Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”)  and Rule 19b-4 thereunder, notice is hereby given that on September 2, 1999, the National Association of Securities Dealers, Inc. (“NASD” or “Association”), through its wholly owned subsidiary NASD Regulation, Inc. (“NASD” or “Association”), through its wholly owned subsidiary NASD Regulation, Inc. (“NASD Regulation”) filed with the Securities and Exchange Commission (“SEC” or “Commission”) a proposed rule change as described in Items I, II, and III below, which Items have been prepared by NASD Regulation. The Commission is publishing this notice to Start Printed Page 45415solicit comments on the proposed rule change from interested persons.
I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change
NASD Regulation is proposing to amend NASD Rule 2330(f)(2), in order to make it consistent with recent amendments by the Commission to Rule 205-3 under the Investment Advisers Act of 1940 (“Advisers Act”). Below is the text of the proposed rule change. Proposed new language is in italics; proposed deletions are in brackets.
Rules of the Association
2300. Transactions With Customers
2330. Customers' Securities or Funds
(a) through (e) (No change).
(f) Sharing in Accounts; Extent Permissible.
(1)(A) and (B) (No change).
(2) Notwithstanding the prohibition of paragraph (f)(1), a member or person associated with a member may receive compensation based on a share in profits or gains in an account if [all of] the following conditions are satisfied:[*]
(A) The member or person associated with a member seeking such compensation obtains prior written authorization from the member carrying the account; and
(B) The compensation arrangement complies with the conditions set forth in any applicable rule promulgated by the Commission.
[(B) The customer has at the time the account is opened either a net worth which the member or person associated with a member reasonably believes to be not less than $1,000,000, or the minimum amount invested in the account is not less than $500,000;
(C) The member or person associated with a member reasonably believes the customer is able to understand the proposed method of compensation and its risks prior to entering into the arrangement;
(D) The compensation arrangement is set forth in a written agreement executed by the customer and the member;
(E) The member or person associated with a member reasonably believes, immediately prior to entering into the arrangement, that the agreement represents an arm's-length arrangement between the parties;
(F) The compensation formula takes into account both gains and losses realized or accrued in the account over a period of at least one year; and
(G) The member has disclosed to the customer all material information relating to the arrangement including the method of compensation and potential conflicts of interest which may result from the compensation formula.]
II. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis of, the Proposed Rule Change
In its filing with the Commission, NASD Regulation included statements concerning the purpose of, and basis for, the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. NASD Regulation has prepared summaries, set forth in Sections A, B, and C below, of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change
Description of Proposed Rule Change. NASD Rule 2330(f) prohibits members and persons associated with members form sharing in customer account profits and gains except under certain conditions. Subparagraph (f)(1)(A) permits sharing in customer account profits and gains where the firm has authorized it and the sharing is proportionate to the member's or associated person's contributions to the account. Subparagraph (f)(2) permits, under certain conditions, members or registered representatives to charge a performance fee (an advisory fee based on a percentage of the capital gains or capital appreciation of an account). Currently, NASD Rule 2330(f)(2) permits the receipt of a performance fee only if: (1) The member or associated person reasonably believes that the customer account meets certain minimum net worth ($1,000,000) or amount invested ($500,000) requirements; (ii) the member or associated person obtains the prior written authorization of the arrangement from the member carrying the account; (iii) the member or associated person reasonably believes that the customer is able to understand the compensation arrangement and its risks; (iv) the compensation agreement is in writing; (v) the member or associated person reasonably believes that the agreement is an arm's length agreement; (vi) the compensation formula takes into account realized and accrued gains and losses over a period of at least one year; and (vii) the member discloses all material information relating to the agreement, including method of compensation and potential conflicts of interest.
The requirements of NASD Rule 2330(f)(2) have always closely tracked the requirements of Rule 205-3 under the Advisers Act. However, effective August 20, 1998, the Commission amended Rule 205-3 to provide greater flexibility in structuring performance fee arrangements with clients who are financially sophisticated or have the resources to obtain sophisticated financial advice regarding these arrangements. The amendments to Rule 205-3 changed and eliminated many of the requirements tracked in NASD Rule 2330(f)(2). As a result of these changes, NASD Rule 2330(f)(2) is now inconsistent with Rule 205-3 under the Advisers Act. In order to restore consistency, the proposed rule change will permit members and their associated persons to share in customer account profits and gains subject to the provisions of Rule 205-3 under the Advisers Act. Thus, in the future, the proposed rule will conform to any subsequent amendments by the Commission to Rule 205-3.
2. Statutory Basis
NASD Regulation believes that the proposed rule change is consistent with the provisions of Section 15A(b)(6) of the Act, which requires, among other things, that the Association's rules be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, and, in general, to protect investors and the public interest. NASD Regulation believes that the proposed rule change will protect investors and the public interest by ensuring that performance fee arrangements are consistent with Commission rules and are structured with clients who are Start Printed Page 45416financially sophisticated or have the resources to obtain sophisticated financial advice regarding the terms of these arrangements.
B. Self-Regulatory Organization's Statement on Burden on Competition
NASD Regulation does not believe that the proposed rule change will result in any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act.
C. Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others
No written comments were solicited or received with respect to the proposed rule change.
III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action
Within 35 days of the date of publication of this notice in the Federal Register or within such longer period (i) as the Commission may designate up to 90 days of such date if it finds such longer period to be appropriate and publishes its reasons for so finding or (ii) as to which NASD Regulation consents, the Commission will:
(A) By order approve such proposed rule change, or
(B) Institute proceedings to determine whether the proposed rule change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. In particular, the Commission seeks comment on how a broker-dealer can best meet its fiduciary obligation to ensure that its customers fully understand the performance fee arrangement. In formulating comments on this proposal, commenters are advised to refer to Advirsors Act Release No. 1731. Persons making written submissions should file six copies thereof with the Secretary, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, DC 20549-0609. Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission's Public Reference Room. Copies of such filing will also be available for inspection and copying at the principal office of the NASD. All submissions should refer to the File No. SR-NASD-99-42 and should be submitted by August 11, 2000.Start Signature
For the Commission, by the Division of Market Regulation, pursuant to delegated authority.
Jonathan G. Katz,
*. It is the position of the Division of Investment Management of the Commission that compensation received by a member or person associated with a member under t his Rule would constitute “special compensation” for purposes of th e broker/dealer exception to the definition of “investment adviser” in Section 202(a)(11)(C) of the Investment Advisers Act of 1940 (Advisers Act). Any member or person associated with a member, required to be registered under the Advisers Act, or state law, who receives compensation based on a share of profits or capital appreciation of a customer's account must comply with Section 205(1) and Rule 205-3 under the Advisers Act, or applicable state law, with respect to such compensation. (SEC Release 34-24355, 52 FR 13778, April 24, 1987).Back to Citation
3. See Investment Advisors Act Release No. 1731 (July 15, 1998), 63 FR 39022 (July 21, 1998).Back to Citation
[FR Doc. 00-18493 Filed 7-20-00; 8:45 am]
BILLING CODE 8010-01-M