Summary
On
November 29, 2005, the Securities and Exchange Commission (“SEC” or
“Commission”) approved amendments1 (the “Amendments”) to
the Interpretation of NYSE Rule 342 (“Offices – Approval,
Supervision and Control”) (see Exhibit A) that, subject to Exchange
approval, allow for the designation of certain branch offices as
“limited purpose offices.” The “limited purpose office” is a new
category that is intended to address branch office locations with
Registered Representatives (“RRs”) that may conduct limited business
activities, may not offer a full range of products, or that may have
limited registration qualifications (e.g., Series 6 – Investment
Company and Variable Contracts Products Representative or Series 52
– Municipal Securities Representative). The Amendments are effective
immediately.
Prior to the
Amendments, all member and member organization branch offices,
except for “small offices,” were required to have an on-site
qualified branch office manager2 (a “small office” is
limited to a total of three RRs).3 The Amendments set
forth a process by which members and member organizations may seek a
waiver of the on-site qualified manager requirement, pursuant to
criteria prescribed in the amended Interpretation of Rule 342.15,
for certain branch offices with more than three RRs. An office for
which such a waiver is granted would be designated a “limited
purpose office.”
Background
As member organizations have been
confronted with and challenged by the ever-changing demographics of
their workforce, as well as with evolving regulatory and market
environments, many have responded by altering the ways in which
their business is conducted. For example, there has been a
significant increase in the number of small, multi-function offices
that offer a combination of services related not only to securities
brokerage, but also to banking and insurance products. Concurrently,
advances in technology have resulted in increasingly sophisticated
surveillance capabilities that enable member organizations to more
effectively supervise and control the business activities of their
associated persons in such offices from off-site locations, such as
another branch office or a firm’s regional or main office.
Given these surveillance and
monitoring capabilities, and the limited nature or scope of
securities-related business activities conducted in these offices,
the requirement to have an on-site qualified branch office manager
may often be neither practical nor necessary from either a business
or a regulatory perspective. Consequently, the Exchange has
determined that requiring on-site supervision for all branch offices
with four or more RRs is no longer necessary under all
circumstances, and that alternate criteria, such as limited
securities sales activity coupled with proper risk-based supervisory
controls and follow-up, should be determining factors for granting
regulatory relief previously available only to small
offices.4
Gramm-Leach-Bliley
Act
Prior to the adoption of the
Gramm-Leach-Bliley Act (the “GLBA”),5 banks were
completely exempted from the definition of the terms “broker” and
“dealer” under the Securities Exchange Act of 1934 (the “Exchange
Act”).6 The GLBA amended the definition of these terms
and replaced the full exception with functional exceptions. Thus,
under the current terms of the Exchange Act, banks must either limit
their securities activities to those that fit within the functional
exceptions, or conduct those activities through a registered
broker-dealer. As a result, many banks with affiliated
broker-dealers have entered into business arrangements with those
broker-dealers to ensure that non-excepted “broker” or “dealer”
activities are properly conducted.
One common practice is for the two entities to “dually
employ” personnel acting in both a banking and a broker or dealer
capacity. This enables banking personnel to register and qualify for
securities license exam qualifications, such as the Series 6
(Investment Company and Variable Contracts Products Representative),
the Series 7 (General Securities Registered Representative) and the
Series 66 (Uniform Combined State Law), in order to conduct broker
and dealer activities on behalf of the registered broker-dealer
affiliate. Other broker-dealer alliances, primarily those with
insurance companies and investment companies, have engaged in dual
employment arrangements to allow for referral business among various
registered entities.
Because the
dually employed persons often primarily conduct business (e.g.,
banking, insurance) other than broker or dealer activities, they
typically physically remain on bank or insurance company premises.
However, because they are also employees of the registered
broker-dealer, the office is considered to be a branch office,
unless exempted pursuant to NYSE Rule 342.10.7
Further, as noted above, a branch
office with more than three RRs has historically been required to
have an on-site qualified branch office manager. This approach
hasn’t offered much flexibility to shared, multi-function
broker-dealer offices with more than three RRs, but without a full
line of securities products and services. Often, offering a limited
selection of securities products is an accommodation to customers of
the bank or insurance company, complementary to such entities’
traditional activities. Some broker-dealer business models are
becoming more reliant on offices of more than three RRs servicing
geographically isolated locations with an abbreviated securities
product/services menu. Because of the limited scope of
securities-related business conducted in these offices, members and
member organizations often have the technological capability to
adequately supervise and control them without having a qualified
branch office manager on-site.
Pursuant to NYSE Rule 342, all offices of members and
member organizations must be subject to an effective system of
supervision and control. As broker-dealers have incorporated
technological advancements into their business activities, they have
been able to make greater use of electronic means to enhance overall
supervision and control. For instance, some firms have enacted
policies and procedures that require their RRs to communicate
through internal e-mail systems which are used by supervisors and
firms for monitoring and surveillance purposes. Centralized
communication networks are likewise used to help monitor trading
activity and the handling of funds in customer accounts serviced in
branch offices. All such activities are generally transacted through
a broker-dealer’s internal order management system, which feeds
surveillance systems and exception reports.
These systems, and the reports generated by them, have
become increasingly important tools utilized by firm personnel to
perform a wide range of regulatory functions including, but not
limited to, the monitoring of registration and continuing education
status; review of customer and employee trade activity; new account
review and approval; order error corrections; customer changes of
address, mutual fund switch exceptions, and the monitoring of
various risk-control parameters.
Given that the development of technologically
sophisticated systems has automated and enhanced many aspects of the
supervisory process and expanded the range of supervisory functions
that can be conducted remotely, the Exchange believes greater
flexibility is appropriate in determining whether a qualified
on-site branch office manager is necessary for offices with more
than three RRs if only a limited range of securities-related
services is offered, or if a limited level of activity is conducted.
The Amendments address this need. Further, they give increased
flexibility to member organizations that acquire new offices through
merger, acquisition or regulatory change, to structure their
business activities in a logical and cost effective manner while
enabling compliance with Exchange supervisory requirements.
Under the revised Interpretation of
Rule 342, members and member organizations seeking a waiver of the
on-site qualified branch office manager requirement for “limited
purpose offices” are required to provide a written plan of
risk-based supervision and control acceptable to the Exchange.
Notwithstanding the grant of a waiver, all limited purpose offices
are required to be under the close supervision and control of a
qualified person, as defined under Rule 342.13, at the main office
or other designated branch office.
The Exchange believes that allowing a risk-based
approach to supervision for “limited purpose offices” will benefit
member organizations’ diverse business models while maintaining the
integrity of their supervision and control systems. The
Interpretation sets forth the following factors to be considered by
the Exchange in determining whether a location qualifies as a
Limited Purpose Office:
(i) the number of registered
persons in the office (the RR to offsite Branch Office Manager
ratio), their registration category, and the functions they perform
(the nature and level of the RRs’ responsibilities would be taken
into account);
(ii) the
scope and types of business activities conducted (in general, the
nature of business should not pose special risks or otherwise
warrant on-site supervision);
(iii) the nature and complexity of products and
services offered (likewise, the products and services offered should
not pose special risks or otherwise warrant on-site supervision);
(iv) the volume of business done
(e.g.,
annual revenues, number of transactions, number of customers, etc.)
Locations with high activity levels would generally be deemed more
likely to require an on-site manager;
(v) the adequacy of procedures to supervise the
“limited purpose office” activities (such procedures must take into
account (i) through (iv) above, as well as any other regulatory
issues particular to the office in question (e.g., the disciplinary
history of branch office personnel) ; and
(vi) the adequacy and independence of systems and
supervisory persons for regular and “for cause” internal and third
party inspections and audits.8
With respect to factors (v) and
(vi) above, the Exchange expects members and member organizations to
present a system of supervision and control reasonably designed to
detect and prevent regulatory violations and which otherwise meets
the requirements of Rule 342. Such a system should include, but is
not limited to, the following elements, where applicable:
(1) clearly articulated policies
and procedures, and sufficient resources to implement them;
(2) systematic monitoring of
activity using routine and exception reporting
criteria;
(3) an appropriate system
of follow-up and review if “red flags” are detected, and mechanisms
for verifying that deficiencies are corrected;
(4) routine and “for cause” inspections, including
possible use of unannounced surprise
inspections;
(5) offsite monitoring
of trading, handling of funds, and use of personal
computers;
(6) adequate designation
of supervisors and clearly delineated supervisory responsibilities,
including a system of review and follow-up to ensure that such
supervision is sufficiently independent and is diligently
exercised;
(7) monitoring of
outside business activities and outside
accounts;
(8) monitoring and
surveillance of internal and external communications;
and
(9) the education and training
of RRs and their supervisors to ensure they understand their
responsibilities under the firm’s procedures and all applicable
securities laws.
In addition to the
factors enumerated above, members and member organizations should
also take into consideration relevant guidance provided by the
Exchange and other regulatory bodies when developing their
supervisory plan for a proposed “limited purpose
office.”9
All of the
above factors will be considered in their totality by the Exchange
to determine whether an application for “limited purpose office”
status should be granted. If an application for “limited purpose
office” status encompasses more than one office, pursuant to a
categorical description or plan, the member organization must submit
the proposed list of prospective offices so as to disclose the scope
of the request.
Members and member
organizations are responsible for maintaining a readily available,
current and accurate list of all locations either specifically
approved and designated by the Exchange as a “limited purpose
office” or otherwise designated as such pursuant to a general
categorical description or plan approved by the Exchange. Further,
any material change with respect to the representations made by any
member or member organization pursuant to this Interpretation with
respect to any location so approved and designated must be promptly
brought to the attention of the Exchange for reconsideration.
Applications for “limited purpose
office” status may be directed to:
The New York Stock Exchange
Rule and Interpretive Standards (23rd
floor)
20 Broad Street
New York, NY 10005
Questions regarding this Information Memo may be
directed to William Jannace at (212) 656-2744 or Stephen A. Kasprzak
at (212) 656-5226.
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