Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change and Amendment No. 1 to Proposed Rule Change by the National Association of Securities Dealers, Inc. Relating to Standards for Individual Correspondence

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-39942; File No. SR-NASD-98-29]

Self-Regulatory Organizations; Notice of Filing of Proposed Rule

Change and Amendment No. 1 to Proposed Rule Change by the National

Association of Securities Dealers, Inc. Relating to Standards for

Individual Correspondence

May 1, 1998.

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934

(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that

on April 6, 1998, the NASD Regulation, Inc. (``NASDR'') filed with the

Securities and Exchange Commission (``SEC'' or ``Commission'') the

proposed rule change as described in Items I, II, and III below, which

Items have been prepared by the NASDR. On April 30, 1998, the NASDR

filed Amendment No. 1 to the proposed rule change.\3\ The Commission is

publishing this notice to solicit comments on the proposed rule change,

as amended, from interested persons.

---------------------------------------------------------------------------

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

\2\ 17 CFR 240.19b-4.

\3\ See Letter from John Ramsay, Vice President and Deputy

General Counsel, NASDR, to Katherine A. England, Assistant Director,

Division of Market Regulation, Commission, dated April 29, 1998

(``Amendment No. 1''). In Amendment No. 1, the NASDR proposes to

amend its filing to clarify that in determing whether a given

communication constitutes correspondence for purposes of the rule,

NASD members, as well as NASDR staff, should consider, among other

things, the form and content of the communication.

---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of

Substance of the Proposed Rule Change

NASDR proposes to amend Rule 2210 of the Conduct Rules of the

National Association of Securities Dealers, Inc. (``NASD'' or

``Association'') to require that written or electronic communications

prepared for a single customer be subject to the general standards and

those specific standards of Rule 2210 that prohibit misleading

statements.

Below is the text of the proposed rule change. Proposed new

language is in italics; proposed deletions are in brackets.

2200. COMMUNICATIONS WITH CUSTOMERS AND THE PUBLIC

2210. Communications with the Public

(a) Definitions--Communications with the public shall include:

(1) Advertisement--For purposes of this Rule and any interpretation

thereof, ``advertisement'' means material published, or designed for

use in, a newspaper, magazine or other periodical, radio, television,

telephone or tape recording, videotape display, signs or billboards,

motion pictures, telephone directories (other than routine listings),

electronic of other public media.

(2) Sales Literature--For purposes of this Rule and any

interpretation thereof, ``sales literature'' means any written or

electronic communication distributed or made generally available to

customers or the public, which communication does not meet the

foregoing definition of ``advertisement.'' Sales literature includes,

but is not limited to, circulars, research reports, market letters,

performance reports or summaries, form letters, telemarketing scripts,

seminar texts, and reprints or excerpts of any other advertisement,

sales literature or published article.

(3) Correspondence--For purposes of this Rule and any

interpretation thereof, ``correspondence'' means any written or

electronic communication prepared for delivery to a single current or

prospective customer, and not for dissemination to multiple customers

or the general public.

Cross Reference--Rules Concerning Review and Endorsement of

Correspondence are Found in paragraph (d) to Conduct Rule 3010.

(b) Approval and Recordkeeping

(1) Each item of advertising and sales literature shall be approved

by signature or initial, prior to use or filing with the Association,

by a registered principal of the member.

(2) A separate file of all advertisements and sales literature,

including the name(s) of the person(s) who prepared them and/or

approved their use, shall be maintained for a period of three years

from the date of each use.

(c) Filing Requirements and Review Procedures

(1) Advertisements and sales literature concerning registered

investment companies (including mutual funds, variable contracts and

unit investment trusts) not included within the requirements of

paragraph (c)(2), and public direct participation programs (as defined

in Rule 2810) shall be filed with the Association's Advertising/

Investment Companies Regulation Department (Department) within 10 days

of first use or publication by any member. The member must provide with

each filing the actual or anticipated date of first use. Filing in

advance of use is recommended. Members are not required to file

advertising and sales literature which have previously been filed and

which are used without change. Any member filing any investment company

advertisement or sales literature pursuant to this paragraph (c) that

includes or incorporates rankings or comparisons of the investment

company with other investment companies shall include a copy of the

ranking or comparison used in the advertisement or sales literature.

(2) Advertisements concerning collateralized mortgage obligations

registered under the Securities Act of 1933, and advertisements and

sales literature concerning registered investment companies (including

mutual funds, variable contracts and unit investment trusts) that

include or incorporate rankings or comparisons of the investment

company with other investment companies where the ranking or comparison

category is not generally published or is the creation, either directly

or indirectly, of the investment company, its underwriter or an

affiliate, shall be filed with the Department for review at least 10

days prior to use (or such shorter period as the Department may allow

in particular

[[Page 25533]]

circumstances) for approval and, if changed by the Association, shall

be withheld from publication or circulation until any changes specified

by the Association have been made or, if expressly disapproved, until

the advertisement has been refiled for, and has received, Association

approval. The member must provide with each filing the actual or

anticipated date of first use. Any member filing any investment company

advertisement or sales literature pursuant to this paragraph shall

include a copy of the data, ranking or comparison on which the ranking

or comparison is based.

(3)(A) Each member of the Association which has not previously

filed advertisements with the Association (or with a registered

securities exchange having standards comparable to those contained in

this Rule) shall file its initial advertisement with the Department at

least ten days prior to use and shall continue to file its

advertisements at least ten days prior to use for a period of one year.

The member must provide with each filing the actual or anticipated date

of first use.

(B) Except for advertisements related to exempted securities (as

defined in Section 3(a)(12) of the Act), municipal securities, direct

participation programs or investment company securities, members

subject to the requirements of paragraph (c)(3)(A) [or (B)] of this

Rule may, in lieu of filing with the Association, file advertisements

on the same basis, and for the same time periods specified in [those]

that subparagraph[s], with any registered securities exchange having

standards comparable to those contained in this Rule.

(4)(A) Notwithstanding the foregoing provisions, any District

Business Conduct Committee of the Association, upon review of a

member's advertising and/or sales literature, and after determining

that the member has departed and there is a reasonable likelihood that

the member will again depart from the standards of this Rule, may

require that such member file all advertising and/or sales literature,

or the portion of such member's material which is related to any

specific types or classes of securities or services, with the

Department and/or the District Committee, at least ten days prior to

use. The member must provide with each filing the actual or anticipated

date of first use.

(B) The Committee shall notify the member in writing of the types

of material to be filed and the length of time such requirement is to

be in effect. The requirement shall not exceed one year, however, and

shall not take effect until 30 days after the member receives the

written notice, during which time the member may request a hearing

before the District Business Conduct Committee, and any such hearing

shall be held in reasonable conformity with the hearing and appeal

procedures of the Code of Procedure as contained in the Rule 9000

Series.

(5) In addition to the foregoing requirements, every member's

[advertising] advertisements and sales literature shall be subject to a

routine spot-check procedure. Upon written request from the Department,

each member shall promptly submit the material requested. Members will

not be required to submit material under this procedure which has been

previously submitted pursuant to one of the foregoing requirements and,

except for material related to exempted securities (as defined in

Section 3(a)(12) of the Act), municipal securities, direct

participation programs or investment company securities, the procedure

will not be applied to members who have been, within the Association's

current examination cycle subjected to a spot-check by a registered

securities exchange or other self-regulatory organization using

procedures comparable to those used by the Association.

(6) The following types of material are excluded from the foregoing

filing requirements and spot-check procedures:

(A) Advertisements or sales literature solely related to changes in

a member's name, personnel, location, ownership, offices, business

structure, officers or partners, telephone or teletype members, or

concerning a merger with, or acquisition by, another member;

(B) Advertisements or sales literature which do no more than

identify the Nasdaq symbol of the member and/or of a security in which

the member is a Nasdaq registered market maker;

(C) Advertisements or sales literature which do no more than

identify the member and/or offer a specific security at a stated price;

(D) Material sent to branch offices or other internal material that

is not distributed to the public;

(E) Prospectuses, preliminary prospectuses, offering circulars and

similar documents used in connection with an offering of securities

which has been registered or filed with the Commission or any state, or

which is exempt from such registration, except that an investment

company prospectus published pursuant to SEC Rule 482 under the

Securities Act of 1933 shall not be considered a prospectus for

purposes of this exclusion;

(F) Advertisements prepared in accordance with Section 2(10)(b) of

the Securities Act of 1933, as amended, or any rule thereunder, such as

SEC Rule 134, unless such advertisements are related to direct

participation programs or securities issued by registered investment

companies.

(7) Material which refers to investment company securities or

direct participation programs, or exempted securities (as defined in

Section 3(a)(12) of the Act) solely as part of a listing of products

and/or services offered by the member, is excluded from the

requirements of subparagraphs (1) and (2).

(d) Standards Applicable to Communications With the Public

(1) General Standards

(A) All member communications with the public shall be based on

principles of fair dealing and good faith and should provide a sound

basis for evaluating the facts in regard to any particular security or

securities or type of security, industry discussed, or service offered.

No material fact or qualification may be omitted if the omission, in

the light of the context of the material presented, would cause the

[advertising or sales literature] communication to be misleading.

(B) Exaggerated, unwarranted or misleading statements or claims are

prohibited in all public communications of members. In preparing such

[literature] communications, members must bear in mind that inherent in

investments are the risks of fluctuating prices and the uncertainty of

dividends, rates of return and yield, and no member shall, directly or

indirectly, publish, circulate or distribute any public communication

that the member knows or has reason to know contains any untrue

statement of a material fact or is otherwise false or misleading.

(C) When sponsoring or participating in a seminar, forum, radio or

television interview, or when otherwise engaged in public appearances

or speaking activities which may not constitute advertisements, members

and persons associated with members shall nevertheless follow the

standards of paragraphs (d) and (f) of this Rule.

(D) In judging whether a communication of a particular element of a

communication may be misleading, several factors should be considered,

including but not limited to:

(i) the overall context in which the statement or statements are

made. A statement made in one context may be

[[Page 25534]]

misleading even though such a statement could be [perfectly]

appropriate in another context. An essential test in this regard is the

balance of treatment of risks and potential benefits.

(ii) the audience to which the communication is directed. Different

levels of explanation or detail may be necessary depending on the

audience to which a communication is directed, and the ability of the

member given the nature of the media used, to restrict the audience

appropriately. If the statements made in a communication would be

applicable only to a limited audience or a single customer, or if

additional information might be necessary for other audiences, it

should be kept in mind that it is not always possible to restrict the

readership of a particular communication.

(iii) the overall clarity of the communication. A statement or

disclosure made in an unclear manner [obviously] can result in a lack

of understanding of the statement, or in a serious misunderstanding. A

complex or overly technical explanation may be [worse] more confusing

than too little information. Likewise, material disclosure relegated to

legends or footnotes [realistically] may not enhance the reader's

understanding of the communication.

(2) Specific Standards

In addition to the foregoing general standards, the following

specific standards apply:

(A) Necessary Data. Advertisements and sales literature shall

contain the name of the member, unless such advertisements and sales

literature comply with paragraph (f). Sales literature shall contain

the name of the person or firm preparing the material, if other than

the member, and the date on which it is first published, circulated or

distributed. If the information in the material is not current, this

fact should be stated.

(B) Making [R]recommendations in advertisements and sales

literature.

(i) In making a recommendation, whether or not labeled as such, a

member must have a reasonable basis for the recommendation and must

disclose any of the following situations which are applicable:

a. that the member usually makes a market in the securities being

recommended, or in the underlying security if the recommended security

is an option, [and/]or that the member or associated persons will sell

to or buy from customers on a principal basis;

b. that the member and/or its officers or partners own options,

rights or warrants to purchase any of the securities of the issuer

whose securities are recommended, unless the extent of such ownership

is nominal;

c. that the member was manager or co-manager of a public offering

of any securities of the recommended issuer within the last three

years.

(ii) The member shall also provide, or offer to furnish upon

request, available investment information supporting the

recommendation. Recommendations on behalf of corporate equities must

provide the price at the time the recommendation is made.

(iii) A member may use material referring to past recommendations

if it sets forth all recommendations as to the same type, kind, grade

or classification of securities made by a member within the last year.

Longer periods of years may be covered if they are consecutive and

include the most recent year. Such material must also name each

security recommended and give the date and nature of each

recommendation (e.g., whether to buy or sell), the price at the time of

the recommendation, the price at which or the price range within which

the recommendation was to be acted upon, and indicate the general

market conditions during the period covered.

(iv) Also permitted is material which does not make any specific

recommendation but which offers to furnish a list of all

recommendations made by a member within the past year or over longer

periods of consecutive years, including the most recent year, if this

list contains all the information specified in subparagraph (iii).

Neither the list of recommendations, nor material offering such list,

shall imply comparable future performance. Reference to the results of

a previous specific recommendation, including such a reference in a

follow-up research report or market letter, is prohibited if the intent

or the effect is to show the success of a past recommendation, unless

all of the foregoing requirements with respect to past recommendations

are met.

(C) Claims and Opinions. Communications with the public must not

contain promises of specific results, exaggerated or unwarranted claims

or unwarranted superlatives, opinions for which there is no reasonable

basis, or forecasts of future events which are unwarranted, or which

are not clearly labeled as forecasts.

(D) Testimonials. In testimonials concerning the quality of a

firm's investment advice, the following points must be clearly stated

in [the] advertisement or sales literature [communication]:

(i) The testimonial may not be representative of the experience of

other clients.

(ii) The testimonial is not indicative of future performance or

success.

(iii) If more than a nominal sum is paid, the fact that it is a

paid testimonial must be indicated.

(iv) If the testimonial concerns a technical aspect of investing,

the person making the testimonial must have knowledge and experience to

form a valid opinion.

(E) Offers of Free Service. Any statement in communications with

the public to the effect that any report, analysis, or other service

will be furnished free or without any charge must not be made unless

such report, analysis or other service actually is or will be furnished

entirely free and without condition or obligation.

(F) Claims for Research Facilities. No claim or implication in

communications with the public may be made for research or other

facilities beyond those which the member actually possesses or has

reasonably capacity to provide.

(G) Hedge Clauses. No cautionary statements or caveats, often

called hedge clauses, may be used in communications with the public if

they are misleading or are inconsistent with the content of the

material.

(H) Recruiting Advertising. Advertisements in connection with the

recruitment of sales personnel must not contain exaggerated or

unwarranted claims or statements about opportunities in the investment

banking or securities business and should not refer to specific

earnings figures or ranges which are not reasonable under the

circumstances.

(I) Periodic Investment Plans. Advertisements and sales literature

[Communications with the public] should not discuss or portray any type

of continuous or periodic investment plan without disclosing that such

a plan does not assure a profit and does not protect against loss in

declining markets. In addition, if the material deals specifically with

the principles of dollar-cost averaging, it should point out that since

such a plan involves continuous investment in securities regardless of

fluctuating price levels of such securities, the investor should

consider his financial ability to continue his purchases through

periods of low price levels.

(J) References to Regulatory Organizations. Communications with the

public shall not make any reference to membership in the Association or

to registration or regulation of the securities being offered, or of

the underwriter, sponsor, or any member or

[[Page 25535]]

associated person, which reference could imply endorsement or approval

by the Association or any federal or state regulatory body. References

to membership in the Association or Securities Investors Protection

Corporation shall comply with all applicable By-Laws and Rules

pertaining thereto.

(K) Identification of Sources. Statistical tables, charts, graphs

or other illustrations used by members in advertising or sales

literature should disclose the source of the information if not

prepared by the member.

(L) Claims of Tax Free/Tax Exempt Returns. Income or investment

returns may not be characterized in communications with the public as

tax free or exempt from income tax where tax liability is merely

postponed or deferred. If taxes are payable upon redemption, that fact

must be disclosed. References to tax free/tax exempt current income

must indicate which income taxes apply or which do not unless income is

free from all applicable taxes. For example, if income from an

investment company investing in municipal bonds may be subject to state

or local income taxes, this should be stated, or the illustration

should otherwise make it clear that income is free from federal income

tax.

(M) Comparisons. In making a comparison in advertisements or sales

literature, either directly or indirectly, the member must make certain

that the purpose of the comparison is clear and must provide a fair and

balanced presentation, including any material differences between the

subjects of comparison. Such differences may include investment

objectives, sales and management fees, liquidity, safety, guarantees or

insurance, fluctuation of principal and/or return, tax features, and

any other factors necessary to make such comparisons fair and not

misleading.

(N) Predictions and projections. In communications with the public.

i[I]nvestment results cannot be predicted or projected. Investment

performance illustrations may not imply that gain or income realized in

the past will be repeated in the future. However, for purposes of this

Rule, hypothetical illustrations of mathematical principles are not

considered projections of performance; e.g., illustrations designed to

show the effects of dollar cost averaging, tax-free compounding, or the

mechanics of variable annuity contracts or variable life policies.

* * * * *

IM-2210-1. Communications with the Public About Collateralized Mortgage

Obligations (CMOs)

(a) General Considerations

For purposes of the following guidelines, the term ``collateralized

mortgage obligation'' (CMO) refers to a multiclass bond backed by a

pool of mortgage pass-through securities or mortgage loans. CMOs are

also known as ``real estate mortgage investment conduits'' (REMICs). As

a result of the 1986 Tax Reform Act, most CMOs are issued in REMIC form

to create certain tax advantages for the issuer. The term CMO and REMIC

are now used interchangeably. In order to prevent [a communication

about] advertisements and sales literature regarding CMOs from being

false or misleading, there are certain factors to be considered,

including, but not limited to, the following:

(1) Product Identification

In order to assure that investors understand exactly what security

is being discussed, all communications concerning CMOs should clearly

describe the product as a ``collateralized mortgage obligation.''

Member firms should not use the proprietary names for CMOs as they do

not adequately identify the product. To prevent confusion and the

possibility of misleading the reader, communications should not contain

comparisons between CMOs and any other investment vehicle, including

Certificates of Deposit.

(2) Educational Material

In order to ensure that customers are adequately informed about

CMOs members are required to offer to customers education material

which covers the following matters:

(A) A discussion of CMO characteristics an investments and their

attendant risks;

(B) An explanation of the structure of a CMO, including the various

types of tranches;

(C) A discussion of mortgage loans and mortgage securities;

(D) Features of CMOs, including: credit quality, prepayment rates

and average lives, interest rates (including effect on value and

prepayment rates), tax considerations, minimum investments,

transactions costs and liquidity;

(E) Questions an investor should ask before investing; and

(F) A glossary of terms that may be helpful to an investor

considering an investment.

(3) Safety Claims

A communication should not overstate the relative safety offered by

the CMO. Although CMOs generally offer low investment risk, they are

subject to market risk like all investment securities and there should

be no implication otherwise. Accordingly, references to liquidity

should be balanced with disclosure that, upon resale, an investor may

receive more or less than his original investment.

(4) Claims About Government Guarantees

(A) Communications should accurately depict the guarantees

associated with CMO securities. For example, in most cases it would be

misleading to state that CMOs are ``government guaranteed'' securities.

A government agency issue could instead be characterized as government

agency backed. Of course, private- issue CMO advertisements should not

contain references to guarantees or backing, but may disclose the

rating.

(B) If the CMO is offered at a premium, the communication should

clearly indicate that the government agency backing applies only to the

face value of the CMO, and not to any premium paid. Furthermore,

communications should not imply that either the market value or the

anticipated yield of the CMO is guaranteed.

(5) Simplicity Claims

CMOs are complex securities and require full, fair and clear

disclosure in order to be understood by the investor. A communication

should not imply that these are simple securities that may be suitable

for any investor seeking high yields. All CMOs do not have the same

characteristics and it is misleading to indicate otherwise. Even though

two CMOs may have the same underlying collateral, they may differ

greatly in their prepayment speed and volatility.

(6) Claims About Predictability

A communication would be misleading if it indicated that the

anticipated yield and average life of a CMO were assured. It should

disclose that the yield and average life will fluctuate depending on

the actual prepayment experience and changes in current interest rates.

II. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

In its filing with the Commission, the NASDR included statements

concerning the purpose of and basis for the

[[Page 25536]]

proposed rule change an discussed any comments it received on the

proposed rule change. The text of these statements may be examined at

the places specified in Item IV below. The NASDR has prepared

summaries, set forth in Sections A, B, and C below, of the most

significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

1. Purpose

Background

NASD Conduct Rule 2210 imposes various requirements on member

communications with the public, designed to ensure that those

communications are fair, balanced and not misleading. Rule 2210 does

not expressly apply to the content of correspondence (i.e., a

communication to only one person). In addition, there is no definition

of correspondence in the NASD rules, even though members are required

to supervise the use of correspondence by their associated persons

under Rule 3010.

Recently, several NASD disciplinary matters raised the issue of

whether correspondence to a single customer constitutes ``sales

literature'' subject to the requirements of Rule 2210.\4\ The National

Business Conduct Committee (``NBCC'') \5\ consistently took the

position in these cases that a document prepared for use with a single

customer, and not for dissemination to the general public, is not

``sales literature'' as that term is defined in subparagraph (a)(2) to

NASD Rule 2210. However, the NBCC also agreed that the application to

correspondence of particular standards in the rules for communications

to the public would be appropriate and would enable NASD staff to bring

enforcement actions on the basis of clear violations of certain

proscribed behavior. The NBCC recommended that the NASD define

``correspondence'' in Rule 2210 and amend the rule to clarify which

standards apply to correspondence. In June 1997, the NASDR requested

comment on these proposed amendments in Notice to Members 97-37 (June

1997).

---------------------------------------------------------------------------

\4\ See, In the Matter of Peter Stuart Bevington, Complaint No.

C8A940021 (March 5, 1997); In the Matter of William Stafford

Thurmond, Complaint No. C06930051 (Feb. 1, 1996): In the Matter of

Jeffery Steven Stone, Complaint No. C06940036 (Feb. 1, 1996); and In

the Matter of Micah C. Douglas, Complaint Nos. C06920046 and

C06930068 (Sept. 19, 1995).

\5\ The NBCC is now called the National Adjudicatory Council.

---------------------------------------------------------------------------

As first proposed, the amendments to Rule 2210 would have required

that communications prepared for a single customer be subject to the

standards, but not the filing and review requirements, of Rule 2210.

Some of these standards define or prohibit the dissemination of

statements that could be considered misleading. Others require that

certain additional disclosure, e.g., that the member makes a market in

a particular security, be included in certain cases in the

communication. Most commenters thought it was appropriate only to apply

the general standards of Rule 2210, which, among other things, prohibit

untrue statements of material facts, the omission of material facts,

and statements that are exaggerated, misleading or unwarranted. These

commenters stated that imposing all of the specific standards on each

item of correspondence, particularly those that require additional

disclosure, would unduly complicate communication with clients and

unnecessarily burden supervisory programs without materially

contributing to the protection of investors. A few commenters supported

the proposed amendments, stating that the proposed exemption of

correspondence from the NASD filing and review requirements strikes the

proper balance. One commenter suggested applying the proposed amendment

only to solicitations, recommendations, and sales letters directed at

an individual customer.

Discussion

The NASDR believes that certain statements pose similar dangers

regardless of whether they are communicated to one person or many

persons. An amendment to Rule 2210 to clarify how the rule applies to

correspondence would provide better guidance to the membership and

would help to assure that investors are adequately protected with

respect to the communications they receive individually. At the same

time, the NASDR recognizes that correspondence is highly individualized

in nature and that much correspondence (unlike advertising and sales

literature) is directed by registered representatives (``RR'') to

customers with whom the RR already has an established relationship.

Therefore, the NASDR has determined that the proposed rule change

should subject correspondence to the general standards and those

specific standards of Rule 2210 that prohibit misleading statements,

but not to the specific standards of the rule that prescribe specific

disclosure.

The proposed rule change creates a category defined as

``communications with the public'' to include the current definitions

of ``advertisement'' and ``sales literature,'' and a new definition of

``correspondence.'' ``Correspondence'' is defined as ``* * * any

written or electronic communication prepared for delivery to a single

current or prospective customer, and not for dissemination to multiple

customers or the general public.'' In determining when a written or

electronic communication is prepared for delivery to a single current

or prospective customer, NASD members should consider and the staff of

the NASDR should examine,\6\ among other things, the form and content

of the communication. Thus, a written or electronic communication

addressed to a single current or prospective customer, the content of

which is substantially identical to that of written or electronic

communications sent to one or more other current or prospective

customers, is a form letter, not ``correspondence.'' Because form

letters are considered ``sales literature'' under Rule 2210, they would

be subject to all of the general and specific standards of Rule 2210.

---------------------------------------------------------------------------

\6\ See Amendment No. 1, supra note 3.

---------------------------------------------------------------------------

The proposed rule change amends Rule 2210 to subject individual

correspondence to the general standards under subparagraph (d)(1) and

the following specific standards under subparagraph (d)(2) of Rule

2210: (i) subparagraph (d)(2)(C), which prohibits exaggerated,

unwarranted, or certain other specific claims or opinions, (ii)

subparagraph (d)(2)(E), which prohibits certain offers of free

services, (iii) subparagraph (d)(2)(F), which prohibits certain claims

for research services, (iv) subparagraph (d)(2)(G), which prohibits

certain hedge clauses, (v) subparagraph (d)(2)(J), which prohibits the

implication of endorsement or approval by regulatory organizations,

(vi) subparagraph (d)(2)(L), which prohibits certain statements

regarding tax free or tax exempt returns, and (vii) subparagraph

(d)(2)(N), which prohibits predictions and projections of investment

results. Each of these specific provisions derive from members' general

obligations not to make statements that are misleading or without a

reasonable basis in fact.

Individual correspondence will not be subject to the following

specific standards of Rule 2210: (i) subparagraph (d)(2)(A), which

requires the inclusion of certain information regarding members' names,

(ii) subparagraph (d)(2)(B), which requires that a member disclose

specified information to the customer when making a recommendation,

(iii) subparagraph

[[Page 25537]]

(d)(2)(D), which requires the inclusion of certain statements regarding

testimonials, (iv) subparagraph (d)(2)(H), which prohibits exaggerated

or unwarranted claims in advertisements for the recruitment of sales

personnel, (v) subparagraph (d)(2)(I), which requires certain

disclosures regarding periodic investment plans; (vi) subparagraph

(d)(2)(K), which requires the identification and disclosure of sources

other than the member for certain statistical tables, charts, graphs,

or other illustrations, and (vii) subparagraph (d)(2)(M), which

requires the inclusion of certain information when making comparisons

of investment alternatives.

The proposed rule change is not intended to change the current

application of Interpretive Memoranda under Rule 2210. Therefore

paragraph (a) to IM-2210-1 (interpretation regarding collaterlized

mortgage obligations) has been amended to clarify that only

advertisements and sales literature are covered by the interpretation.

Finally, the proposed amendments also incorporate several minor

technical changes that are non-substantive in nature.

2. Statutory Basis

The NASDR believes that the proposed rule change is consistent with

the provisions of Section 15A(b)(6) of the Act,\7\ which require that

the Association adopt and amend its rules to promote just and equitable

principles of fair trade, and generally provide for the protection of

investors and the public interest. By subjecting individual

correspondence to the general standards and those individual standards

in Rule 2210 that prohibit misleading statements, the NASDR believes

that the proposed rule change strikes the appropriate balance between

protecting investors from misleading or inappropriate communications in

correspondence and imposing workable regulatory requirements that

reasonably permit member firms to exercise effective compliance

oversight with respect to correspondence.

---------------------------------------------------------------------------

\7\ 15 U.S.C. 78o-3(b)(6).

---------------------------------------------------------------------------

The NASDR is requesting that the proposed rule change be effective

within 45 days of SEC approval.

B. Self-Regulatory Organization's Statement on Burden on Competition

The NASDR does not believe the proposed rule change will result in

any burden on competition that is not necessary or appropriate in

furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed

Rule Change Received From Members, Participants or Others

The proposed rule change was published for comment in Notice to

Members 97-37 (June 1997). Eighteen comments were received in response

thereto. Of the 18 comment letters received, 4 were in favor of the

proposed rule change and 14 were opposed. Most of the commenters either

opposed the proposed rule change or thought only the general standards

of Rule 2210 should apply.

American Express strongly supported the proposed rule change

stating that the NASD's willingness to address the dangers of

misleading or unwarranted statements in correspondence while exempting

such correspondence from NASD filing and review requirements is the

proper balance.

AmeriTrade Holding Corporation stated that the proposed rule change

would be beneficial as long as it only applies to solicitations,

recommendations, and sales letters directed at an individual customer.

The Equitable and Banc One were generally supportive of goals of

the proposed rule change but thought it was appropriate to focus on

applying only the general standards of the Rule, rather than the

specific standards. The Equitable stated that imposing all of the

specific standards of Rule 2210 on each item of correspondence would

unduly complicate communication with clients and unnecessarily burden

supervisory programs without materially contributing to the protection

of investors.

PSA, The Bond Market Trade Association, The Securities Industry

Association, The Investment Company Institute, New York Life Insurance

Co., American Funds Distributors, Inc., Mutual Service Corporation, A.

G. Edwards & Sons, Inc., T. Rowe Price Associates, Inc., Arlington

Securities Inc., JP Morgan, and CUSO Financial Services, Inc. all

opposed the proposed rule change stating that (i) existing NASD rules

sufficiently govern the content and use of correspondence, (ii) the

application of the Rule to a large amount of a firm's correspondence

would be irrelevant, and (iii) review of all such correspondence would

be burdensome.

Merrill Lynch stated that if the proposed rule change is adopted as

proposed, a letter to a client disclosing his or her quarterly mutual

fund distributions would presumably be subject to the requirements of

Securities Act Rule 482, and would require inclusion of the five-year,

ten-year and since-inception performance of the fund, disclosures that

past performance is no assurance of future results, and disclosures

that the investment return and principal value will fluctuate so that

the investor's shares, when redeemed, may be worth more or less than

their original cost.

PSA stated that the proposed rule change would unnecessarily

inhibit the use of electronic communications media, because electronic

correspondence, unlike sales literature and advertisements, often takes

the form of an ongoing dialogue between two parties, involving the

exchange of multiple messages, and that the application of the specific

content requirements of Rule 2210 to all such communications would

require member firms to repeat large amounts of information in each

message.

III. Date of Effectiveness of the Proposed Rule Change and Timing

for Commission Action

Within 35 days of the publication of this notice in the Federal

Register or within such longer period (i) as the Commission may

designate up to 90 days of such date if it finds such longer period to

be appropriate and publishes its reasons for so finding or (ii) as to

which the self-regulatory organization consents, the Commission will:

A. by order approve such proposed rule change, or

B. institute proceedings to determine whether the proposed rule

change should be disapproved.

IV. Solicitation of Comments

Interested persons are invited to submit data, views and arguments

concerning the foregoing, including whether the proposed rule change,

as amended, is consistent with the Act. Persons making written

submissions should file six copies thereof with the Secretary,

Securities and Exchange Commission, 450 Fifth Street, NW., Washington,

DC 20549. Copies of the submissions, all subsequent amendments, all

written statements with respect to the proposed rule change that are

filed with the Commission and all written communications relating to

the proposed rule change between the Commission and any person, other

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

provisions of 5 U.S.C. 552, will be available for inspection and

copying at the Commission's Public Reference Room, 450 Fifth Street,

NW, Washington, D.C. 20549. Copies of such filing will also be

available for

[[Page 25538]]

inspection and copying at the principal office of the NASD. All

submissions should refer to File No. SR-NASD-98-29 and should be

submitted by May 29, 1998.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\8\

---------------------------------------------------------------------------

\8\ 17 CFR 200.30-3(a)(12).

---------------------------------------------------------------------------

Jonathan G. Katz,

Secretary.

[FR Doc. 98-12264 Filed 5-7-98; 8:45 am]

BILLING CODE 8010-01-M