Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the National Association of Securities Dealers, Inc., Relating to Enhanced Supervision of Unregistered Persons Performing Limited Marketing Activities

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40784; File No. SR-NASD-98-44]

Self-Regulatory Organizations; Notice of Filing of Proposed Rule

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

Relating to Enhanced Supervision of Unregistered Persons Performing

Limited Marketing Activities

December 11, 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 July 6, 1998, the National Association of Securities Dealers, Inc.

(``NASD'' or ``Association'') through its wholly-owned subsidiary, 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 December 2, 1998, the NASDR submitted

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

publishing this notice to solicit comments on the proposed rule change

from interested persons.

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

\2\ 17 CFR 240.19b-4.

\3\ See Letter from Gary L. Goldsholle, Assistant General

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

Division of Market Regulation, Commission, dated November 30, 1998

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

amend its filing by deleting its reference to the use by member

firms of third-party telemarketing firms for limited marketing

activities.

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

Substance of the Proposed Rule Change

The NASDR is proposing to amend Rule 1060 and create a new

Interpretative Material, IM-3010, to codify existing practice by

exempting from registration persons whose securities business is

limited to certain limited marketing activities and specify supervisory

requirements for members concerning such unregistered persons. Below is

the text of the proposed rule change. Proposed new language is in

italics.

1060. Persons Exempt From Registration

(a) The following persons associated with a member are not required

to be registered with the Association:

(1) persons associated with a member whose functions are solely and

exclusively clerical or ministerial;

(2) persons associated with a member who are not actively engaged

in the investment banking or securities business;

(3) persons associated with a member whose functions are related

solely and exclusively to the member's needs for nominal corporate

officers or for capital participation; and

(4) persons associated with a member whose functions are related

solely and exclusively to:

(A) effecting transactions on the floor of a national securities

exchange and who are registered as floor members with such exchange;

(B) transactions in municipal securities, except as provided in

Rule 1110 hereof, or

(C) transactions in commodities; and

(5) persons associated with a member whose investment banking or

securities business is limited to marketing activities through the

telephone or other electronic communications media for the following:

(A) extending invitations to firm-sponsored events at which any

substantive presentations and account or order solicitation will be

conducted by appropriately registered personnel;

(B) inquiring whether the prospective or existing customer wishes

to discuss investments with a registered person; and

(C) inquiring whether the prospective or existing customer wishes

to receive investment literature from the firm.

In connection with subparagraphs (A), (B) and (C), unregistered persons

shall be permitted to mention the products and services generally

available from

[[Page 70174]]

the member, provided, however, that such unregistered persons shall not

discuss the attributes or merits of any particular investment products

or services or class of products or services, pre-qualify prospective

customers as to financial status and investment history and objectives,

or solicit new accounts or orders. Nothing in this subparagraph shall

affect the ability of administrative personnel to contact customers

regarding clerical or ministerial matters affecting a customer's

account(s).

IM-3010. Supervision of Solicitation and Marketing Activities by

Unregistered Persons

Each member employing or using unregistered associated persons in

accordance with Rule 1060(a)(5) (hereinafter referred to as

``unregistered marketers'') shall ensure that the member's supervisory

system includes the following:

(a) Background Investigation. Prior to employing or using an

unregistered marketer, the member shall conduct a reasonable

investigation into the background of such person to determine that he

or she is not subject to a disqualification as defined in the

Association's By-Laws.

(b) Instruction and Training. The member, or a person designated by

the member, shall instruct all unregistered marketers acting on behalf

of the member concerning the scope of their permissible activities,

including: the matters that they may discuss pursuant to Rule

1060(a)(5), the telemarketing time-of-day and disclosure obligations

required under Rule 2211, and the requirement to make and maintain a

centralized do-not-call list pursuant to IM-3110 and to refrain from

soliciting customers whose names are included on the list.

(c) Designated Principals. The member shall designate one or more

principals who shall be responsible for implementing and overseeing the

member's supervisory system concerning the employment or use of

unregistered marketers;

(d) Signed Acknowledgment. The member shall not permit unregistered

marketers to contact customers on behalf of the member until the

unregistered marketer acknowledges, in writing or by electronic means,

that he or she:

(i) is an associated person of the member;

(ii) as an associated person:

a. is not subject to a disqualification as defined in the

Association's By-Laws; and

b. submits to the authority of the jurisdiction of the Association

and

(iii) has been instructed by the member, or a person designated by

the member, concerning the permissible activities of unregistered

marketers, as specified in subparagraph (b).

(e) Compensation. Unregistered marketers shall be compensated on an

hourly or salary basis only, and shall not receive any bonus or

additional compensation or other incentives tied to transactions.

(f) Monitoring. Registered persons shall periodically monitor calls

made by unregistered marketers to ensure that they comply with the

limitations described in Rule 1060(a)(5).

(g) Recordkeeping. The member shall prepare written records

demonstrating compliance with the provisions of this interpretation,

which shall include reports documenting the frequency of periodic

monitoring and the results of such monitoring. The member also shall

keep copies of all scripts used by unregistered marketers calling on

their behalf. The member shall preserve each record for a period of not

less than three years from the date the record was created, the first

two years in a readily accessible place. In addition, the member shall

retain the acknowledgment required in subparagraph (d) for a period of

not less than three years from the date an individual ceased marketing

on behalf of the member, the first two years in a readily accessible

place.

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 proposed rule change and

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

The Association's current policy, contained in Notice to Members

(``NTM'') 88-50, permits unregistered individuals to extend invitations

to firm-sponsored events and to inquire whether a prospective customer

wishes to discuss investments with a registered person or receive

investment literature. The proposed rule change adds certain specific

supervisory requirements concerning the activities of these

unregistered persons, while codifying in the NASD's rules the extent to

which such persons may act on behalf of a member without registration.

Specifically, under the proposed rule change, members using

unregistered persons for the permitted activities will be required to

supervise and periodically monitor such persons to ensure that their

marketing activities do not exceed the narrowly prescribed limits. In

addition, members will be required to conduct a background

investigation on unregistered persons, provide instruction and training

on the scope of their limited permissible activities, designate one or

more principals to be responsible for the marketing activities of

unregistered persons, and compensate such unregistered persons on an

hourly or salary basis only. Any unregistered person who proposes

marketing to customers on behalf of a member also must acknowledge in

writing certain matters, including that he or she submits to the

authority of the Association.

The Proposal in Notice to Members 97-58

In August 1997, in NTM 97-58, the NASDR proposed a requirement to

register all persons associated with or used by a member who

communicate with the public for the purpose of soliciting the purchase

of securities or related services or identifying prospective customers.

The proposal contained an exemption permitting unregistered persons to

communicate with existing customers of a member firm for three limited

activities: (1) extending invitations to firm-sponsored events; (2)

inquiring whether a customer wishes to speak with a registered person;

and (3) inquiring whether a customer wishes to receive investment

literature from the firm.

The proposed rule change herein, like its predecessor in NTM 97-58,

is designed to address the use of high pressure and aggressive cold

calls by unregistered persons, often using specially designed scripts.

It also addresses the NASDR's concern that members may not be

consistently applying the current cold calling requirements and that

members may be employing unregistered persons under the guise of

performing the limited functions described above, when in fact such

persons are engaged in much broader solicitation activities. Finally,

it addresses the NASDR's concern that unregistered persons soliciting

[[Page 70175]]

customers may provide inaccurate or misleading information to

customers.

Based upon the comments received in response to NTM 97-58, and

input provided by the various NASD standing-committees, the NASDR is

recommending an alternative approach. The proposed rule change is no

longer as much a general rule on ``cold calling'' per se as it is a

rule addressing the circumstances under which unregistered persons may

conduct limited marketing activities, such as extending invitations to

firm-sponsored events, inquiring whether a prospective or existing

customer wishes to speak with a registered person or receive investment

literature.

The proposed rule change represents a significant shift from the

position articulated in NTM 97-58. This shift stems from the NASDR's

conclusion after considering all of the input received in the

rulemaking process, that registration may not be the most appropriate

regulatory mechanism to address the NASDR's concerns. This point was

raised by many of the commenters and committees that considered the

initial proposal. In general, the commenters and committees believe

that registration would not address the substance of cold calls, which,

they believe, is what really should be of concern to the NASDR. The

commenters and committees also believe that registration should not be

required of persons who perform the limited functions permitted in NTM

88-50. Registration, they argue, would be a costly and impractical

solution to a problem that is more effectively addressed through

increased supervision and enforcement.

The New Proposal

The NASDR's proposed rule change codifies generally the current

restrictions governing the use of unregistered persons that engage in

marketing activities as set forth in NTM 88-50, and establishes more

comprehensive supervisory responsibilities of members towards such

unregistered persons. The NASDR believes that the proposed rule change

would achieve several important regulatory objectives. First, it would

educate members about their responsibilities regarding the use of

unregistered persons that engage in marketing activities. Second, it

would signal to the membership the NASDR's renewed attention to the

problem of marketing. Third, and perhaps most importantly, since the

new rule would require SEC approval, it would provide a clear, and in

some cases, an additional and more easily provable basis on which to

bring enforcement actions against firms and individuals that exceed the

narrow boundaries established for the use of unregistered persons to

engage in marketing activities.

The proposed rule change also seeks a more careful balance between

the burdens and benefits of registration. While avoid the expense of

registration, the NASDR believes the proposed rule change retains many

of the protections that registration would provide. Under the proposed

rule change, line NTM 88-50, members would be required to conduct a

reasonable background investigation to determine that no prospective

unregistered person who intends marketing to customers on behalf of the

member is subject to a disqualification as defined by the By-Laws. In

addition, under the proposed rule change, such unregistered persons

would continue to be deemed associated persons, and thus, subject to

the jurisdiction of the Association. The proposed rule change makes the

status of unregistered persons who perform limited marketing activity

more clear than NTM 88-50 by requiring all such persons to execute an

acknowledgment stating that they are associated persons and subject to

the Association's jurisdiction. Persons performing these functions,

however, would not be required to complete the series 7 examination--an

examination that the staff believes is unnecessary for the limited

activities permitted by unregistered persons. NASDR staff considered

implementing a specific ``cold calling'' exam but concluded that there

would not be sufficient material to make such an examination

meaningful.

While the proposed rule change was originally conceived to address

problems resulting from cold calling activity, the current proposal

covers activity occurring in electronic communications media generally.

In light of the rapid growth of the Internet and other electronic

communications media, the proposed rule change ensures that the

requirements imposed by these new rules cannot be circumvented by

moving marketing activity from the telephone to non-traditional media.

If, for example, a member uses an unregistered person to post a message

inviting the public to a seminar on an Internet bulletin board or

during a conversation in a chat room, such conduct should be subject to

the same requirements and supervision as communication over the

telephone.

The proposed rule change is based upon the premise, as articulated

in NTM 88-50, and set forth in NASD Rule 1031(b), that persons

associated with a member who are engaged in the investment banking or

securities business for the member, including the functions of

solicitation'' are required to register as a ``representative.'' Rule

1060 lists a series of exemptions from registration for certain

categories of persons associated with a member. Proposed new rule

1060(a)(5) would add a new category and exempt persons whose investment

banking or securities business is limited to marketing to customers

through the telephone or other electronic communications media for the

following: (1) extending invitations to firm-sponsored events at which

any substantive presentations and account or order solicitation will be

conducted by appropriately registered personnel; (2) inquiring whether

the prospective or existing customer wishes to discuss investments with

a registered person; and (3) inquiring whether the prospective or

existing customer wishes to receive investment literature from the

firm. By including marketing towards existing as well as prospective

customers, the new rule makes clear that contacts with existing

customers should be governed by the same restrictions as contacts with

prospective customers.

New rule 1060(a)(5) clarifies what unregistered persons may say in

connection with their marketing activities. Specifically, the rule

states that ``unregistered persons shall be permitted to mention the

products and services generally available from the member, provided

that they do not discuss the attributes or merits of any particular

investment products or services, pre-qualify prospective customers as

to financial status and investment history and objectives, or solicit

new accounts or orders.'' In addition, new rule 1060(a)(5) states that

it shall not affect the ability of administrative personnel to contact

customers regarding clerical or ministerial matters affecting a

customer's account.

Supervisory Responsibilities

The comprehensive supervisory responsibilities set forth in the

proposed rule change contain many of the supervisory responsibilities

set forth in NTM 88-50, with several significant additions. The

supervisory responsibilities contained in NTM 88-50 and codified in the

proposed IM-3010 are: (1) Instructing unregistered persons who are

marketing on behalf of a member concerning the scope of their

permissible activities; (2) conducting a reasonable investigation into

the background of any potential unregistered person to determine that

[[Page 70176]]

such person is not statutorily disqualified from becoming associated

with the member; and (3) compensating unregistered persons on an hourly

or salary basis only, without any bonuses or other incentives tied to

transactions.

The additional supervisory obligations that would be imposed by the

proposed rule change include a requirement for members to obtain an

acknowledgement from any unregistered person who intends marketing to

customers on behalf of the member stating that he or she: (1) Is an

associated person of the member; (2) as an associated person (a) is not

subject to a disqualification as defined in the By-Laws and (b) submits

to the jurisdiction of the Association; and (3) has been instructed by

the member, or a person designated by the member, concerning the scope

of permissible marketing activities in which such unregistered persons

may engage.

The proposed rule change also would require members to periodically

monitor the activities of unregistered persons marketing on their

behalf to confirm that such persons are complying with the limitations

placed upon them. The NASDR proposes allowing members to determine what

level and form of monitoring is appropriate, although we would expect

members to increase the frequency of monitoring in response to

complaints or other indicia that marketing abuses may be taking place.

Members may satisfy the monitoring requirements in a variety of

methods, including periodically ``listening in'' on marketing calls, or

contacting previously marketed persons to determine the scope of any

communication by the unregistered person. Whatever method members

choose, they would be required to maintain a written record of the

verification procedures used and the results of the periodic

monitoring.

The recordkeeping requirements of the proposed rule change are an

integral part of the supervisory system. The signed acknowledgements

and records of periodic monitoring will help provide assurance that the

restrictions placed upon unregistered marketers are being followed.

NASDR staff has also included a specific requirement for members to

maintain copies of all scripts used by unregistered persons calling on

their behalf. Scripts used by marketers frequently contain the issues

to be discussed and suggested responses to questions that may arise

during a conversation. From a regulatory perspective, scripts are often

very probative of the substance of a cold call or marketing effort, and

thus would be particularly useful in determining whether a member's use

of unregistered marketers is in compliance with the limitations imposed

by the proposed rule.

The proposed rule change also would require members to designate

one or more registered principals to be responsible for overseeing the

member's supervisory obligations relating to the employment and use of

unregistered persons engaged in marketing on behalf of the member. The

NASDR believes that firms are likely to be more diligent in supervising

unregistered persons if members designate specific individuals with

responsibility for overseeing such activity.

Additional Issues

Some banks and bank affiliated firms have argued that the proposed

rule change could unduly limit marketing activities by bank employees.

Although the NASDR preliminarily believes that the potential customer

protections that will be derived from the increased supervision of the

activities of unregistered persons outweigh these concerns, we would be

interested in receiving further comments on the advisability of

applying these rules to bank employees, as well as any possible bases

for excluding such employees. In particular, for example, would it be

appropriate to exclude entities that are otherwise regulated under

federal or state law, such as banks and insurance companies?

We also wish to obtain further public comment on whether the

proposed rule change should be modified to reach the activities of

unregistered third-party telemarketing firms that independently

generate leads and then sell such leads to member firms. Since the

Association's jurisdiction would not extend to communications by third-

party telemarketing firms that are not made on behalf of a particular

member, we are concerned about a potential loophole in our proposed

rule change in that members may be able to avoid application of the

proposed rule change simply by purchasing leads from third-party

telemarketing firms that independently generate leads and/or prequalify

customers but do not do so on behalf of any particular member. On the

other hand, if a member repeatedly purchases leads from a third-party

telemarketing firm, the NASDR would take the position that the third-

party telemarketing firm is impliedly acting on behalf of the member

and would be subject to the provisions of the proposed rule change.

2. Statutory Basis

The NASDR believes that the proposed rule change is consistent with

the provisions of Section 15A(b)(6) of the Act,\4\ which require that

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

principles of trade, and generally provide for the protection of

investors and the public interest. The NASDR believes that the proposed

rule change codifying the Association's marketing and cold calling

restrictions, with the addition of specified supervisory requirements,

will sharply and effectively limit the marketing activities of

unregistered persons while ensuring the member firms closely supervise

and monitor the activities of unregistered persons marketing on their

behalf.

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\4\ 15 U.S.C. 78o-3(b)(6).

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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

NASD's Notice to Members 97-58 was published for comment in August

1997. Forty-three comments were received in response to the Notice. Of

the forty-three comment letters received, 14 were in favor of the

proposal and 25 were opposed, and 4 expressed no opinion.

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 written data, views and

arguments concerning the foregoing, including whether the proposed rule

change is consistent with the Act. In addition to any other issues that

the public may wish to address, the

[[Page 70177]]

Commission specifically requests comments on the following questions:

Should NASD member firms be permitted to use third-party

telemarketing firms for the limited marketing activities set forth in

the proposal (i.e., as unregistered marketers)?

To what extent are third-party telemarketing firms currently used

by member firms for cold calling or marketing purposes?

What types of member firms typically rely on third-party

telemarketing firms to conduct cold calling on their behalf (i.e.,

large firms, medium-sized, or small firms)?

The proposal requires member firms to ``periodically monitor'' the

calls made by unregistered persons on their behalf to ensure that the

discussions are limited to permissible topics. There is, however, no

requirement that such calls be tape recorded. How would member firms

monitor calls by unregistered persons working off-site at third-party

telemarketing firms or working for member firms off-site?

If a member firm can use third-party telemarketers, how can a

member firm be certain that unregistered persons working for third-

party telemarketing firms will limit their conversations with existing

and prospective members to the permissible topics?

Will the required ``reasonable background investigation'' be

sufficient to ensure that individuals who have been suspended from the

industry are not permitted to engage in limited marketing activities?

Would member firms be able to adequately supervise the limited

marketing activities of employees of third-party telemarketing firms?

What steps should firms take if a third-party telemarketer fails to

comply with these requirements?

What should the NASD do to ensure that such limited marketing

activities conducted off-site at third-party telemarketing firms are

appropriately supervised by member firms?

If the use of third-party telemarketing firms is permitted, the

proposal would require employees of third party telemarketing firms to

acknowledge in writing or electronically that they are associated

persons. The Commission notes that there is no requirement for an

electronic signature or any other heightened restrictions in place.

Will an electronic acknowledgment provide the member firm and the NASD

with sufficient information as to the true identity of the individual?

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 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. Copies of such 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-98-44 and should be

submitted by January 8, 1999.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\5\

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\5\ 17 CFR 200.30-3(a)(12).

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Jonathan G. Katz,

Secretary.

[FR Doc. 98-33558 Filed 12-17-98; 8:45 am]

BILLING CODE 8010-01-M