SEC_training

Each year the Securities Industry/Regulatory Council on Continuing Education (Council) identifies and recommends to firms pertinent regulation and sales practice issues for possible inclusion in Firm Element training plans. Included in this Firm Element Advisory are topics which the Council considers to be particularly relevant to the industry at this time. The list is based on a review of recent regulatory events, as well as advisories issued by industry self-regulatory organizations (SROs) since the last Firm Element Advisory of September 1999. The Council recommends using the Firm Element Advisory when undertaking your annual Firm Element Needs Analysis to identify training topics. Select the training topics from the Firm Element Advisory that are relevant to your firm’s business and use the related training point and reference material (available on the SRO Web Sites) as part of the training specified in your written Firm Element training plan. Other training topics may be prompted by a review of previous issues of the Firm Element Advisory, new rules, customer complaints, regulatory examination findings, or new products or services your firm plans to offer to investors. Remember that the topics included in your written training plan should be relevant to your firm’s unique situation including any supervisory needs you identify. Training programs should be appropriate to your firm’s size and structure. The Council will periodically highlight additional relevant regulatory areas to assist the industry and it invites your assistance. Please direct your comments, suggestions or questions about this and future issues of the Firm Element Advisory to either Roni Meikle, Continuing Education Manager, the New York Stock Exchange (NYSE), at (212) 656-2156; or John Linnehan, Director, Continuing Education, NASD Regulation, Inc. (NASD RegulationSM), at (240) 386-4684. Firm Element Advisory—October 2000 1 CEP The Securities Industry Continuing Education Program The Securities Industry Continuing Education Program Firm Element Advisory Firm Element Advisory—October 2000 2 Training Topic Relevant Training Point(s) and Reference(s) Decimalization The securities industry is preparing to convert to decimal pricing. The industry began conversion on a pilot basis in August 2000, consistent with the timetable set by Securities and Exchange Commission (SEC) order. Decimal trading will ultimately increase the number of possible trading increments within a dollar from 16 to 100. Decimal pricing should make prices more easily understood by individual investors. Spreads in highly liquid stocks may tighten, thereby providing potential savings for investors, particularly if the minimum price variation is reduced to a penny. Decimalization may also improve the competitiveness of U.S. markets on a global basis. See SEC Release No. 34-42914, “Order Directing the Exchanges and the National Association of Securities Dealers, Inc. to Submit a Phase-In Plan to Implement Decimal Pricing in Equity Securities and Options Pursuant to Section 11 (a)(3)(B) of the Securities Exchange Act of 1934,” dated June 8, 2000. Also see these Web Sites: NASD Regulation (www.nasdr.com); New York Stock Exchange (www.nyse.com/decimalization); Securities Industry Association (www.sia.com/decimalization) Foreign Jurisdictions Sales Practices It has come to the attention of the SROs that persons associated with broker/dealers may be soliciting business in the regulators’ jurisdictions in violation of local foreign laws. Members considering soliciting business in foreign jurisdictions should ensure that such activities comply with all applicable laws. The consequences of breaching applicable foreign laws can be far-reaching, and broker/dealers in violation of particular foreign laws may be committing a criminal offense and be liable to prosecution. See NASD Notice to Members 00-02, NASD Alerts Members To Their Obligations Concerning Soliciting Business In Foreign Jurisdictions, January 2000. Firm Element Advisory—October 2000 3 Training Topic Relevant Training Point(s) and Reference(s) Investment Banking Securities Offerings Under SEC Rule 504 And Intra-State Offerings SEC Rule 504 provides an exemption from registration under Section 5 of the Securities Act of 1933 (Securities Act) for offerings of up to $1 million of securities. The SEC amended Rule 504 in early 1992 to provide that securities sold under Rule 504 will be deemed “restricted securities” under SEC Rule 144, and general solicitation and advertising will be prohibited unless the offering is: 1) registered in at least one state that requires public filing and delivery of a disclosure document before sale; or 2) offered exclusively in states that provide exemptions from registration and permit general solicitation and advertising, but that require that sales be made only to “accredited investors.” Securities deemed to be “restricted securities” under SEC Rule 144 may only be sold into the public market in compliance with the holding period, manner of sale, and volume restrictions of that rule. The NASD has amended its rules to clarify that Rule 504 offerings that are public offerings of unrestricted securities are required to be filed with NASD Regulation for review of underwriting terms and arrangements under NASD Rules 2710 and 2810, and compliance with the requirements of NASD Rule 2720. See NASD Notice to Members 00-12, Amendments Adopted To Clarify The Application Of NASD Rules To Offerings Under SEC Rule 504 And Intra-State- Only Offerings, February 2000. Margin Options Changes to Option Margin Rules – Effective January 20, 2000, the SEC approved changes to the margin rules of the Chicago Board Options Exchange (CBOE) and NYSE. Some of the changes include, but are not limited to, loan value on long-term options (LEAPS); reduced maintenance requirements for stock hedged with options; certain spreads, if comprised of European style index options, can be carried in a cash account. Firm Element Advisory—October 2000 4 Training Topic Relevant Training Point(s) and Reference(s) Margin Options (continued) The significant changes are summarized below: • The types of option strategies eligible for cash accounts have been expanded; • The amendments establish reduced maintenance margin requirements for certain hedged option strategies; • The amendments also allow for loan value on certain LEAPS; • The minimum margin requirement on short, uncovered puts is now based on the exercise price of the option; and • New definitions of butterfly spreads and box spreads have been added. See CBOE Regulatory Circular RG00-22, Option Mar- gin Rule Changes, and NYSE Information Memo No. 99-59, “Amendments to Rule 431(“Margin Require- ments”) Regarding Options”, December 31, 1999. Municipal Securities Consultants Municipal Securities Rulemaking Board (MSRB) Rule G-38 defines a consultant as any person used by a dealer to obtain or retain municipal securities business through direct or indirect communication by such person with an issuer on the dealer’s behalf where the communication is undertaken by such person in exchange for, or with the understanding of receiving, payment from the dealer or any other person. Dealers must disclose to issuers certain information about their consultants and report certain information about their consultants to the MSRB on Form G-37/G-38, including certain of their consultants’ political contributions to issuer officials and payments to state and local political parties. See MSRB Rule G-38: Consultants, MSRB Rule Book. Firm Element Advisory—October 2000 5 Training Topic Relevant Training Point(s) and Reference(s) Municipal Securities Delivery Of Official Statements And Advance Refunding Documents To The MSRB Managing underwriters are required to deliver to the MSRB, among other things, copies of final official statements for most primary offerings of municipal securities, if such documents are prepared by or on behalf of the municipal securities issuer. For refunding issues, dealers must send to the MSRB two copies of the refunding escrow agreement, or its equivalent, if prepared by or on behalf of the municipal securities issuer. Dealers must send these documents to the MSRB using the appropriate form—Form G-36(OS) to be sent with official statements and Form G-36(ARD) to be sent with advance refunding documents. See MSRB Rule G-36: Delivery of Official Statements, Advance Refunding Documents and Forms G-36(OS) and G-36(ARD) to Board or its Designee, MSRB Rule Book. See also Form G-36 Manual published by the MSRB. Municipal Securities Delivery Of Official Statements To Customers And Other Dealers During the underwriting period, a dealer is prohibited from selling new issue municipal securities (other than commercial paper) to a customer unless the dealer delivers to the customer by settlement of the transaction a copy of the final official statement if one is prepared by or on behalf of the issuer. If a municipal securities issuer will prepare only a preliminary official statement and not a final official statement, a dealer must deliver the preliminary version along with a written notice to customers that no final official statement will be prepared. See MSRB Rule G-32: Disclosures in Connection with New Issues, MSRB Rule Book. Municipal Securities Political Contributions And Prohibitions On Municipal Securities Business Dealers are prohibited from engaging in municipal securities business with a municipal securities issuer within two years after any contribution to an official of such issuer made by the dealer, any municipal finance professional associated with such dealer, or any political action committee controlled by the dealer or any municipal finance professional. The only exception to this absolute prohibition on municipal securities business is for certain contributions made to issuer officials by municipal finance professionals, but only if the municipal finance professional is entitled to Firm Element Advisory—October 2000 6 Training Topic Relevant Training Point(s) and Reference(s) Municipal Securities Political Contributions And Prohibitions On Municipal Securities Business (continued) vote for such official and provided any contributions by such municipal finance professional do not exceed, in total, $250 to each official, per election. Dealers must report certain information about political contributions, political party payments, municipal securities business, and consultants to the MSRB on Form G-37/G-38 or, if appropriate, dealers may file a Form G-37x with the MSRB. See MSRB Rule G-37: Political Contributions and Prohibitions on Municipal Securities Business, MSRB Rule Book. Mutual Funds Advertising Recent Performance Broker/dealers have a responsibility to present fund performance information in a fair and balanced manner and not to create unrealistic investor expectations with regard to future fund performance. Recent unusually strong equity market performance helped some mutual funds, particularly those that are heavily invested in technology stocks, to achieve extraordinary total return figures during the last year (or shorter period). Some members are using advertisements that promote this total return information to attract new investors. Broker/dealers have a responsibility to base their communications on principles of fair dealing and good faith and to avoid statements that are exaggerated, unwarranted, or misleading. See NASD Notice to Members 00-21, NASD Regulation Reminds Members Of Their Responsibilities When Advertising Recent Mutual Fund Performance, April 2000. [This Notice cautions NASD members that if they choose to present extraordinary recent fund performance information, they should do so in a manner designed to lessen the possibility that investors will have unreasonable expectations concerning the future performance of these mutual funds.] Firm Element Advisory—October 2000 7 Training Topic Relevant Training Point(s) and Reference(s) Mutual Funds Bond Fund Volatility Ratings Bond mutual fund volatility ratings describe the sensitivity of bond mutual fund portfolios to changing market conditions. Previously, NASD Regulation interpreted its rules to prohibit members from using bond mutual fund volatility ratings in supplemental sales literature. New NASD Rule IM-2210-5 permits members and associated persons to include bond mutual fund volatility ratings in supplemental sales literature for an 18-month pilot period. The pilot program expires August 31, 2001, unless extended or permanently approved by the NASD at or before such date. See NASD Notice to Members 00-23, SEC Approves New Rules Relating To Bond Mutual Fund Volatility Ratings, April 2000. Mutual Funds Sales Charges Of Investment Companies And Variable Contracts On October 20, 1999, the SEC approved amendments to NASD Rules 2820 (Variable Contracts Rule) and 2830 (Investment Company Rule) that regulate the sales charges imposed by investment companies and variable annuity contracts sold by broker/dealers. Generally, the amendments revise the Investment Company Rule to: • provide maximum aggregate sales charge limits for fund-of-funds arrangements; • permit mutual funds to charge installment loads; • prohibit loads on reinvested dividends; • impose redemption order requirements for shares subject to contingent deferred sales loads (CDSLs); and • eliminate duplicate prospectus disclosure. The amendments revise the Variable Contracts Rule to eliminate the specific sales charge limitations in the rule and a filing requirement relating to changes in sales charges. See NASD Notice to Members 99-103, SEC Approves Rule Change Relating To Sales Charges For Investment Companies And Variable Contracts; Effective Date: April 1, 2000. December 1999. Firm Element Advisory—October 2000 8 Training Topic Relevant Training Point(s) and Reference(s) Options Communications With The Public Options Worksheets – On February 1, 2000, the SEC approved a rule change permitting the use of worksheets that are not standardized throughout a member organization provided such worksheets meet the requirements applicable to sale literature. This change gives broker/dealers or their associated persons the ability to tailor worksheets to specific prospective or existing clients, to utilize worksheets that may be commercially available, or to use industry developed worksheets. See CBOE Regulatory Circular RG00-43 “Communications to Customers.” Options Order Entry Access to Retail Automatic Execution System (RAES) It is a violation of CBOE rules to enter, at or about the same time and for the same account (or for accounts with any common ownership), multiple RAES orders in the same or similar options series for the purpose of circumventing the limitation on RAES order size. It is also a violation of CBOE rules to enter a limit order for placement on the Exchange’s limit order book, or on the book of a competing exchange, for the purpose of effecting the execution price of a RAES transaction. If a member grants a non-member direct access to the Exchange’s limit order book or to RAES through the member’s order routing systems, it is a violation for such member either to knowingly facilitate the non- member’s violation of Exchange rules through such systems and/or to fail to establish procedures reasonably designed to prevent the non-member’s access to such systems from being used to effect such violations. See CBOE Regulatory Circular RG00-27 “Access to Retail Automatic Execution System (RAES).” Options Sales Practices Day Trades Exceeding Account Approval Level — The CBOE has issued guidelines that its member organizations are required to follow with respect to proper identification of options day trades that exceed an account’s approved strategy level. As part of a member organization’s supervisory program, member organizations are required to establish and maintain reasonable procedures to identify, on at least a post- trade date basis, options day trades in customer accounts that exceed an account’s approved strategy level. Firm Element Advisory—October 2000 9 Training Topic Relevant Training Point(s) and Reference(s) Options Sales Practices (continued) See CBOE Regulatory Circular RG00-08 “Options Day Trades Exceeding Account Approval Level.” Short Selling A long-standing position of NASD Regulation and Nasdaq® states that broker/dealers must comply with the rules concerning short sales regardless of how a short-sale order is received, e.g., through the telephone, an electronic transmission, the Internet, or otherwise. Accordingly, firms must comply with the bid test, make affirmative determinations, and identify short sales in the Automated Confirmation Transaction ServiceSM (ACTSM) for all proprietary and customer short-sale orders that are received electronically through proprietary electronic order routing systems, the Internet, or otherwise. See NASD Notice to Members 99-98, NASD Regulation Reiterates That Members Must Comply With All Short Sale Rules When Receiving Orders Through Electronic Order Systems Or The Internet And Reiterates The Operation Of The Affirmative Determination Rule, December 1999. Suitability & Disclosure Of Risk Suitability and disclosure of risk are relevant topics for all Firm Element training plans. Applicable SRO rules are NASD Conduct Rule 2310 — Recommendations to Customers (Suitability) and NYSE 405 — Diligence as to Accounts. The specific training topics listed in this Firm Element Advisory should also be considered. Callable Common Stock An investor purchasing callable common stock is subject to unique risks not typically associated with ownership of common stock, even when such stock is called away at a premium. Moreover, the ability of an issuer’s common stock to be called away from a shareholder generally will be a material fact to an investor. Accordingly, high standards of commercial honor and just and equitable principles of trade require that any member that provides a written confirmation for a transaction involving callable common stock must disclose on the confirmation that the security is callable and that the customer may contact the member for more information. Interpretive Material (IM-2110-6) states that a member that provides a confirmation pursuant to SEC Rule 10b-10 in connection with any transaction in callable common stock shall disclose on such confirmation Firm Element Advisory—October 2000 10 Training Topic Relevant Training Point(s) and Reference(s) Suitability & Disclosure Of Risk Callable Common Stock (continued) that the security is callable and that the customer may wish to contact the member for more information regarding the security. Disclosure of the call feature on the confirmation in no way relieves a member of its obligation to consider the callable nature of the security when complying with any applicable suitability obligations. See NASD Notice to Members 00-33, NASD Regulation Adopts New Rule Interpretation To Require Confirmation Disclosure Of Callable Common Stock, May 2000. Suitability & Disclosure Of Risk Certificates Of Deposit Broker/dealers that offer brokered certificates of deposit to investors have an obligation to disclose all relevant features of these investments, such as variable rates, call features, early withdrawal penalties, liquidity, etc. See “Certificates of Deposit: Tips for Investors,” SEC Web Site at www.sec.gov/consumer/certific.htm, and NASD Regulation Regulatory & Compliance Alert, “Regulatory Short Takes — Investment Instruments Offered By CD Brokers,” Summer 2000. Suitability & Disclosure Of Risk Extended Hours Di