Summary
On
November 16, 2005, the Securities and Exchange Commission (“SEC” or
“Commission”) approved amendments1 (the “Amendments”) to
New York Stock Exchange (“NYSE” or the “Exchange”) Rule 342
(“Offices – Approval, Supervision and Control”) and its
Interpretation that require each member not associated with a member
organization (“non-associated member”) and each member organization
to file with the Exchange, by April 1st of each year, a
report (the “Annual Report”) that addresses the member’s or member
organization’s supervision and compliance efforts during the
preceding calendar year, as well as ongoing compliance processes and
procedures.
The Amendments also
require that each member organization’s Annual Report include the
designation of a principal executive officer or general partner as
Chief Compliance Officer (“CCO”). The Amendments further require
that the Annual Report include a certification, signed by the
non-associated member or the Chief Executive Officer (“CEO”) of the
member organization submitting it, that processes are in place to
establish, maintain and review policies and procedures reasonably
designed to achieve compliance with applicable Exchange rules and
federal securities laws and regulations (a sample Certification Form
is included as Exhibit C). These requirements are discussed in
greater detail below. The amendments are effective immediately; the
annual report for calendar year 2005 is due April 1,
2006.2
Rule
Amendments
Submission of Annual Report to the
Exchange
NYSE Rule 342 generally requires
supervision of the offices, departments, and business activities
of members and member organizations. Rule 342.30 requires each
non-associated member and each member organization to prepare a
report addressing prescribed supervisory and compliance issues by
April 1st of each year. Specifically, this Annual
Report requires:
a) A tabulation
of the reports pertaining to customer complaints and internal
investigations made to the Exchange during the preceding year
pursuant to NYSE Rules 351(d) and (e)(ii);
b) Identification and analysis of significant
compliance problems, plans for future systems or procedures to
prevent and detect violations and problems, and an assessment of the
preceding year’s efforts of this nature; and
c) Discussion of the preceding year’s compliance
efforts, new procedures, educational programs, etc. in each of the
following areas:
i) Antifraud and
trading practices
ii) Investment
banking activities
iii) Sales
practices
iv) Books and
records
v) Finance and
operations
vi) Supervision
vii) Internal controls,
and
viii) Anti-money laundering.
Prior to the Amendments, Rule 342.30
required that each Annual Report prepared by a member organization
be submitted to that member organization’s CEO or managing partner
by April 1st of each year. Such reports have typically been provided
to the Exchange at the time of, or in connection with, examinations
of members and member organizations. The Amendments now require that
each Annual Report be filed with the Exchange by April 1st of each
year.3 The Amendments further require that the Annual
Report address the non-associated member’s or member organization’s
ongoing compliance processes and procedures, which would include any
proposed or prospective regulatory initiatives.
The filing of Annual Reports with the Exchange will
provide it with timely information about the compliance efforts and
related issues of its membership, thus strengthening and rendering
more efficient its ability to conduct regulatory oversight.
In addition, note that the
Amendments now require that the scope of the report be expanded to
address anti-money laundering issues.
Addition of Anti-Money
Laundering Discussion to Annual Report
The USA PATRIOT Act4 has
imposed significant new requirements on the securities industry and
directed new focus on the way in which it addresses issues related
to anti-money laundering. Accordingly, the Amendments now require
that compliance efforts relative to anti-money
laundering5 be addressed in the Annual Report. The
addition of anti-money laundering policies and procedures to the
list of required areas to be addressed in the Annual Report reflects
the importance attached to these critical regulatory functions, and
is the continuation of a process intended to focus attention on
specific areas of concern that have emerged in connection with an
evolving regulatory environment.6
Designation of Chief
Compliance Officer
The
Amendments require that each member organization designate a
principal executive officer or general partner as CCO.7
This requirement recognizes the importance the Exchange places on
regulatory compliance functions8 in member organizations,
and emphasizes the critical role of the CCO in administering these
functions.9
The
Amendments include criteria to further clarify the qualification
requirements of designated CCOs.10 Specifically, the
amended Interpretation of Rule 342 provides that a CCO must have
adequate knowledge of the following:
1. The products, services or line functions that need
to be the subject of written compliance policies and written
supervisory procedures;
2. The relevant rules,
regulations, laws and standards of conduct pertaining to such
products, services or line functions based on experience and or
consultation with those persons who have a technical expertise in
such areas of the member’s or member organization’s
business;
3. Developing, or
advising business persons charged with the obligation to develop,
policies and procedures that are reasonably designed to achieve
compliance with those relevant rules, regulations, laws and
standards of conduct as prescribed by the applicable self-regulatory
organizations and the SEC;
4. The
process of supervision by line managers who are responsible for the
execution of compliance procedures; and
5. Developing programs to test compliance with the
member’s or member organization’s policies and procedures.
Note that while Exchange Rule 311(b)(5)
requires that “principal executive officers” exercise responsibility
over each of the prescribed business areas of a member organization,
the Amendments do not define compliance functions to be a “business
area.” While the Exchange strongly believes that the responsibility
to ensure compliance with the multitude of regulatory requirements
should be accorded the same importance as that accorded the
oversight of business areas, a CCO designation does not, in and of
itself, imply or impart supervisory responsibilities over business
line functions. Such determinations are made on a case-by-case
basis, subject to a facts and circumstances analysis.
A person holding the CCO designation is
not precluded from performing other duties or holding other
designations, including that of CEO, provided such arrangements
otherwise comply with Rule 311 and its Interpretation, and do not
compromise the designee’s professional
effectiveness.11
CEO
Certification
The
Amendments require that each non-associated member and each member
organization’s CEO (or equivalent officer) certify12 that
processes are in place to:
A) establish, maintain and review
policies and procedures reasonably designed
to achieve compliance with applicable
Exchange rules and federal securities
laws and regulations;
B) modify such
policies and procedures as business, regulatory and legislative
changes and events dictate; and
C) test the effectiveness of such
policies and procedures on a periodic basis, the timing of which is
reasonably designed to ensure continuing compliance with Exchange
and federal securities laws and regulations.
In addition, the certification of
each member organization’s CEO (or equivalent officer) must include
the following:
1) That he or she
has conducted one or more meetings with the CCO during the preceding
12 months, and that they discussed and reviewed the matters
described in the certification, including the organization’s prior
compliance efforts, and identified and addressed significant
compliance problems and plans for emerging business areas.
The substance of such meetings
should be the identification and resolution of any significant or
ongoing compliance problems, as well the regulatory implications
related to any emerging business areas. It is the Exchange’s
expectation that the CEO certification requirement will result in a
meaningful and substantive interaction between the CEO, CCO, and
others responsible for the member organization’s regulatory
compliance. The overarching purpose of this process is to provide
the CEO with an informed basis for the certification. Accordingly,
mere pro forma meetings that do not substantively support the
certification will not comply with the requirements of the
rule.
2) That the member organization’s
compliance processes13 are evidenced in a written report
that has been reviewed by the CEO (or equivalent officer), the CCO,
and other such officers of the member organization as the
organization may deem necessary to make the certification, and that
such report has been submitted to the organization’s board of
directors and audit committee (if such committee
exists).14
The report
must be produced prior to the execution of the CEO certification and
include the manner in which the member organization’s compliance
processes are administered and the identity of the officers and
supervisors who have responsibility for its administration.
3) That
he or she has consulted with the CCO, and other officers of the
member organization, and outside consultants, lawyers and
accountants to the extent they deem appropriate in order to attest
to the statements made in the certification.
The expertise of the CCO in the matters that form the
basis for the certification make his or her role in the process
critical and, thus, make the CCO an indispensable party to the CEO’s
signature of the certification.
Interpretive Guidance
Amendments to the Interpretation of
Rule 342.30 provide the following interpretive guidance15
with respect to the Annual Certification:
· Any certification made by a
CEO or equivalent officer under circumstances where the CCO has
concluded, after the consultations contemplated in this procedure,
that there is an inadequate basis for making such certification
would be, without limitation, a failure to adhere to the principles
of good business practice and a violation of Rule 401 (Business
Conduct).
· The requirement that a member’s or member
organization’s processes include a review of the report by the board
of directors and audit committee does not apply to members and
member organizations that do not utilize these types of governing
bodies and committees in the conduct of their
business.
· Compliance with the time and content requirements of
Rule 342.30(e)(ii) pertaining to meetings between the chief
executive officer (or equivalent officer) and the chief compliance
officer does not necessarily satisfy the full extent of the
obligations under such rule, which will vary with the facts and
circumstances of a member’s or member organization’s business
activities and organizational structure.
· The report required in Rule
342.30(e)(iii) must be produced prior to execution of the
certification and be reviewed by the chief executive officer (or
equivalent officer), chief compliance officer and any other officers
the member organization deems necessary to make the certification
and must be provided to the member organization’s board of directors
and audit committee.
· The report required in Rule 342.30(e)(iii) must
document the member organization’s processes for establishing,
maintaining, reviewing, testing and modifying compliance policies
that are reasonably designed to achieve compliance with applicable
Exchange rules and federal securities laws and regulations. Any
member, allied member or other person designated by the member
organization pursuant to Rule 342(b) may prepare the report. The
report should include the manner and frequency in which the
processes are administered, as well as the identification of
officers and supervisors who have responsibility for such
administration.
· The report may be combined with any other compliance
report or other similar report required by any other self-regulatory
organization provided that (1) such report is clearly titled in a
manner indicating that it is responsive to the requirements of the
certification; (2) a member or member organization that submits a
report for review in response to an Exchange request must submit it
in its entirety; and (3) the member or member organization must make
such a report in a timely manner as required by the rule.
Questions regarding this memo may
be directed to Gregory F. Taylor at (212) 656-2920, Stephen Kasprzak
at (212) 656-5226 or William Jannace at (212)
656-2744.
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