
[Federal Register Volume 77, Number 32 (Thursday, February 16, 2012)]
[Notices]
[Pages 9290-9293]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-3612]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-66372; File No. SR-NASDAQ-2012-021]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change by NASDAQ Stock Market LLC 
Relating to Fidelity Bonds

February 10, 2012.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4\2\ thereunder, notice is hereby given that 
on January 31, 2012, The NASDAQ Stock Market LLC (``NASDAQ'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I and II below, which Items have been prepared by NASDAQ. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The NASDAQ Stock Market LLC proposes to amend NASDAQ Rule 3020 to 
reflect recent changes to a corresponding rule of the Financial 
Industry Regulatory Authority (``FINRA'').
    The text of the proposed rule change is available on the Exchange's 
Web site at http://www.nasdaq.cchwallstreet.com, at the principal 
office of the Exchange, and at the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the Exchange included statements 
concerning the purpose of, and basis for, the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange 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

1. Purpose
    Many of NASDAQ's rules are based on rules of FINRA (formerly the 
National Association of Securities Dealers (``NASD'')). Beginning in 
2008, FINRA embarked on an extended process of moving rules formerly 
designated as ``NASD Rules'' into a consolidated FINRA rulebook. In 
most cases, FINRA has renumbered these rules, and in some cases has 
substantively amended them. Accordingly, NASDAQ also has initiated a 
process of modifying its rulebook to ensure that NASDAQ rules 
corresponding to FINRA/NASD rules continue to mirror them as closely as 
practicable.
    This proposed rule change concerns NASDAQ Rule 3020 entitled 
``Fidelity Bonds,'' which follows and incorporates by reference former 
NASD Rule 3020.\3\ FINRA recently amended its rules to adopt former 
NASD Rule 3020, relating to Fidelity Bonds, with certain changes, into 
the consolidated FINRA rulebook as FINRA Rule 4360.\4\ NASDAQ Rule 3020 
provides that ``[a] member designated to Nasdaq for oversight pursuant 
to SEC Rule 17d-1 shall comply with NASD Rule 3020 as if such Rule were 
part of Nasdaq's Rules.'' The Exchange proposes to amend this text to 
reference new FINRA Rule 4360, which replaced NASD Rule 3020.
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    \3\ The purpose of the fidelity bond is to protect a member 
against certain types of losses, including, but not limited to, 
those caused by the malfeasance of its officers and employees, and 
the effect of such losses on the member's capital.
    \4\ See Securities Exchange Act Release No. 63961 (February 24, 
2011), 76 FR 11542 (March 2, 2011) (SR-FINRA-2010-059) (a rule 
change to adopt a rule of the National Association of Securities 
Dealers, Inc. (``NASD'') as part of the consolidation of the FINRA 
rulebook). This new rule took into account Incorporated NYSE Rule 
319 (Fidelity Bonds) and its Interpretation.
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    NASD Rule 3020(a) generally provides that each member required to 
join the Securities Investor Protection Corporation (``SIPC'') that has 
employees and that is not a member in good standing of one of the 
enumerated national securities exchanges must maintain fidelity bond 
coverage. FINRA Rule 4360 requires each member that is required to join 
SIPC to maintain blanket fidelity bond coverage with specified amounts 
of coverage based on the member's net capital requirement, with certain 
exceptions. NASD Rule 3020(a)(1) requires members to maintain a blanket 
fidelity bond in a form substantially similar to the standard form of 
Brokers Blanket Bond promulgated by the Surety Association of America. 
New FINRA Rule 4360 requires members to maintain fidelity bond coverage 
that provides for per loss coverage without an aggregate limit of 
liability. Also, pursuant to FINRA Rule 4360, a member's fidelity bond 
must provide against loss and have Insuring Agreements covering at 
least the following: Fidelity, on premises, in transit, forgery and 
alteration, securities and counterfeit currency. The rule change 
modified the descriptive headings for these Insuring Agreements, in 
part, from NASD Rule 3020(a)(1) and NYSE Rule 319(d) to align them with 
the headings in the current bond forms available to broker-dealers. 
FINRA Rule 4360 also eliminates the specific coverage provisions in 
NASD Rule

[[Page 9291]]

3020(a)(4) and (a)(5), and NYSE Rule 319(d)(ii)(B) and (C), and 
(e)(ii)(B) and (C), that permit less than 100 percent of coverage for 
certain Insuring Agreements (i.e., fraudulent trading and securities 
forgery) to require that coverage for all Insuring Agreements be equal 
to 100 percent of the firm's minimum required bond coverage.\5\
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    \5\ Members may elect to carry additional, optional Insuring 
Agreements not required by FINRA Rule 4360 for an amount less than 
100 percent of the minimum required bond coverage.
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    Further, FINRA Rule 4360 requires that a member's fidelity bond 
include a cancellation rider providing that the insurer will use its 
best efforts to promptly notify FINRA in the event the bond is 
cancelled, terminated or ``substantially modified.'' Also, the rule 
change adopted the definition of ``substantially modified'' in NYSE 
Rule 319 and would incorporate NYSE Rule 319.12's standard that a firm 
must immediately advise FINRA in writing if its fidelity bond is 
cancelled, terminated or substantially modified.\6\ FINRA added 
supplementary material to FINRA Rule 4360 requiring members that do not 
qualify for a bond with per loss coverage without an aggregate limit of 
liability to secure alternative coverage. Specifically, a member that 
does not qualify for blanket fidelity bond coverage as required by 
FINRA Rule 4360(a)(3) is required to maintain substantially similar 
fidelity bond coverage in compliance with all other provisions of the 
rule, provided that the member maintains written correspondence from 
two insurance providers stating that the member does not qualify for 
the coverage required by FINRA Rule 4360(a)(3).
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    \6\ NYSE Rule 319 defines the term ``substantially modified'' as 
any change in the type or amount of fidelity bonding coverage, or in 
the exclusions to which the bond is subject, or any other change in 
the bond such that it no longer complies with the requirements of 
the rule.
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    FINRA Rule 4360 requires each member to maintain, at a minimum, 
fidelity bond coverage for any person associated with the member, 
except directors or trustees of a member who are not performing acts 
within the scope of the usual duties of an officer or employee. As 
further detailed below, the rule change eliminated the exemption in 
NASD Rule 3020 for sole stockholders and sole proprietors. The rule 
change also increased the minimum required fidelity bond coverage for 
members, while continuing to base the coverage on a member's net 
capital requirement. To that end, FINRA Rule 4360 required a member 
with a net capital requirement that is less than $250,000 to maintain 
minimum coverage of the greater of 120 percent of the firm's required 
net capital under Exchange Act Rule 15c3-1 or $100,000. The increase to 
$100,000 modifies the present minimum requirement of $25,000.
    Under the new FINRA Rule 4360, members with a net capital 
requirement of at least $250,000 must use a table in the rule to 
determine their minimum fidelity bond coverage requirement. The table 
is a modified version of the tables in NASD Rule 3020(a)(3) and NYSE 
Rule 319(e)(i). The identical NASD and NYSE requirements for members 
that have a minimum net capital requirement that exceeds $1 million are 
retained in the new Rule; however, the rule adopts the higher 
requirements in NYSE Rule 319(e)(i) for a member with a net capital 
requirement of at least $250,000, but less than $1 million. Under the 
new rule, the entire amount of a member's minimum required coverage 
must be available for covered losses and may not be eroded by the costs 
an insurer may incur if it chooses to defend a claim. Specifically, any 
defense costs for covered losses must be in addition to a member's 
minimum coverage requirements. A member may include defense costs as 
part of its fidelity bond coverage, but only to the extent that it does 
not reduce a member's minimum required coverage under the rule.
    Under prior NASD Rule 3020(b), a deductible provision may be 
included in a member's bond of up to $5,000 or 10% of the member's 
minimum insurance requirement, whichever is greater. If a member 
desires to maintain coverage in excess of the minimum insurance 
requirement, then a deductible provision may be included in the bond of 
up to $5,000 or 10% of the amount of blanket coverage provided in the 
bond purchased, whichever is greater. The excess of any such deductible 
amount over the maximum permissible deductible amount based on the 
member's minimum required coverage must be deducted from the member's 
net worth in the calculation of the member's net capital for purposes 
of Exchange Act Rule 15c3-1. Where the member is a subsidiary of 
another member, the excess may be deducted from the parent's rather 
than the subsidiary's net worth, but only if the parent guarantees the 
subsidiary's net capital in writing.\7\ FINRA Rule 4360 provides for an 
allowable deductible amount of up to 25% of the fidelity bond coverage 
purchased by a member. Any deductible amount elected by the firm that 
is greater than 10% of the coverage purchased by the member \8\ would 
be deducted from the member's net worth in the calculation of its net 
capital for purposes of Exchange Act Rule 15c3-1.\9\ Like the NASD and 
NYSE rules, if the member is a subsidiary of another FINRA member, this 
amount may be deducted from the parent's rather than the subsidiary's 
net worth, but only if the parent guarantees the subsidiary's net 
capital in writing.
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    \7\ Under NYSE Rule 319(b), each member organization may self-
insure to the extent of $10,000 or 10% of its minimum insurance 
requirement as fixed by the NYSE, whichever is greater, for each 
type of coverage required by the rule. Self-insurance in amounts 
exceeding the above maximum may be permitted by the NYSE provided 
the member or member organization certifies to the satisfaction of 
the NYSE that it is unable to obtain greater bonding coverage, and 
agrees to reduce its self-insurance so as to comply with the above 
stated limits as soon as possible, and appropriate charges to 
capital are made pursuant to Exchange Act Rule 15c3-1. This 
provision also contains identical language to the NASD rule 
regarding net worth deductions for subsidiaries.
    \8\ FINRA notes that a member may elect, subject to 
availability, a deductible of less than 10 percent of the coverage 
purchased.
    \9\ NASD Rule 3020 bases the deduction from net worth for an 
excess deductible on a firm's minimum required coverage, while FINRA 
Rule 4360 would base such deduction from net worth on coverage 
purchased by the member.
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    Consistent with NASD Rule 3020(c) and NYSE Rule 319.10, FINRA Rule 
4360 requires a member (including a firm that signs a multi-year 
insurance policy), annually as of the yearly anniversary date of the 
issuance of the fidelity bond, to review the adequacy of its fidelity 
bond coverage and make any required adjustments to its coverage, as set 
forth in the rule. Under FINRA Rule 4360(d), a member's highest net 
capital requirement during the preceding 12-month period, based on the 
applicable method of computing net capital (dollar minimum, aggregate 
indebtedness or alternative standard), is used as the basis for 
determining the member's minimum required fidelity bond coverage for 
the succeeding 12-month period. The ``preceding 12-month period'' 
includes the 12-month period that ends 60 days before the yearly 
anniversary date of a member's fidelity bond. This would give a firm 
time to determine its required fidelity bond coverage by the 
anniversary date of the bond.
    Further, FINRA Rule 4360 allows a member that has only been in 
business for one year and elected the aggregate indebtedness ratio for 
calculating its net capital requirement to use, solely for the purpose 
of determining the adequacy of its fidelity bond coverage for its 
second year, the 15 to 1 ratio of aggregate indebtedness to net capital 
in lieu of the 8 to 1 ratio (required for broker-dealers

[[Page 9292]]

in their first year of business) to calculate its net capital 
requirement. Notwithstanding the above, such member would not be 
permitted to carry less minimum fidelity bond coverage in its second 
year than it carried in its first year.
    Based in part on NASD Rule 3020(a), FINRA Rule 4360 exempts from 
the fidelity bond requirements members in good standing with a national 
securities exchange that maintain a fidelity bond subject to the 
requirements of such exchange that are equal to or greater than the 
requirements set forth in Rule 4360. Additionally, consistent with NYSE 
Rule Interpretation 319/01, FINRA Rule 4360 continues to exempt from 
the fidelity bond requirements any firm that acts solely as a 
Designated Market Maker (``DMM''),\10\ floor broker or registered floor 
trader and does not conduct business with the public. FINRA Rule 4360 
does not maintain the exemption in NASD Rule 3020(e) for a one-person 
firm.\11\ Historically, a sole proprietor or sole stockholder member 
was excluded from the fidelity bond requirements based upon the 
assumption that such firms were one-person shops and, therefore, could 
not obtain coverage for their own acts. FINRA has determined that sole 
proprietors and sole stockholder firms can and often do acquire 
fidelity bond coverage, even though it is currently not required, since 
all claims (irrespective of firm size) are likely to be paid or denied 
on a facts-and-circumstances basis. Also, certain coverage areas of the 
fidelity bond benefit a one-person shop (e.g., those covering customer 
property lost in transit).
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    \10\ See [sic] Exchange Act Release No. 58845 (Oct. 24, 2008), 
73 FR 64379 (Oct. 29, 2008) (Order Approving File No. SR-NYSE-2008-
46). In this rule filing, the role of the specialist was altered in 
certain respects and the term ``specialist'' was replaced with the 
term ``Designated Market Maker.''
    \11\ A one-person member (that is, a firm owned by a sole 
proprietor or stockholder that has no other associated persons, 
registered or unregistered) has no ``employees'' for purposes of 
NASD Rule 3020, and therefore such a firm currently is not subject 
to the fidelity bonding requirements. Conversely, a firm owned by a 
sole proprietor or stockholder that has other associated persons has 
``employees'' for purposes of NASD Rule 3020, and currently is, and 
will continue to be, subject to the fidelity bonding requirements.
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2. Statutory Basis
    The Exchange believes that its proposal is consistent with Section 
6(b) of the Act \12\ in general, and furthers the objectives of Section 
6(b)(5) of the Act \13\ in particular, in that it is designed to 
promote just and equitable principles of trade, to remove impediments 
to and perfect the mechanism of a free and open market and a national 
market system, and, in general to protect investors and the public 
interest, by updating and clarifying the requirements governing 
fidelity bonds. The Exchange believes that the proposed requirements of 
Rule 4360, including, but not limited to, requiring each member that is 
required to join SIPC to maintain blanket fidelity bond coverage, 
increasing the minimum requirement fidelity bond coverage and 
maintaining a fidelity bond that provides for per loss coverage without 
an aggregate limit of liability promotes investor protection by 
protecting firms from unforeseen losses. The proposed amendments will 
conform NASDAQ Rule 3020 to recent changes made to a corresponding 
FINRA rule, to promote application of consistent regulatory standards.
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    \12\ 15 U.S.C. 78f(b).
    \13\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition 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 either solicited or received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Because the foregoing proposed rule change does not: (i) 
Significantly affect the protection of investors or the public 
interest; (ii) impose any significant burden on competition; and (iii) 
become operative for 30 days after the date of the filing, or such 
shorter time as the Commission may designate, it has become effective 
pursuant to 19(b)(3)(A) of the Act \14\ and Rule 19b-4(f)(6) \15\ 
thereunder.
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    \14\ 15 U.S.C. 78s(b)(3)(A).
    \15\ 17 CFR 240.19b-4(f)(6). In addition, Rule 19b-4(f)(6) 
requires a self-regulatory organization to give the Commission 
written notice of its intent to file the proposed rule change at 
least five business days prior to the date of filing of the proposed 
rule change, or such shorter time as designated by the Commission. 
The Exchange has satisfied this requirement.
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    The Exchange has requested that the Commission waive the 30-day 
operative delay. The Commission believes that waiver of the operative 
delay is consistent with the protection of investors and the public 
interest because the proposed rule change presents no novel issues, and 
NASDAQ members are currently subject to FINRA Rule 4360. Therefore, the 
Commission designates the proposal operative upon filing.\16\
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    \16\ For purposes only of waiving the 30-day operative delay, 
the Commission has considered the proposed rule's impact on 
efficiency, competition, and capital formation. See 15 U.S.C. 
78c(f).
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    At any time within 60 days of the filing of the proposed rule 
change, the Commission summarily may temporarily suspend such rule 
change if it appears to the Commission that such action is necessary or 
appropriate in the public interest, for the protection of investors, or 
otherwise in furtherance of the purposes of the Act.

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. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to rule-comments@sec.gov. Please include 
File Number SR-NASDAQ-2012-021 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-NASDAQ-2012-021. This 
file number should be included on the subject line if email is used. To 
help the Commission process and review your comments more efficiently, 
please use only one method. The Commission will post all comments on 
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml).
    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 Web site viewing and printing in 
the Commission's Public Reference Room, 100 F Street NE., Washington, 
DC 20549, on official business days between the hours of 10

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a.m. and 3 p.m. Copies of the filing also will be available for 
inspection and copying at the principal office of the Exchange. All 
comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to File Number SR-NASDAQ-2012-021 and should 
be submitted on or before March 8, 2012.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\17\
Kevin M. O'Neill,
Deputy Secretary.
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    \17\ 17 CFR 200.30-3(a)(12).
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[FR Doc. 2012-3612 Filed 2-15-12; 8:45 am]
BILLING CODE 8011-01-P


