On March 16, 2000, the Securities and Exchange Commission approved amendments to rules G-8, on books and records, G-9, on preservation of records, and G-27, on supervision.[1] The amendments will become effective on September 19, 2000. The amendments will allow brokers, dealers and municipal securities dealers ("dealers") to develop flexible supervisory procedures for the review of correspondence with the public. This notice is being issued to provide guidance to dealers on how to implement these rules.

Background

Technology has greatly expanded how communications between dealers and their customers take place. These new means of communication (e.g., e-mail, Internet) will continue to significantly affect the manner in which dealers and their associated persons conduct their business. While these changes allow timely and efficient communication with customers, prospective customers, and others, the significant changes in communications media and capacity raise questions regarding supervision, review, and retention of correspondence with the public.

In May 1996, the SEC issued an Interpretive Release on the use of Electronic Media by Broker-Dealers, Transfer Agents, and Investment Advisors for Delivery of Information.[2] That release expressed the views of the SEC with respect to the delivery of information through electronic media in satisfaction of requirements in the federal securities laws, but did not address the applicability of any self-regulatory organization ("SRO") rules. In its release the SEC did, however, strongly encourage the SROs to work with broker/dealer firms to adapt SRO supervisory review requirements governing communications with customers to accommodate the use of electronic communications.[3]

On December 31, 1997, the SEC approved proposed rule changes filed by the National Association of Securities Dealers ("NASD")[4] and the New York Stock Exchange ("NYSE")[5] to update rules governing supervision of communication with the public. NASD Notice to Members 98-11 announced approval of the proposed rule change, provided guidance to firms on how to implement these rules and stated that the amendments to NASD Rules 3010 and 3110 would be effective on February 15, 1998. Over the next year, further amendments were made to NASD Rules 3010 and 3110. NASD Regulation received final SEC approval of amendments to Rule 3010 on November 30, 1998.[6] The rule amendments were effective on March 15, 1999.[7]

As amended, NASD Rule 3010(d)(1) provides that procedures for review of correspondence with the public relating to a member's investment banking or securities business be designed to provide reasonable supervision for each registered representative, be described in an organization's written supervisory procedures, and be evidenced in an appropriate manner. NASD Rule 3010(d)(2) requires each member to develop written policies and procedures for review of correspondence with the public relating to its investment banking or securities business tailored to its structure and the nature and size of its business and customers. These procedures must also include the review of incoming, written correspondence directed to registered representatives and related to the member's investment banking or securities business to properly identify and handle customer complaints and to ensure that customer funds and securities are handled in accordance with firm procedures.

The Board has determined to adopt substantially similar rule changes. The Board believes that conforming its rule language to the language in the NASD rules will help ensure a coordinated regulatory approach to the supervision of correspondence.

Amended Rules

Rule G-27(d)(i), as revised, provides that procedures for review of correspondence with the public relating to a dealer's municipal securities activities be designed to provide reasonable supervision for each municipal securities representative, be described in the dealer's written supervisory procedures, and be evidenced in an appropriate manner.

Rule G-27(d)(ii) requires each dealer to develop written policies and procedures for review of correspondence with the public relating to its municipal securities activities, tailored to its structure and the nature and size of its business and customers. The rule requires that any dealer that does not conduct either an electronic or manual pre-use review will be required to:

• develop appropriate supervisory procedures;

• monitor and test to ensure these policies and procedures are being implemented and complied with;

• provide education and training to all appropriate employees concerning the dealer's current policies and procedures governing correspondence, and update this training as policies and procedures are changed; and

• maintain records documenting how and when employees are educated and trained.

The rule change states that these procedures must also 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.

It is the understanding and view of the Board that dealers possess the legal capacity to insist that mail addressed to their offices be deemed to be related to their businesses, even if marked to the attention of a particular associated person, if they advise associated persons that personal correspondence should not be received at their firms. Dealers, other than non-NASD member bank dealers, are reminded that SEC Rule 17a-4(b)(4) requires that "originals of all communications received . . . by such member, broker or dealer, relating to its business as such . . ." must be preserved for not less than three years.

The retention requirements of the amendments to rule G-27 cross reference rules G-8(a)(xx) and G-9(b)(viii) and (xiv) and state that the names of persons who prepared, reviewed and approved correspondence must be readily ascertainable from the retained records. The records must be made available, upon request, to the appropriate enforcement agency (i.e., NASD or federal bank regulatory agency).

Guidelines For Supervision And Review

In adopting review procedures pursuant to rule G-27(d)(i), dealers must:

• specify, in writing, the dealer's policies and procedures for reviewing different types of correspondence;

• identify how supervisory reviews will be conducted and documented;

• identify what types of correspondence will be pre- or post-reviewed;

• identify the organizational position(s) responsible for conducting review of the different types of correspondence;

• specify the minimum frequency of the reviews for each type of correspondence;

• monitor the implementation of and compliance with the dealer's procedures for reviewing public correspondence; and

• periodically re-evaluate the effectiveness of the dealer's procedures for reviewing public correspondence and consider any necessary revisions.

In conducting reviews, dealers may use reasonable sampling techniques. As an example of appropriate evidence of review, e-mail related to the dealer's municipal securities activities may be reviewed electronically and the evidence of review may be recorded electronically.

In developing supervisory procedures for the review of correspondence with the public pursuant to rule G-27(d)(ii), each dealer must consider its structure, the nature and size of its business, other pertinent characteristics, and the appropriateness of implementing uniform firm-wide procedures or tailored procedures (i.e., by specific function, office/location, individual, or group of persons).

In adopting review procedures pursuant to rule G-27(d)(ii), dealers must, at a minimum:

• specify procedures for reviewing municipal securities representatives' recommendations to customers;

• require supervisory review of some of each municipal securities representative's public correspondence, including recommendations to customers;

• consider the complaint and overall disciplinary history, if any, of municipal securities representatives and other employees (with particular emphasis on complaints regarding written or oral communications with clients); and

• consider the nature and extent of training provided municipal securities representatives and other employees, as well as their experience in using communications media (although a dealer's procedures may not eliminate or provide for minimal supervisory reviews based on an employee's training or level of experience in using communications media).

Although dealers may consider the number, size, and location of offices, as well as the volume of correspondence overall or in specific areas of the organization, dealers must nonetheless develop appropriate supervisory policies and procedures in light of their duty to supervise their associated persons. The factors listed above are not exclusive and dealers must consider all appropriate factors when developing their supervisory procedures and implementing their supervisory reviews.

Supervisory policy and procedures must also:

• provide that all customer complaints, whether received via e-mail or in written form from the customer, are kept and maintained;

• describe any dealer standards for the content of different types of correspondence; and

• prohibit municipal securities representatives' and other employees' use of electronic correspondence to the public unless such communications are subject to supervisory and review procedures developed by the dealer. For example, the Board would expect dealers to prohibit correspondence with customers from employees' home computers or through third party systems unless the dealer is capable of monitoring such communications.

The method used for conducting reviews of incoming, written correspondence to identify customer complaints and funds may vary depending on the dealer's office structure. Where the office structure permits review of all correspondence, dealers should designate a municipal securities representative or other appropriate person to open and review correspondence prior to use or distribution to identify customer complaints and funds. The designated person must not be supervised or under the control of the municipal securities representative whose correspondence is opened and reviewed. Unregistered persons who have received sufficient training to enable them to identify complaints and funds would be permitted to review correspondence.

Where the office structure does not permit the review of correspondence prior to use or distribution, appropriate procedures that could be adopted include the following:

• forwarding opened incoming written correspondence related to the dealer's municipal securities activities to a designated office, or supervising branch office, for review on a weekly basis;

• maintenance of a separate log for all checks received and securities products sold, which is forwarded to the supervising branch office on a weekly basis;

• communication to clients that they can contact the dealer directly for any matter, including the filing of a complaint, and providing them with an address and telephone number of a central office of the dealer for this purpose; and

• branch examination verification that the procedures are being followed.

Regardless of the method used for initial review of incoming, written correspondence, as with other types of correspondence, rule G-27 would still require review by a designated principal of some of each municipal securities representative's correspondence with the public relating to the dealer's municipal securities activities. Given the complexity and cost of establishing appropriate systems for effectively reviewing electronic communications, some members may determine to conduct a pre-use or distribution review of all incoming and outgoing correspondence (written or electronic).

Dealers must continually assess the effectiveness of these supervisory systems. Education and training must be timely (prior to or concurrent with implementation of the policies and procedures) and must include all appropriate employees. Dealers may incorporate the required education and training on correspondence into their Continuing Education Firm Element Training Program (see rule G-3(h) on continuing education requirements). The requirement for training regarding correspondence may also apply to employees who are not included under the Continuing Education requirements.

Municipal securities representative: credit department employees. This will acknowledge receipt of your letter of October 18, 1979, concerning a proposed arrangement for the performance of municipal credit analysis functions at your bank. In your letter you indicate that the bank wishes to have certain basic statistical and data gathering activities with respect to proposed new issues of municipal securities performed by its Credit Department. The Credit Department will provide the information resulting from these activities to registered personnel in the Investment Department, which will evaluate the credit of the issuer and determine the appropriateness of the issue for the bank's own investment activities and for the bank's customers. You inquire whether the personnel in the Credit Department would be required to register and qualify as municipal securities representatives due to their performance of these activities.

Your question was referred to a committee of the Board which has the responsibility for administering the professional qualifications program on the Board's behalf. The Committee concluded that such persons would not be required to register and qualify as representatives if their functions are limited to information-gathering and performance of basic statistical computations. However, if such persons engage in any type of evaluative activity or if such persons make recommendations or suggest conclusions with respect to the securities, registration and qualification would be required. Further, should these persons produce any documents or research products intended for distribution or for use in the solicitation of customers, they would be required to register and qualify. MSRB interpretation of December 10, 1979.

Legend satisfying requirement. I refer to your letter of June 29, 1979 in which you request advice regarding rule G-21(c) on product advertisements. As you noted in your letter, the notice of approval of rule G-34 [prior rule on advertising] stated that the Board believes that the advertisements may be misleading if they show

only a percentage rate without specifying whether it is the coupon rate or yield and, if yield, the basis on which calculated (for example, discount, par or premium securities and if discount securities, whether before-tax or after-tax yield).

You have requested advice as whether the following legend, to be used in connection with the sale of discount bonds, would be satisfactory for purposes of the rule:

"Discount bonds may be subject to capital gains tax. Rates of such tax vary for individual taxpayers. Discount yields shown herein are gross yields to maturity."

As I previously indicated to you in our telephone conversation, the proposed legend would satisfy the requirements of rule G-21(c). MSRB interpretation of August 28, 1979.

Records of original entry. This will acknowledge receipt of your letter of June 13, 1979, concerning the requirement under Board rule G-8 for records of original entry. In your letter you discuss a "Bond Register" used by your firm, which is organized by security, and presents on separate cards all transactions in particular securities arranged in chronological order. You inquire whether this is satisfactory for purposes of the Board's recordkeeping rule.

The "record of original entry" required under rule G-8(a)(i) is intended to reflect all transactions effected by a municipal securities dealer on a particular day, all transactions cleared on such day, and all receipts and disbursements of cash on such day. The record is intended to provide a complete review of the dealer's activity for the day in question. It is therefore necessary that the record be organized by date. A record organized by security would not serve the purposes of a record of original entry as envisioned in the Board's rule. MSRB interpretation of August 9, 1979.

Clerical or ministerial duties. I refer to your letter of June 22, 1979, in which you request advice regarding the applicability of rule G-3 on professional qualifications to an employee of [Company name deleted]. According to your letter, the activities of the employee in question are limited to checking the mathematical accuracy of bids received by an issuer for which [Company name deleted] acts as financial advisor and reporting the results to the issuer.

Based on the facts stated in your letter, the employee is not required to qualify as a municipal securities representative under rule G-3. The Board does not intend the qualification requirements of the rule to apply to persons performing solely clerical or ministerial functions, such as in this case. MSRB interpretation of July 24, 1979.

Maintenance of securities record. I refer to your letter of April 9, 1979 concerning rule G-8(a)(iii), which requires the maintenance of a securities record. This letter is intended to address your questions concerning that provision.

Rule G-8(a)(iii) requires every municipal securities dealer to make and keep

records showing separately for each municipal security all positions (including, in the case of a municipal securities dealer other than a bank dealer, securities in safekeeping) carried by such municipal securities dealer for its own account or for the account of a customer (with all "short" trading positions so designated), the location of all such securities long and the offsetting position to all such securities short, and the name or other designation of the account in which each position is carried.

Rule G-8(a)(iii) further provides that "[s]uch records shall consist of a single record system...," and that "...a bank dealer shall maintain records of the location of securities in its own trading account."

The purpose of the requirement to maintain a "securities record" is to provide a means of securities control, ensuring that all securities owned by the dealer or with respect to which the dealer has outstanding contractual commitments are accounted for in the dealer's records. To achieve this purpose, the record is commonly constructed in "trial balance" format, with information as to the "ownership" of securities reflected on the "long," or debit side, and information as to the location on the "short," or credit side of the record. The record therefore serves a different function from the subsidiary records, such as the "fail" records, required to be maintained under other provisions of the rule. The subsidiary records reflect the details of particular securities transactions; the securities record assures that a municipal securities dealer's over-all position is in balance.

In your letter you inquire specifically whether this record can be constructed through the use of duplicate copies of subsidiary records. The rule requires a system of records organized by security, showing all positions in such security. Record systems organized by position or locations, showing all securities held in such position or location, cannot serve the same balancing and control function.

The securities record, however, does not have to be maintained on a single sheet or ledger card per security. Although this is the most common means of maintaining a securities record, certain municipal securities dealers prepare segments of the record in different physical locations, bringing the segments together at the close of the business day to compose the securities record. This practice is permissible under the rule.

Finally, you have inquired regarding the possibility of maintaining the securities record on a unit system basis. Records in such a system are kept in the form of a group of documents or related groups of documents, most often files of duplicate confirmations. The maintenance of the securities record on such a basis would be acceptable provided that the required information is clearly and accurately reflected and there is an adequate basis for audit. I would note, however, that utilization of a unit system would probably only be feasible for a municipal securities dealer with very limited activity.

I hope this letter is helpful to you in responding to inquiries from your members. If you or any of your members have any further questions regarding this matter, please do not hesitate to contact us. MSRB interpretation of April 16, 1979.

Furnishing of official statements: duplication of copies. [It] is the Board’s position that if an official statement is made available by an issuer, it is incumbent upon municipal securities dealers to see that their customers receive copies of the official statement. A municipal securities dealer cannot avoid the rule on the grounds that the issuer did not supply a sufficient number of official statements for distribution. The dealer in such a case has to bear the burden of reproducing the official statement. MSRB interpretation of March 7, 1979.

Note: The above letter refers to the text of rule G-32 as in effect prior to the amendments effective on August 30, 1985.

Particularity of legend. I refer to your recent letter in which you inquired regarding the appropriateness of using a particular legend to satisfy certain requirements of rule G-15 on customer confirmations. As you note in your letter, rule G-15 requires that information concerning time of execution of a transaction and the identity of the contra-side of an agency transaction be furnished to customers, at least upon request. You have requested advice as to whether the following legend satisfies the requirements of rule G-15 with respect to this information:

"Other details about this trade may be obtained by written request to the above address."

We are of the opinion that the legend in question does not satisfy the requirements of rule G-15 because it is too general in nature. The legend does not sufficiently apprise customers of their right to obtain information pertaining to the time of execution of a transaction or the identity of the contra-party, as contemplated by rule G-15. A legend specifically alluding to the availability of such information is necessary to satisfy the rule.

The Board has not adopted a standardized form, nor approved particular language for use in compliance with the requirements of the rule. I believe, however, that [Name deleted] is a member of the Dealer Bank Association. I suggest that you refer to the Forms Book prepared by the Dealer Bank Association, which may be of help to you. MSRB interpretation of March 6, 1979.

Employer of customer’s spouse. This will acknowledge receipt of your letter of January 10, 1979, requesting an interpretive opinion with respect to rule G-28 of the Municipal Securities Rulemaking Board (the "Board"). Rule G-28 requires a municipal securities dealer to take certain specified actions in connection with municipal securities transactions effected for the account of customers who are employed by, or the partner of another municipal securities dealer or for or on behalf of the spouse or minor child of such a person. I understand from a subsequent conversation which we had that your principal concern is whether a municipal securities dealer must obtain information regarding the employer of a spouse of a current customer, in view of the requirements of rule G-28.

Although rule G-28 applies to the spouse or minor child of a customer who is employed by another municipal securities dealer, there is no requirement at the present time in rule G-28 or in rule G-8, the recordkeeping rule, for a municipal securities dealer to obtain information about the employment status of spouses or minor children. Accordingly, a municipal securities dealer does not have to inquire of current customers whether their spouses are employed by another municipal securities dealer. A municipal securities dealer would have to comply with rule G-28 if the dealer actually knows that a spouse is employed by another municipal securities dealer. MSRB interpretation of March 6, 1979.