Brothers Inc. (``Lehman''), dated

October 31, 1996; (26) Letter from Kenneth S. Spirer, Merrill Lynch,

Pierce, Fenner & Smith (``Merrill Lynch''), dated November 14, 1996;

(27) Letter from Jack G. Levin, Montgomery Securities

(``Montgomery''), dated January 16, 1997; (28) Letter from Frederick

W. Bogdan, Morgan Stanley & Co., Incorporated (``Morgan Stanley''),

dated October 30, 1996; (29) Letter from Dennis S. Kaminski, Mutual

Service Corporation (``MSC''), dated October 29, 1996; (30) Letter

from Richard Berenger, Nathan & Lewis Securities, Inc. (``Nathan &

Lewis''), dated October 18, 1996; (31) Letter from Douglas L.

Dunahay, Neidiger/Tucker/Bruner Inc. (``Neidiger''), dated October

29, 1996; (32) Letter from Edward T. Borer, Philadelphia Corporation

(``PC''), dated October 17, 1996; (33) Letter from Michael

Flannigan, Protective Group Securities Corporation (``PGSC''), dated

September 24, 1996; (34) Letter from Robert A. Fitzner, Jr., RAF

Financial Corporation (``RAF''), dated October 29, 1996; (35) Letter

from Glen F. Hackmann, Robert W. Baird & Co., Incorporated

(``Baird''), dated October 31, 1996; (36) Letter from Douglas F.

Schofield, Schofield Investments, Inc., dated September 18, 1996;

(37) Letter from Richard O. Scribner, Allen B. Holeman, and C. Evan

Steward, SIA, dated November 4, 1996; (38) Letter from Dov S.

Schecter, Smith Barney Inc. (``Smith Barney''), dated October 31,

1996; (39) Letter from Patrick G. Haayes, Stratton Oakmont, Inc.

(``Stratton''), dated October 30, 1996; (40) Letter from Walter H.

Schlobohm, dated February 10, 1997; (41) Letter from John Maceranka,

The Windmill Group, Inc., dated September 28, 1996; and (42) Letter

from Stanley J. Allen Jr., Yee, Desmond, Schroeder & Allen, Inc.

(``Yee''), dated October 28, 1996.

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The definition of a Disciplined Firm is too broad: NASD Regulation

stated that many of the commenters believe the definition of a

Disciplined Firm in the original Rule was too broad. For example, the

original definition would have included a firm that was the subject of

an injunction for a technical or inadvertent violation of state law or

as the result of a consensual injunction involving only a fraction of

the firm's business and employees. NASD Regulation responded by

narrowing the definition of a Disciplined Firm to include firms that

have been expelled from membership in a securities industry SRO or that

have had their registration revoked by the SEC due to telemarketing or

sales practice abuses.

The Rule is too broad with respect to the individuals included in

the percentage calculation and the time frame: NASD Regulation stated

that commenters complained the Rule was too broad in several respects.

First, commenters said the Rule would target firms and individuals for

the actions of other firms and individuals of which they had no

knowledge or control \13\ Second, the commenters criticized the Rule's

application to all individuals that had ever been employed by a

Disciplined Firm in the calculation of the percentage that would

trigger the special supervisor procedures.\14\ Finally, NASD Regulation

stated that commenters believed the Rule should be limited to personnel

who have contact with customers, such as registered representatives,

and should exclude clerical and ministerial employees from both the 20%

calculation and the taping requirement.\15\

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\13\ See, e.g., letters from Lehman and Morgan Stanley.

\14\ See, e.g., letters from Edwards, Morgan Stanley, Nathan &

Lewis, PC, SIA, and Stratton.

\15\ See, e.g., letters from Edwards, Barington, Chatfield Dean,

Cullum, Duke II, ESI, ISC, Morgan Stanley, Baird, and Stratton.

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In response, NASD Regulation narrowed the scope of the original

Rule to apply only to firms that hire a specified percentage of

individuals who were employed at a Disciplined Firm within the last

three years. NASD Regulation also limited the individuals calculated in

the percentage to register persons, leaving out clerical and

ministerial personnel. Also, NASD Regulation limited the persons

subject to the taping requirement to registered representative in

conversations with both existing and potential customers.

The Rule does not achieve the stated purpose: NASD Regulation noted

that several commenters questioned whether the original Rule goes

beyond the scope of the Sweep Report and would be effective in

achieving the Sweep Report recommendations because taping is not an

effective means of supervising sales efforts.\16\

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\16\ See, e.g., letters from CIS, Duke II, ESI, Lehman, Merrill

Lynch, MSC, Nathan & Lewis, and SIA.

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NASD Regulation responded by emphasing that the taping requirement

is being restricted to particularly egregious situations. They stated

their concern that when a firm hires high percentages of employees from

firms that have been expelled by an SRO or that have had their

registration revoked by the Commission, these groups of employees are

unlikely to have been trained or supervised adequately. In addition,

NASD Regulation stated its belief in the in terrorem effect of

recording telephone conversations to deter sales practice abuses.

Finally, the NASD believes the Rule directly addresses the issues

raised when a firm hires a high percentage of individuals who were

employed by a Disciplined Firm where they were inadequately trained and

supervised.

The costs of the Rule are too great: The NASD noted that some

commenters expressed concerns that the costs of the original Rule would

be too high, considering the limited benefits of the Rule. The

commenters also stated that the Rule would have a disproportionate

effect on small firms.\17\

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\17\ The commenters stated that small firms would be

disproportionately effected both in the cost of taping and in the

numbers of firms likely to become subject to the threshold

percentage of 20%. See letters from Capital, Cowen, Duncan-Smith,

Hoak, SIA, and Yee.

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The NASD stated that its narrowing of many aspects of the Rule

would result in lower compliance costs. Specifically, in the revised

proposal, the NASD exempted firms with five or fewer registered persons

from the Rule and tiered the structure for determining the percentage

of employees that trigger the taping requirement so that smaller firms

would have to hire 30% or more of their registered persons from

Disciplined Firms before they would trigger the requirement. In

addition, the NASD stated that by narrowing the definition of a

Disciplined Firm, fewer firms will be subject to the taping

requirement.\18\ Finally, with respect to certain practical compliance

difficulties, the NASD agreed to provide firms with all the relevant

information they need to determine whether they are in compliance with

the Rule.

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\18\ The NASD revised the definition of Disciplined Firm to

include only expelled and revoked firms in order to focus, at least

initially, on the most egregious cases with the greatest supervisory

and disciplinary problems. For the two-year period 1995-1996, 14

firms met the definition of Disciplined Firm: 4 firms were expelled

from SRO membership and 10 had their registrations revoked. This

approach is similar to the one taken by the NFA, and will allow the

NASD to gain experience with the implementation of the Rule before

it considers expanding the definition of Disciplined Firm to include

firms that have been suspended from SRO membership or from SEC

registration.

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Privacy concerns: The NASD stated that many commenters felt the

original Rule would invade the privacy of both a firm's customers as

well as the firm's registered representatives, which would be unfair to

both firms and registered representatives that did not have

disciplinary histories. Commenters also believe that the Rule would

conflict with federal and state wiretapping laws. Finally, they are

concerned that the

[[Page 20235]]

Rule does not restrict the accessibility and manner in which the tapes

may be used.\19\

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\19\ See, e.g., letters from AEFA, Duke II, Lawrence, Kamin,

Lehman, Morgan Stanley, MSC, Neidiger, Montgomery, SIA, and Smith

Barney.

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As stated above, because the Rule has been revised to address only

the most egregious situations, the impact on privacy will be minimized.

Also, upon approval, NASD Regulation will inform NASD members that, in

complying with this Rule, they must also comply with federal and state

civil and criminal statutes governing the tape recording of

conversations. This is the same approach the NFA has taken with respect

to this issue.\20\

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\20\ See Interpretive Notice to NFA Compliance Rule 2-9,

Supervision of Telemarketing Activity, 9021 (February 18, 1997).

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Each state has a statute governing wiretapping; there also is a

federal statute governing wiretapping and electronic surveillance.\21\

The federal statute and the majority of the state statutes permit

taping of telephone conversations with the consent of one party (``one-

party statutes''),\22\ a minority of state statutes require the consent

of all parties to the conversation (``two-party statutes'').\23\ Three

issues arise from the proposed Rule: what is necessary to comply with

one-party statutes; what is necessary to comply with two-party

statutes; and how to comply where a conversation occurs between a

person in a one-party state and a person in a two-party state. The NASD

has left compliance with the state statutes on wiretapping and privacy

for each broker-dealer.

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\21\ 18 U.S.C. Secs. 2519 et seq.

\22\ In one-party statute states, the only issue is whether the

registered representative knows of and consents to the tape

recording. Since the recording requirement would run to the firm,

and the equipment would be the firm's, it might be argued that the

firm, and not the representative, is doing the recording. Therefore,

it would be necessary for the firm to insure that the representative

has notice and consents to the tape recording of his or her

telephone conversations. This could be accomplished through a clause

in an employment agreement or employee handbook or other written

notice to the representative.

\23\ In two-party statute states, it would be necessary to

insert on the firm's telephone line a recording stating that all

telephone conversations are being taped, similar to customer service

lines in other industries. Some states require a system of beeps or

buzzers that sound throughout the conversation. Another possibility

is to insert a clause into the customer agreement notifying

customers that their calls will be tape recorded. Some states also

have a ``business use exception'' to the two-party statute consent

requirement, but it is worded and applied differently in each state.

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C. Proposed Rule

As revised and filed with the Commission, the proposed Rule would

apply whenever a specified percentage of a member firm's sales force is

comprised of registered persons who were employed within the last three

years by a firm that has been expelled from membership in a securities

industry SRO or has had its registration as a broker/dealer revoked by

the SEC. The requisite percentage varies depending on the size of the

firm, from 40 percent for a small firm to 20 percent for a larger firm.

The firm must establish the required supervisory procedures within 30

days of receiving notice from NASD Regulation or obtaining actual

knowledge that it is subject to the provisions of the Rule.

Under the proposed Rule, if the requisite percentage of a member's

sales force previously was employed by a Disciplined Firm, the member

would be required to adopt special written procedures to supervise the

telemarketing activities of all of its registered persons. The

procedures would require, at a minimum, that the member tape record all

telephone conversations between all of its registered persons and both

existing and potential customers for a period of three years, and

maintain these supervisory procedures for two years. The Rule would

require firms to ensure that they tape record all regularly used means

of telecommunications, including cellular phones. The Rule also would

require firms subject to the taping requirement to establish reasonable

procedures for reviewing the tape recordings to ensure compliance with

securities laws and NASD rules, to submit reports to the NASD on their

supervision of telemarketing, and to retain and catalog the tapes.

While each firm is responsible for complying with the Rule, NASD

Regulation will provide firms with all of the information that they

need to determine if they are subject to the requirements of the Rule.

NASD Regulation believes that firms should be able to rely on the

accuracy of the information provided to them by the NASD. Therefore,

the NASD anticipates that a firm will be disciplined for failure to

comply with the Rule only if it has actual knowledge of information

that would make the firm subject to the Rule that is inconsistent with

the information provided by NASD Regulation to the firm that indicated

that the firm was not subject to the Rule.

NASD Regulation will compile and maintain several lists that firms

will be able to review on a quarterly basis to assist them to determine

if they are in compliance with the Rule. The primary list that will be

prepared will be a list of firms that meet the definition of

Disciplined Firm. Two additional lists will be prepared that should be

helpful. One list will contain an alphabetical listing of all

registered persons who had worked for Disciplined Firms within the last

three years. Another list will be compiled containing the same list of

people grouped according to the firm for which they currently work. In

order to alert firms that they are approaching the percentage that

would make them subject to the requirements of the Rule, the second

list will contain a computation of the percentage of all registered

persons at the firm represented by registered persons who had been

employed at a Disciplined Firm within the last three years.

The Rule is thus very similar to an NFA interpretation concerning

supervision of telemarketing activity.\24\ NFA member firms subject to

the requirements of the interpretation must tape record all sales

solicitations. The NFA interpretation applies to firms that meet

criteria relating to the percentage of the firm's associated persons

who formerly were employed at a firm that was closed down and barred

from the industry through enforcement actions for deceptive

telemarketing practices.\25\ These firms are required by the NFA

interpretation to tape record sales solicitations. An NFA member

subject to these procedures may seek a waiver of the taping requirement

upon a satisfactory showing that its current supervisory procedures

provide effective supervision over its employees, including enabling

the member to identify potential problem areas before customer abuse

occurs. The NFA has rarely granted such waivers. In one instance, a

waiver was granted to a firm that did not engage in telemarketing and

had only institutional customers. In two other instances, partial

waivers were granted to firms that hired outside consultants. NFA

informed NASD Regulation that they were not satisfied with the work

performed by the outside consultants and would not grant such waivers

in the future.\26\ In response to commenter requests, NASD Regulation

has included a waiver provision in the proposed Rule, and also has

proposed a

[[Page 20236]]

conforming change to the Rule 9600 Series.\27\

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\24\ See Interpretive Notice to NFA Compliance Rule 2-9,

Supervision of Telemarketing Activity, para. 9021 (February 18,

1997).

\25\ In early 1997, 44 firms met the NFA definition of

Disciplined Firm. See Interpretive Notice to NFA Compliance Rule 2-

9, Supervision of Telemarketing Activity, para. 9021 (February 18,

1997).

\26\ Telephone conversation between Mary N. Revell, Associate

General Counsel, NASD, and Daniel Driscoll, Vice President,

Compliance, NFA (February 26, 1997).

\27\ See, e.g., letters from Edwards, Barington, Cullum, Duke I,

Duke II, Duncan-Smith, GKN, Hoak, Morgan Stanley, Baird, and

Montgomery.

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III. Discussion

For the reasons discussed below, the Commission finds that the

proposed rule change is consistent with the requirements of the Act and

the rules and the regulations thereunder applicable to registered

securities associations, in particular the requirements of Section

15A(b)(6) of the Act.\28\ Among other things, Section 15A(b)(6) of the

Act requires that the rules of a national securities association be

designed to foster cooperation and coordination with persons engaged in

regulating, clearing, settling, processing information with respect to,

and facilitating transactions in securities, to remove impediments to

and perfect the mechanism of a free and open market and a national

market system, and in general, to protect investors and the public

interest.

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\28\ 15 U.S.C. Sec. 78o-3(b)(6).

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In particular, the Commission believes that the proposed rule

change will discourage the revival of disciplined firms that have been

barred by the industry or that have had their registrations revoked by

the Commission. In essence, firms that decide to hire significant

numbers of employees from disciplined firms will be required to ensure

a proper supervisory environment that protects investors and prevents

fraudulent and manipulative telemarketing acts and practices. The

monitoring of registered persons' telephone conversations will help to

provide additional supervision of individuals who formerly worked at a

disciplined firm where they were inadequately trained and supervised.

In the Notice, the Commission requested comments on all aspects of

the proposal, as well as the need to inform investors that their calls

are being taped. The Commission received one comment letter concerning

the proposal. The SIA expressed general concerns about tape recording

conversations as a method of supervision. While the Commission

recognizes the limitations of this form of supervision, the Commission

believes that if registered persons know their phone calls are being

taped then they are more likely to avoid making false or exaggerated

representations. In addition, compliance officals will have another

tool to monitor persons who worked previously at firms with significant

sales practice problems. Moreover, the fact that tapes of the telephone

conversations will be available to persons who have disputes with

broker-dealer firms will spur firms with a substantial percentage of

representatives from an expelled firm to take extra measures to

supervise these persons.

No comments were received concerning the issue of notice to

investors that their calls are being taped. NASD Regulation has

indicated its belief that the issue of notification is addressed by

state privacy laws and that firms will be required to independently

determine that state laws are satisfied. The Commission believes that

the best practice would be for member firms to notify their registered

persons and customers that their telephone calls are being tape

recorded.

The Commission expects the NASD to monitor the Rule and assess its

effectiveness. For example, the NASD should monitor the number of firms

that become subject to the Rule as well as firms that hire

representatives from disciplined firms but do not trigger the taping

requirement to see if there is a need to adjust the percentages. Also,

the NASD should monitor the number of firms exempt from the Rule

because they have five or fewer employees to determine if this is an

effective exclusion. Furthermore, the NASD should make sure firms

comply with state laws on notification.

The Commission finds good cause for approving Amendment No. 2 prior

to the thirtieth day after the date of publication of notice thereof in

the Federal Register. Amendment No. 2 applies the proposal to member

firms with a work force comprised of a specified number of registered

persons who were employed by a ``disciplined firm'' within the last

three years instead of two years.\29\ In the Notice, the Commission

requested comment on whether the original two-year time frame was

appropriate. Although no comments were received on this issue, NASD

Regulation and the Commission believe that a three-year time frame will

better capture registered persons who worked at disciplined firms

during a period of inadequate training, supervision, and sales practice

abuses. Therefore, the Commission believes that granting accelerated

approval to Amendment No. 2 is appropriate and consistent with Section

15A of the Act.\30\

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\29\ Amendment No. 2 also makes several technical amendments

which clarify the application of the previously noticed changes to

Rules 3010 and 9610.

\30\ 15 U.S.C. Sec. 78o-3.

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IV. Solicitation of Comments

Interested persons are invited to submit written data, views and

arguments concerning Amendment No. 2 to the proposed rule change,

including whether the proposed rule change is consistent with the Act.

Persons making written submissions should file six copies thereof with

the Secretary, Securities and Exchange Commission, 450 Fifth Street,

N.W., Washington, D.C. 20549. Copies of the submission, all subsequent

amendments,' all written statements with respect to Amendment No. 2

that are filed with the Commission, and all written communications

relating to Amendment No. 2 between the Commission and any persons,

other than those that may be withheld from the public in accordance

with the provisions of 5 U.S.C. Sec. 552, will be available for

inspection and copying in the Commission's Public Reference Room.

Copies of the filing will also be available for inspection and copying

at the principal office of the NASD. All submissions should refer to

File No. SR-NASD-97-69 and should be submitted by May 15, 1998.

V. Conclusion

It is therefore ordered, pursuant to Section 19(b)(2) of the

Act,\31\ that the proposed rule change (SR-NASD-97-69), including

Amendment No. 2 thereto, is approved on an accelerated basis.

\31\ 15 U.S.C. Sec. 78s(b)(2).

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For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\32\

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\32\ 17 CFR 200.30-3(a)(12).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 98-10796 Filed 4-22-98; 8:45 am]

BILLING CODE 8010-01-M