On November 24, 2006, the Municipal
Securities Rulemaking Board (“MSRB”) filed with the Securities and Exchange
Commission (“SEC”) a proposed rule change to amend Rule G-27, on supervision,
and the related recordkeeping and record retention provisions of Rules G-8 and
G-9. [1]
The MSRB has proposed that the amendments become effective six months after approval
by the SEC. [2]
MSRB Rule G-27, on supervision, requires brokers,
dealers and municipal securities dealers (collectively referred to as
“dealers”) to supervise their municipal securities activities by designating
individuals with supervisory responsibilities for municipal securities
activities, adopting written supervisory procedures, and reviewing transactions
and correspondence. Similarly, NASD Rule 3010 (Supervision) requires dealers
to establish a supervisory system, adopt written supervisory procedures, review
transactions and correspondence, and, most recently, to conduct internal
inspections with minimum inspection cycles. NASD also recently adopted new
Rule 3012 (Supervisory Control System) to require that dealers: (1) test and
verify that its supervisory procedures are sufficient, and amend or create
additional supervisory procedures where the testing and verification identify a
need; and (2) establish procedures that are reasonably designed to review and
supervise, on a day-to-day basis, the customer account activity conducted by
the dealer’s producing managers.
In April 2006, the MSRB published for comment draft
amendments to Rule G-27, which incorporated most of NASD requirements contained
in Rules 3010 and 3012, in order to promote regulatory consistency and make
these requirements specifically applicable to the municipal securities
activities of securities firms and bank dealers. [3]
The Board received two comment letters in response to the notice, both of which
expressed support for the draft amendments. [4]
Based on the comment letters received, as well as discussions with various
industry participants and the relevant regulatory agencies, the Board
determined to adopt the draft amendments with one substantive revision relating
to the designation of appropriate principal. Although the new supervisory activities required under the
proposed rule change are derived from NASD requirements, these activities
relate specifically to a dealer’s municipal securities activities and require
in-depth knowledge of MSRB rules. Therefore, the Board believes it is
appropriate that these supervisory activities be undertaken by a municipal
securities principal (or a municipal fund securities limited principal in the
case of activities related to municipal fund securities). The proposed rule
change clarifies these requirements by amending the “Appropriate
Principal” provision in Rule G-27(b)(ii)(C). [5]
The MSRB believes that adopting most of the
requirements of NASD Rules 3010 and 3012 will help ensure a coordinated
regulatory approach in the area of supervision, and will facilitate inspection
and enforcement. [6]
The proposed amendments to Rule G-27 are described below.
SUMMARY OF PROPOSED AMENDMENTS
The proposed amendments modify section
(b) of Rule G-27, on supervisory system; add new subsection (c)(ii), on tape
recording of conversations; add new subsection (c)(iii) on updating written
supervisory procedures; add new section (d), on internal inspections; add new
section (f), on supervisory control system; and add new definitions section (g).
As a general principle, the requirements of Rule G-27 apply only with respect
to those registered persons who engage in municipal securities activities and
those offices in which such municipal securities activities are undertaken
(regardless of the level or amount of such municipal securities activities).
Supervisory System
The proposed amendments modify section (b) of Rule
G-27, on supervisory system, to include the following five provisions: [7]
• Designation of certain locations as offices of supervisory
jurisdiction (“OSJ”) (G‑27(b)(iii));
• Designation of one or more appropriately registered principals in
each OSJ, including the main office, and one or more appropriately registered
representatives or principals in each non-OSJ branch office with authority to
carry out the supervisory responsibilities assigned to that office by the
dealer (G‑27(b)(iv));
• Assignment of each registered person to an appropriately
registered representative or principal who shall be responsible for supervising
that person’s activities (G‑27(b)(v));
• Reasonable efforts to determine that all supervisory personnel
are qualified by virtue of experience or training to carry out their assigned
responsibilities (G‑27(b)(vi)); and
• Participation of each registered representative and principal in
an annual meeting to discuss compliance matters (G-27(b)(vii)).
The amendments also include a reference in Rule G-27(b)(ii)(C)
to “municipal fund securities limited principal” that is added to explicitly
affirm the supervisory functions that such a principal may undertake pursuant
to Rule G-3, on professional qualifications. Specifically, paragraph
(b)(iv)(C) of Rule G-3 allows a municipal fund securities limited principal to
“undertake all actions required or permitted under any Board rule to be taken
by a municipal securities principal, but solely with respect to activities
related to municipal fund securities.”
Tape Recording of Conversations
The amendments incorporate NASD Rule
3010(b)(2), on tape recording of conversations, in Rule G-27(c)(ii).
Subsection (c)(ii) requires dealers to establish special supervisory
procedures, including the tape recording of conversations, when they have hired
more than a specified percentage of registered persons from certain firms that
have been expelled or have had their broker/dealer registrations revoked for
violations of sales practice rules. The requisite percentage varies
depending on the size of the dealer, from 40 percent for a small dealer to 20
percent for a larger dealer. The dealer must establish the required
supervisory procedures within 30 days of receiving notice from their registered
securities association or bank regulator, or obtaining actual knowledge that it
is subject to this provision of the rule.
Under this provision, if the requisite
percentage of a dealer’s sales force previously was employed by a disciplined
firm, the dealer will be required to adopt special written procedures to
supervise the telemarketing activities of all its registered persons. The
procedures require, at a minimum, that the dealer tape record all telephone
conversations between all of its registered persons and both existing and
potential customers for a period of two years. The measures required by
this provision are designed to prevent a recurrence of sales practice abuse or
other customer harm that caused the disciplined firm to have its registration
revoked.
This provision also requires dealers
subject to the taping requirement to establish reasonable procedures for
reviewing tape recordings to ensure compliance with securities laws and
applicable rules and regulations, to retain and catalog the tapes, and to
submit reports to the appropriate registered securities association or bank
regulator on their supervision of telemarketing.
Updating Written Supervisory Procedures
Subsection (c)(iii) is added to
replace existing section (e), which currently requires a dealer to revise and
update its written supervisory procedures as necessary to respond to
changes in Board or other applicable rules. Proposed subsection (c)(iii)
has language that mirrors the language in NASD Rule 3010(b)(4), and requires
each dealer to keep a copy of procedures at each location where supervisory
activities are conducted and to amend its written supervisory procedures within
a reasonable time after changes occur.
Internal Inspections
The amendments incorporate NASD Rule
3010(c), on internal inspections, in new section (d) under Rule
G-27. This new section imposes office inspection requirements that
establish minimum inspection cycles and delineate the topics that must be
covered during such inspections as well as the manner in which inspections are
documented. [8]
In addition, the amendments include new section (g) which defines the
designations “office of supervisory jurisdiction” and “branch office” used in
section (d), among other terms.
Mandatory Inspection Cycles. Section
(d) obligates dealers to inspect OSJs and supervisory branch offices on at
least an annual basis. [9]
It also requires dealers to inspect all non-supervisory branch offices at least
once every three years. It directs dealers, however, to consider when it
might be appropriate to conduct more frequent inspection of non-supervisory
branch offices. Further, Rule G-27(d) requires dealers to inspect non-branch
locations “on a regular periodic schedule.” Each dealer must document, as
part of its written supervisory procedures, an explanation of how the dealer
determined the frequency of its examination schedule. In establishing the
schedule, dealers should consider the nature and complexity of the securities
activities for which each non-branch location is responsible, and the frequency
of customer contact at the non-branch location.
Independent Office Inspections. Section
(d) places limits on who is eligible to perform the required inspection
function. This provision prohibits office inspections from being
performed by:
• the branch office manager;
• any person within the office who has supervisory
responsibilities; or
• any individual who is directly or indirectly supervised by
such person(s).
However, an exception to this limitation is provided if the dealer is so
limited in size and resources that it cannot comply with it.
Content of Inspections and Requirements for
Inspection Reports. Dealers must document each office inspection by
preparing a written report that documents when it conducted the inspection and
the results of its testing and verification in the following areas:
• Safeguarding customer funds and securities;
• Maintaining books and records;
• Supervising customer accounts services by branch office managers;
• Transmitting funds between customer and registered representative
and between customers and third parties;
• Validating customer address changes; and
• Validating changes in customer account information.
Heightened Inspection Requirements. Section
(d) also requires dealers to adopt, under certain circumstances, procedures
that require heightened inspections designed to avoid conflicts of interest
arising from economic, commercial or financial interests that the branch
manager’s supervisor holds in the person or activities being inspected. Such
heightened inspection procedures are required if (1) the person conducting the
inspection reports to the branch office manager’s supervisor or works in
an office supervised by the branch manager’s supervisor; and (2) the
branch office manager generates 20% or more of the revenue of the business
units supervised by the branch office manager’s supervisor.[10] Dealers must calculate the 20%
threshold in the same manner as when determining whether a producing manager
must be subject to heightened supervision, as described below.
Supervisory Control System
The amendments also include new
section (f), derived from NASD Rule 3012, which incorporates the following new
requirements:
Testing and Verification of Supervisory Control
Procedures. Section (f) requires dealers to designate and identify
one or more principals charged with establishing, maintaining and enforcing a
system of “supervisory control policies and procedures” that:
• test and verify that a dealer’s supervisory procedures are
reasonably designed to achieve compliance with the federal securities laws and
MSRB rules; and
• create additional or amended supervisory procedures where a need
for such procedures is identified by such testing.
Annual Submission of Report to
Senior Management. At least once annually, the principal(s)
designated under section (f) must submit a report to senior management that
details the dealer’s supervisory control policies and procedures, summarizes
the results of testing and identifies significant weaknesses, and discusses
additional or amended procedures implemented in response to such testing.
The Board recognizes that situations
may arise where a dealer is required under the rules of another self-regulatory
organization to produce a similar report. The Board does not intend for a
dealer to produce duplicative reports in such situations. Instead, for
purposes of this section (f), a dealer may prepare a single report so long as
there is coordination in the preparation and submission of such report between
any principal(s) designated by the dealer pursuant to the rules of another
self-regulatory organization and the principal designated under Rule
G-27(b)(ii)(C) or (f)(i). The dealer should adequately document such
coordination between or among the various principals.
Supervision of Producing Manager’s
Customer Account Activity. Section (f) requires dealers to adopt
procedures to review and supervise daily customer account activities of each
branch office manager, sales manager, regional or district sales manager, or
any person performing similar supervisory functions (“producing
managers”). These policies and procedures must include “a means of
customer confirmation, notification, or follow-up that can be
documented.” Specifically, the provision requires that policies and
procedures must be reasonably designed to review and monitor the following
activities:
• All transmittals of funds and securities to and from customer
accounts;
• Changes of customer’s address, including procedures to validate
change of address; and
• Changes in customer investment objectives, including validation
of such changes.[11]
Independent Review of Producing
Manager. Section (f) requires an independent review of the producing
manager. This review must be conducted by a person or persons who are
senior to, or “otherwise independent” of, the producing manager. To be
considered “otherwise independent” of the producing manager, the person
performing the review:
• must not report, either directly or indirectly, to the producing
manager he or she is reviewing;
• must be located at a different office than the producing manager;
• must not have supervisory authority over any of the activity
under review, including not being directly compensated in whole or in
part as a result of such activity; and
• must alternate such review responsibility with another person at
least once every two years.
Section (f) also requires dealers to
adopt, under certain circumstances, heightened supervisory procedures designed
to avoid conflicts of interest arising from economic, commercial or financial
interests that the supervisor holds in the person or activities being
supervised. Such heightened supervisory procedures are required with respect to
producing managers who are responsible for generating at least 20% of the
revenue of the business which is supervised by the producing manager’s
supervisor.[12]
As noted above, the relevant provisions of Rule G-27 would apply if any portion
of the 20% threshold is attributable to revenue generated through municipal
securities transactions. However, the heightened supervision requirement does
not apply where an otherwise independent person conducts the producing
manager’s reviews.
Finally, section (f) provides an
exception from the independent review requirement if a dealer is so limited in
size and resources that it is unable to identify anyone who is senior to or
otherwise independent of the producing manager to conduct the review (the
“limited size and resource” exception).
* * * * *
The MSRB intends generally that the
provisions of Rule G-27 be read consistently with the analogous NASD
provisions, unless the MSRB specifically indicates otherwise. Thus,
relevant NASD interpretations would be presumed to apply to the comparable MSRB
provision, subject to the MSRB’s right to make distinctions when necessary and
appropriate. The MSRB recommends that dealers, including bank dealers,
regularly visit or link to the relevant portions of the NASD web site on supervision
for current NASD interpretations of such analogous provisions.[13] Furthermore, the MSRB intends to
continue coordinating its requirements relating to supervision with those of
the other relevant self-regulatory organizations in the securities markets
whenever appropriate for dealers engaging in municipal securities transactions.
Finally,
NASD Rule 3012 (Supervisory Control System) provides that “Any member in
compliance with substantially similar requirements of the New York Stock
Exchange, Inc. shall be deemed to be in compliance with the provisions of this
Rule.” We note that the amendments to Rule G-27 incorporate substantially all
of NASD Rule 3012. Therefore, the MSRB believes that any dealer in compliance
with similar NASD or NYSE requirements would be deemed in compliance with the
comparable requirements of Rule G-27(f), on supervisory control system, so long
as there is coordination between or among any principal(s) designated by the
dealer pursuant to the rules of NASD or the NYSE and the appropriate principal
designated pursuant to Rule G-27(b)(ii)(C).
* * * * *
Questions concerning this notice should be directed
to Jill C. Finder, Assistant General Counsel, at 703-797-6600.
November 24, 2006
TEXT OF AMENDMENTS [14]
Rule G-27: Supervision
(a) Obligation to supervise. Each broker, dealer and municipal
securities dealer ("dealer") shall supervise the conduct of the
municipal securities activities of the dealer and its associated persons to
ensure compliance with Board rules and the applicable provisions of the Act and
rules thereunder (“applicable rules”).
(b) Supervisory System. Each dealer shall establish and maintain a
system to supervise the municipal securities activities of each registered
representative, registered principal, and other associated person that is
reasonably designed to achieve compliance with applicable securities laws and
regulations, and with applicable Board rules. Final responsibility for
proper supervision shall rest with the dealer. A dealer’s supervisory
system shall provide, at a minimum, for the following:
(i) The establishment and maintenance of written
procedures as required by sections (c), (d), (e) and (f) of this rule.
(ii)(A) General. The designation of one
or more associated persons qualified as municipal securities principals,
municipal securities sales principals, municipal fund securities limited
principals, financial and operations principals in accordance with Board rules,
or as general securities principals to be responsible for the supervision of
the municipal securities activities of the dealer and its associated persons as
required by this rule.
(B) Written Record. A
written record of each supervisory designation and of the designated
principal's responsibilities under this rule shall be maintained and updated as
required under Rule G-9.
(C) Appropriate Principal. Each
dealer shall designate a municipal securities principal as responsible for its
supervision under sections (a), (c), (d), (e) and (f) of this rule, except as
provided in this section. A non-bank dealer shall designate a financial and
operations principal as responsible for the financial reporting duties
specified in Rule G-3(d)(i)(A-E) and with primary responsibility for books and
records under paragraph (c)(i)(E) below; provided, however, that a non-bank
dealer meeting the requirements of Securities Exchange Act Rule
15c3-1(a)(2)(iv), (v) or (vi) or the exemption under Rule 15c3-1(b)(3) may, but
is not required to, designate a financial and operations principal as
responsible for such financial reporting duties and with primary responsibility
for such books and records. In addition, a municipal securities sales principal
may be designated as responsible for supervision under paragraphs (c)(i)(B),
(C) and (G) and subsection (e)(i) of this rule, to the extent the activities
pertain to sales to or purchases from a customer; a general securities
principal may be designated as responsible for supervision under paragraph
(c)(i)(E) and subparagraph (c)(i)(G)(1) of this rule and under Rules G-7(b) and
G-21(e); and a financial and operations principal may be designated as
responsible for supervision under paragraph (c)(i)(F) of this rule. A
municipal fund securities limited principal may be designated as responsible
for supervision under sections (a), (c), (d), (e) and (f) of this rule to the
extent that the activities pertain solely to transactions in municipal fund
securities.
(iii) The designation as an office of
supervisory jurisdiction of each location that meets the definition contained
in section (g) of this rule. Each dealer shall also designate such other
offices of supervisory jurisdiction as it determines to be necessary in order
to supervise its registered representatives, registered principals, and other
associated persons in accordance with the standards set forth in this rule,
taking into consideration the following factors:
(A) whether registered persons
at the location engage in retail sales or other activities involving
regular contact with public customers;
(B) whether a substantial
number of registered persons conduct securities activities at, or are
otherwise supervised from, such location;
(C) whether the location is
geographically distant from another office of supervisory jurisdiction of the
dealer;
(D) whether the dealer’s
registered persons are geographically dispersed; and
(E) whether the
securities activities at such location are diverse and/or complex.
(iv) The designation of one or more
appropriately registered principals in each office of supervisory jurisdiction,
including the main office, and one or more appropriately registered
representatives or principals in each non-office of supervisory jurisdiction
branch office with authority to carry out the supervisory responsibilities
assigned to that office by the dealer.
(v) The assignment of each registered person to
an appropriately registered representative(s) and/or principal(s) who shall be
responsible for supervising that person's activities.
(vi) Reasonable efforts to determine that all
supervisory personnel are qualified by virtue of experience or training to
carry out their assigned responsibilities.
(vii) The participation of each registered
representative and registered principal, either individually or collectively,
no less than annually, in an interview or meeting conducted by persons
designated by the dealer at which compliance matters relevant to the activities
of the representative(s) and principal(s) are discussed. Such interview or
meeting may occur in conjunction with the discussion of other matters and may
be conducted at a central or regional location or at the representative’s(’) or
principal’s(’) place of business.
[(b) Designation of principals.
(i) General. Each dealer shall specifically
designate one or more associated persons qualified as municipal securities
principals, municipal securities sales principals, financial and operations
principals in accordance with Board rules, or as general securities principals
to be responsible for the supervision of the municipal securities activities of
the dealer and its associated persons as required by this rule.
(ii) Written Record. A written record of
each supervisory designation and of the designated principal's responsibilities
under this rule shall be maintained and updated as required under rule G-9.
(iii) Appropriate principal. Each dealer
shall designate a municipal securities principal as responsible for its
supervision under sections (a) and (c) of this rule, except as provided in this
section. A non-bank dealer shall designate a financial and operations principal
as responsible for the financial reporting duties specified in rule
G-3(d)(i)(A-E) and with primary responsibility for books and records under
section (c)(v) below; provided, however, that a non-bank dealer meeting the
requirements of Securities Exchange Act rule 15c3-1(a)(2)(iv), (v) or (vi) or
the exemption under rule 15c3-1(b)(3) may, but is not required to, designate a
financial and operations principal as responsible for such financial reporting
duties and with primary responsibility for such books and records. In addition,
a municipal securities sales principal may be designated as responsible for
supervision under sections (c)(ii), (iii) and (vii) of this rule, to the extent
the activities pertain to sales to or purchases from a customer; a general
securities principal may be designated as responsible for supervision under
sections (c)(v) and (vii)(A) of this rule and under rules G-7(b) and G-21(e);
and a financial and operations principal may be designated as responsible for supervision
under section (c)(vi) of this rule.]
(c) Written supervisory procedures.
(i) General provisions. Each
dealer shall adopt, maintain and enforce written supervisory procedures
reasonably designed to ensure that the conduct of the municipal securities
activities of the dealer and its associated persons are in compliance as
required in section (a) of this rule. Such procedures shall codify the dealer’s
supervisory system for ensuring compliance and, at a minimum, shall establish
procedures
(A) [(i)] that state how a
designated principal shall monitor for compliance by the dealer with all
applicable rules and supervise the activities of associated persons specified
in [r]Rule G-3(a)(i);
(B) [(ii)] a designated
principal shall follow when a customer complaint concerning the dealer's
municipal securities activities is received;
(C) [(iii)] for the
regular and frequent review and approval by a designated principal of customer
accounts introduced or carried by the dealer in which transactions in municipal
securities are effected; such review shall be designed to ensure that such
transactions are in accordance with all applicable rules and to detect and
prevent irregularities and abuses;
(D) [(iv)] for the
periodic review by a designated principal of each office which engages in
municipal securities activities pursuant to section (d) of this rule;
(E) [(v)] for the
maintenance and preservation, by a designated principal, of the books and
records required to be maintained and preserved by [r]Rules G-8 and G-9
of the Board;
(F) [(vi)] for the
supervision by a designated principal of the processing, clearance, and in the
case of a non-bank dealer safekeeping of municipal securities; and
(G) [(vii)] for the prompt
review and written approval by a designated principal of:
(1) [(A)] the opening of
each customer account introduced or carried by the dealer in which transactions
in municipal securities may be effected; and
(2) [(B)] each
transaction in municipal securities on a daily basis, including each transaction
in municipal securities effected with or for a discretionary account introduced
or carried by the dealer.
(ii) Provisions concerning
tape recording of conversations.
(A) Each dealer that either is
notified by the applicable regulatory authority (as defined in subsection
(g)(iii)) or otherwise has actual knowledge that it meets one of the criteria
in paragraph (c)(ii)(H) relating to the employment history of its registered
persons at a disciplined firm (as defined in subsection (g)(v)) shall establish,
maintain, and enforce special written procedures for supervising the
telemarketing activities of all of its registered persons.
(B) The dealer must establish
and implement the supervisory procedures required by this subsection (ii)
within 60 days of receiving notice from the applicable regulatory authority or
obtaining actual knowledge that it is subject to the provisions of this
subsection.
A dealer that meets one of the
criteria in paragraph (c)(ii)(H) for the first time may reduce its staffing levels
to fall below the threshold levels within 30 days after receiving notice from
the applicable regulatory authority or obtaining actual knowledge that it is
subject to the provisions of paragraph (c)(ii)(H), provided the dealer promptly
notifies the applicable regulatory authority in writing of its becoming subject
to this rule. Once the dealer has reduced its staffing levels to fall below the
threshold levels, it shall not rehire a person terminated to accomplish the
staff reduction for a period of 180 days. On or prior to reducing staffing
levels pursuant to this paragraph (B), a dealer must provide the applicable
regulatory authority with written notice identifying the terminated person(s).
(C) The procedures required by
this subsection shall include tape-recording all telephone conversations
between the dealer's registered persons and both existing and potential
customers.
(D) The dealer shall establish
reasonable procedures for reviewing the tape recordings made pursuant to the
requirements of this subsection to ensure compliance with applicable securities
laws and regulations and applicable rules. The procedures must be appropriate
for the dealer's business, size, structure, and customers.
(E) All tape recordings made
pursuant to the requirements of this subsection shall be retained for a period
of not less than three years from the date the tape was created, the first two
years in an easily accessible place. Each dealer shall catalog the retained
tapes by registered person and date.
(F) Such procedures shall be
maintained for a period of three years from the date that the dealer
establishes and implements the procedures required by the provisions of this
subsection.
(G) By the 30th day of the
month following the end of each calendar quarter, each dealer subject to the
requirements of this subsection shall submit to the applicable regulatory
authority a report on the dealer's supervision of the telemarketing activities
of its registered persons.
(H) The following dealers shall
be required to adopt special supervisory procedures over the telemarketing
activities of their registered persons:
(1) A dealer with at least
five but fewer than ten registered persons, where 40% or more of its registered
persons have been associated with one or more disciplined firms in a registered
capacity within the last three years;
(2) A dealer with at least ten
but fewer than twenty registered persons, where four or more of its registered
persons have been associated with one or more disciplined firms in a registered
capacity within the last three years;
(3) A dealer with at least
twenty registered persons, where 20% or more of its registered persons have
been associated with one or more disciplined firms in a registered capacity
within the last three years.
(4) For purposes of the
calculations required in paragraph (H), dealers should not include registered
persons who:
(a) have been registered for
an aggregate total of 90 days or less with one or more disciplined firms within
the past three years; and
(b) do not have a disciplinary
history (as defined in subsection (g)(vi)).
(I) The applicable regulatory
authority, upon application and pursuant to such procedures as such authority
shall prescribe, may in exceptional circumstances, taking into consideration
all relevant factors, exempt such dealer unconditionally or on specified terms
and conditions from the requirements of this subsection (ii). A dealer
seeking an exemption must file a written application within 30 days after
receiving notice from the applicable regulatory authority or obtaining actual
knowledge that it meets one of the criteria in paragraph (c)(ii)(H). A dealer
that meets one of the criteria in paragraph (c)(ii)(H) for the first time may
elect to reduce its staffing levels pursuant to the provisions of paragraph
(c)(ii)(B) or, alternatively, to seek an exemption pursuant to paragraph
(c)(ii)(I), as appropriate; such a dealer may not seek relief from this rule by
both reducing its staffing levels pursuant to paragraph (c)(ii)(B) and
requesting an exemption.
(iii) Availability of and revisions to
written supervisory procedures. A copy of a dealer’s written supervisory
procedures, or the relevant portions thereof, shall be kept and maintained in
each office of supervisory jurisdiction and at each location where supervisory
activities are conducted on behalf of the dealer. Each dealer shall amend
its written supervisory procedures as appropriate within a reasonable time
after changes occur in Board or other applicable rules and as changes occur in
its supervisory system, and each dealer shall be responsible for communicating
amendments through its organization.
(d) Internal Inspections.
(i) Each dealer shall conduct a review, at least
annually, of the municipal securities activities in which it engages, which
review shall be reasonably designed to assist in detecting and preventing
violations of, and achieving compliance with, applicable securities laws and
regulations, and with applicable Board rules. Each dealer shall review the
municipal securities activities of each office, which shall include the
periodic examination of customer accounts to detect and prevent irregularities
or abuses.
(A) Each dealer shall inspect
at least annually every office of supervisory jurisdiction and any branch
office that supervises one or more non-branch locations.
(B) Each dealer shall inspect
at least every three years every branch office that does not supervise one or
more non-branch locations. In establishing how often to inspect each
non-supervisory branch office, the dealer shall consider whether the nature and
complexity of the securities activities for which the location is responsible,
the volume of business done, and the number of associated persons assigned to
the location require the non-supervisory branch office to be inspected more
frequently than every three years. If a dealer establishes a more frequent
inspection cycle, the dealer must ensure that at least every three years, the
inspection requirements enumerated in subsection (d)(ii) have been met. The
non-supervisory branch office examination cycle, an explanation of the factors
the dealer used in determining the frequency of the examinations in the cycle,
and the manner in which a dealer will comply with subsection (d)(ii) if using
more frequent inspections than every three years shall be set forth in the
dealer’s written supervisory and inspection procedures.
(C) Each dealer shall inspect
on a regular periodic schedule every non-branch location. In establishing such
schedule, the dealer shall consider the nature and complexity of the securities
activities for which the location is responsible and the nature and extent of
contact with customers. The schedule and an explanation regarding how the
dealer determined the frequency of the examination schedule shall be set forth
in the dealer’s written supervisory and inspection procedures.
Each dealer shall retain a written record of the dates upon which each
review and inspection is conducted.
(ii) An office inspection and review by a dealer
pursuant to subsection (d)(i) must be reduced to a written report and kept on
file by the dealer for a minimum of three years, unless the inspection is being
conducted pursuant to paragraph (d)(i)(C) and the regular periodic schedule is
longer than a three-year cycle, in which case the report must be kept on file
at least until the next inspection report has been written. The written
inspection report must also include, without limitation, the testing and
verification of the dealer’s policies and procedures, including supervisory policies
and procedures in the following areas:
(A) Safeguarding of customer
funds and securities;
(B) Maintaining books and
records;
(C) Supervision of customer
accounts serviced by branch office managers;
(D) Transmittal of funds
between customers and registered representatives and between customers and
third parties;
(E) Validation of customer
address changes; and
(F) Validation of changes in
customer account information.
If a dealer does not engage in all of the activities enumerated above,
the dealer must identify those activities in which it does not engage in the
written inspection report and document in the report that supervisory policies
and procedures for such activities must be in place before the dealer can
engage in them.
(iii) An office inspection by a dealer pursuant
to subsection (d)(i) may not be conducted by the branch office manager or any
person within that office who has supervisory responsibilities or by any
individual who is supervised by such person(s). However, if a dealer is so limited
in size and resources that it cannot comply with this limitation (e.g., a
dealer with only one office or a dealer has a business model where small or
single-person offices report directly to an office of supervisory jurisdiction
manager who is also considered the offices’ branch office manager), the dealer
may have a principal who has the requisite knowledge to conduct an office
inspection perform the inspections. The dealer, however, must document in the
office inspection reports the factors it has relied upon in determining that it
is so limited in size and resources that it has no other alternative than to
comply in this manner.
A dealer must have in place procedures that are
reasonably designed to provide heightened office inspections if the person conducting
the inspection reports to the branch office manager’s supervisor or works in an
office supervised by the branch manager’s supervisor and the branch office
manager generates 20% or more of the revenue of the business units supervised
by the branch office manager’s supervisor. For the purposes of this subsection
(d)(iii) only, the term "heightened inspection" shall mean those
inspection procedures that are designed to avoid conflicts of interest that
serve to undermine complete and effective inspection because of the economic,
commercial, or financial interests that the branch manager’s supervisor holds
in the associated persons and businesses being inspected. In addition, for the
purpose of this subsection only, when calculating the 20% threshold, all of the
revenue generated by or credited to the branch office or branch office manager
shall be attributed as revenue generated by the business units supervised by
the branch office manager’s supervisor irrespective of a dealer’s internal
allocation of such revenue. A dealer must calculate the 20% threshold on a
rolling, twelve-month basis.
(e) [(d)] Review of Correspondence.
(i) Supervision of Municipal Securities
Representatives. Each dealer shall establish procedures for the review by a
designated principal of incoming and outgoing written (i.e., non-electronic)
and electronic correspondence of its municipal securities representatives with
the public relating to the municipal securities activities of such dealer. Such
procedures must be in writing and be designed to reasonably supervise each
municipal securities representative. Evidence that these supervisory procedures
have been implemented and carried out must be maintained and made available,
upon request, to a registered securities association or the appropriate
regulatory agency [as defined in section 3(a)(34) of the Act].
(ii) Review of correspondence.
Each dealer shall develop written procedures that are appropriate to its
business, size, structure, and customers for the review of incoming and outgoing
written (i.e., non-electronic) and electronic correspondence with the public
relating to its municipal securities activities, including review for
compliance with Rule G-21(e)(vii) to the extent applicable to such dealer’s
business. Procedures shall include the review of incoming, written
correspondence directed to municipal securities representatives and related to
the dealer’s municipal securities activities to properly identify and handle
customer complaints and to ensure that customer funds and securities are
handled in accordance with the dealer’s procedures. Where such procedures for
the review of correspondence do not require review of all correspondence prior
to use or distribution, they must include provisions for the education and
training of associated persons as to the dealer's procedures governing
correspondence; documentation of such education and training; and surveillance
and follow-up to ensure that such procedures are implemented and adhered to.
(iii) Retention of correspondence. Each dealer
shall retain correspondence of municipal securities representatives relating to
its municipal securities activities in accordance with [r]Rules
G-8(a)(xx) and G-9(b)(viii) and (xiv). The names of the persons who prepared
outgoing correspondence and who reviewed the correspondence shall be
ascertainable from the retained records and the retained records shall be
readily available, upon request, to a registered securities association or the
appropriate regulatory agency [as defined in Section 3(a)(34) of the Act].
[(e) Duty to update and review written procedures. Each dealer shall revise
and update its written supervisory procedures as necessary to respond to
changes in Board or other applicable rules and as other circumstances require.
In addition, each dealer shall review, at least on an annual basis, its
supervisory system and written supervisory procedures adopted under sections
(c) and (d) of this rule to determine whether they are adequate and up-to-date
and shall ensure that the dealer is in compliance with this rule.]
(f) Supervisory Control System.
(i) Each dealer shall designate one or more
principals who shall establish, maintain, and enforce a system of supervisory
control policies and procedures that (A) test and verify that the dealer’s
supervisory procedures are reasonably designed with respect to the municipal
securities activities of the dealer and its registered representatives and
associated persons to achieve compliance with applicable rules and (B) create
additional or amend supervisory procedures where the need is identified by such
testing and verification. The designated principal or principals must submit to
the dealer’s senior management no less than annually a report detailing each
dealer’s system of supervisory controls, the summary of the test results and
significant identified exceptions, and any additional or amended supervisory
procedures created in response to the test results.
(ii) The establishment, maintenance, and
enforcement of written supervisory control policies and procedures pursuant to
subsection (f)(i) shall include:
(A) procedures that are
reasonably designed to review and supervise the customer account activity
conducted by the dealer’s branch office managers, sales managers, regional or
district sales managers, or any person performing a similar supervisory
function.
(1) General Supervisory
Requirement. A person who is either senior to, or otherwise independent
of, the producing manager must perform such supervisory reviews. For purposes
of this rule, an "otherwise independent" person: may not report
either directly or indirectly to the producing manager under review; must be
situated in an office other than the office of the producing manager; must not
otherwise have supervisory responsibility over the activity being reviewed
(including not being directly compensated based in whole or in part on the
revenues accruing for those activities); and must alternate such review
responsibility with another qualified person every two years or less.
(2) “Limited Size and
Resources” Exception. If a dealer is so limited in size and resources
that there is no qualified person senior to, or otherwise independent of, the
producing manager to conduct the reviews pursuant to subparagraph (1) above
(e.g., a dealer has only one office or an insufficient number of qualified
personnel who can conduct reviews on a two-year rotation), the reviews may be
conducted by a principal who is sufficiently knowledgeable of the dealer's
supervisory control procedures, provided that the reviews are in compliance
with subparagraph (1) to the extent practicable.
(3) Notification Requirement.
If a dealer determines that it must rely on the "limited size and
resources" exception set forth in subparagraph (2) above to conduct any of
its producing managers' supervisory reviews, the dealer must notify the
applicable regulatory authority through an electronic process (or any other
process prescribed by such authority) within 30 days of the date on which the
dealer first relies on the exception, and annually thereafter. If a
dealer subsequently determines that it no longer needs to rely on the exception
to conduct any of its producing managers’ supervisory reviews, the dealer must,
within 30 days of ceasing to rely on the exception, notify the applicable
regulatory authority by using the electronic process or any other process
prescribed by such authority.
(4) Documentation
Requirement. A dealer relying on subparagraph (2) above must document in
its supervisory control procedures the factors used to determine that complete
compliance with all of the provisions of subparagraph (1) is not possible and
that the required supervisory systems and procedures in place with respect to
any producing manager comply with the provisions of subparagraph (1) above to
the extent practicable.
(B) procedures that are
reasonably designed to review and monitor the following activities:
(1) all transmittals of funds
(e.g., wires or checks, etc.) or securities from customers to third party
accounts (i.e., a transmittal that would result in a change of beneficial
ownership); from customer accounts to outside entities (e.g., banks, investment
companies, etc.); from customer accounts to locations other than a customer's
primary residence (e.g., post office box, "in care of" accounts,
alternate address, etc.); and between customers and registered representatives,
including the hand-delivery of checks;
(2) customer changes of
address and the validation of such changes of address; and
(3) customer changes of
investment objectives and the validation of such changes of investment
objectives.
The policies and procedures established pursuant
to this paragraph (f)(ii)(B) must include a means or method of customer
confirmation, notification, or follow-up that can be documented. If a dealer
does not engage in all of the activities enumerated above, the dealer must
identify those activities in which it does not engage in its written
supervisory control policies and procedures and document in those policies and
procedures that additional supervisory policies and procedures for such
activities must be in place before the dealer can engage in them; and
(C) procedures that are
reasonably designed to provide heightened supervision over the activities of
each producing manager who is responsible for generating 20% or more of the
revenue of the business units supervised by the producing manager's supervisor.
For the purposes of this subsection only, the term "heightened
supervision" shall mean those supervisory procedures that evidence supervisory
activities that are designed to avoid conflicts of interest that serve to
undermine complete and effective supervision because of the economic,
commercial, or financial interests that the supervisor holds in the associated
persons and businesses being supervised. In addition, for the purpose of this
section only, when calculating the 20% threshold, all of the revenue generated
by or credited to the producing manager or the producing manager's office shall
be attributed as revenue generated by the business units supervised by the
producing manager's supervisor irrespective of a dealer's internal allocation
of such revenue. A dealer must calculate the 20% threshold on a rolling,
twelve-month basis.
(g) Definitions. For purposes of this rule, the following terms
have the following meanings:
(i) "Office of supervisory
jurisdiction" means any office of a dealer at which any one or more of the
following functions take place:
(A) order execution and/or
market making;
(B) structuring of public
offerings or private placements;
(C) maintaining custody of
customers' funds and/or securities;
(D) final acceptance (approval)
of new accounts on behalf of the dealer;
(E) review and endorsement of
customer orders, pursuant to subparagraph (c)(i)(G)(2) above;
(F) final approval of
advertising or sales literature for use by persons associated with the dealer,
pursuant to Rule G-21(f); or
(G) responsibility for
supervising the activities of persons associated with the dealer at one or more
other branch offices of the dealer.
(ii)(A) A "branch office" is any
location where one or more associated persons of a dealer regularly conducts
the business of effecting any transactions in, or inducing or attempting to
induce the purchase or sale of any municipal security, or is held out as such,
excluding:
(1) Any location that is
established solely for customer service and/or back office type functions where
no sales activities are conducted and that is not held out to the public as a
branch office;
(2) Any location that is the
associated person's primary residence; provided that
(a) Only one associated
person, or multiple associated persons who reside at that location and are
members of the same immediate family, conduct business at the location;
(b) The location is not held
out to the public as an office and the associated person does not meet with
customers at the location;
(c) Neither customer funds nor
securities are handled at that location;
(d) The associated person is
assigned to a designated branch office, and such designated branch office is
reflected on all business cards, stationery, advertisements and other
communications to the public by such associated person;
(e) The associated person's
correspondence and communications with the public are subject to the dealer's
supervision in accordance with this rule;
(f) Electronic communications
(e.g., e-mail) are made through the dealer's electronic system;
(g) All orders are entered
through the designated branch office or an electronic system established by the
dealer that is reviewable at the branch office;
(h) Written supervisory
procedures pertaining to supervision of sales activities conducted at the
residence are maintained by the dealer; and
(i) A list of the residence
locations is maintained by the dealer;
(3) Any location, other than a
primary residence, that is used for municipal securities activities for less
than 30 business days in any one calendar year, provided the dealer complies
with the provisions of clauses (ii)(A)(2)(a) through (h) above;
(4) Any office of convenience,
where associated persons occasionally and exclusively by appointment meet with
customers, which is not held out to the public as an office. Where such
office of convenience is located on bank premises, signage necessary to comply
with applicable federal and state laws, rules and regulations, and applicable
rules and regulations of any self-regulatory organizations and securities and
banking regulators, may be displayed and shall not be deemed “holding out” for
the purposes of this section;
(5) Any location that is used
primarily to engage in non-securities activities and from which the associated
person(s) effects no more than 25 securities transactions in any one calendar
year; provided that any advertisement or sales literature identifying such
location also sets forth the address and telephone number of the location from
which the associated person(s) conducting business at the non-branch locations
are directly supervised;
(6) The floor of a registered
national securities exchange where a dealer conducts a direct access business
with public customers; or
(7) A temporary location
established in response to the implementation of a business continuity plan.
(B) Notwithstanding the
exclusions in paragraph (ii)(A), any location that is responsible for
supervising the activities of persons associated with the dealer at one or more
non-branch locations of the dealer is considered to be a branch office.
(C) The term "business
day" as used in paragraph (ii)(A) shall not include any partial business
day provided that the associated person spends at least four hours on such
business day at his or her designated branch office during the hours that such
office is normally open for business.
(iii) “Applicable regulatory authority” means
(i) with respect to a dealer that is a member of a registered securities
association, such registered securities association, and (ii) with respect to
any other dealer, the appropriate regulatory agency as defined in Section
3(a)(34) of the Act.
(iv) "Registered person" means any
person qualified to act as a representative, principal or limited principal
pursuant to Rule G-3.
(v) "Disciplined firm" means either a
dealer that, in connection with sales practices involving the offer, purchase,
or sale of any security, has been expelled from membership or participation in
any securities industry self-regulatory organization or is subject to an order
of the Securities and Exchange Commission revoking its registration as a
broker/dealer; or a futures commission merchant or introducing broker that has
been formally charged by either the Commodity Futures Trading Commission or a
registered futures association with deceptive telemarketing practices or
promotional material relating to security futures, those charges have been
resolved, and the futures commission merchant or introducing broker has been
closed down and permanently barred from the futures industry as a result of
those charges; or a futures commission merchant or introducing broker that, in
connection with sales practices involving the offer, purchase, or sale of
security futures is subject to an order of the Securities and Exchange
Commission revoking its registration as a broker or dealer.
(vi) "Disciplinary history" means a
finding of violation by a registered person in the past five years by the
Securities and Exchange Commission, a self-regulatory organization, or a
foreign financial regulatory authority of one or more of the following rules
(or comparable foreign provision): Sections 15(b)(4)(E) and 15(c) of the Act;
Section 17(a) of the Securities Act of 1933; SEC Rules 10b-5 and 15g-1 through
15g-9; NASD Rules 2110, 2120, 2310, 2330, 2440, 3010 (failure to supervise
only), 3310, and 3330; MSRB Rules G-19, G-30, and G-37(b) and (c).
Rule G-8: Books and Records to be Made by Brokers, Dealers and Municipal
Securities Dealers
(a)(i) – (xiii) No change.
(xiv) Designation of Persons Responsible for Recordkeeping.
A record of all designations of persons responsible for the maintenance and
preservation of books and records as required by rule G-27(b)(ii)(B).
(xv) - (xix) No change.
(xx) Records Concerning Compliance with Rule G-27. Each broker,
dealer and municipal securities dealer shall maintain the records required
under G-27(c), [and G-27](d), (e) and (f) .
(xxi) - (xxii) No change.
(b) – (g) No change.
Rule G-9: Preservation of Records
(a) Records to be Preserved for Six Years. Every broker, dealer and
municipal securities dealer shall preserve the following records for a period
of not less than six years:
(i) – (vi) No change.
(vii) the record, described in rule G-27(b)(ii)(B),
of each person designated as responsible for supervision of the municipal
securities activities of the broker, dealer, or municipal securities dealer and
the designated principal’s supervisory responsibilities, provided that such
record shall be preserved for the period of designation of each person
designated and for at least six years following any change in such designation;
(viii) – (x) No change.
(b) – (g) No change.
