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).
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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).
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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.
