no part in selecting the DPP products whose sales will trigger eligibility for the sales incentive bonus. Finally, it has no control over the sales literature that sponsors distribute to associated persons in an effort to advertise certain bonuses. Moreover, the NASD has concluded that sales incentives in the public market for DPPs have become so prevalent that many members are not in a position to refuse to pass on non-cash sales incentives to their associated persons. The NASD has found that associates attracted by a particular sales incentive program often seek to induce their employer to participate in the sales incentive program;13 further, there is sometimes an implicit or explicit threat that those associated persons will seek employment elsewhere should the employer decline to participate. 14 In light of this threat of defections by associated persons should the member not adopt a particular program, the NASD believes that its members do not in fact have discretion to refuse to permit associated persons to participate in non-cash sales incentive programs offered by sponsors. 15

The Commission recognizes the serious questions raised by an absolute ban on non-cash sales incentives. Nevertheless, in weighing whether such a ban is necessary and appropriate under the Act the Commission believes that the NASD has appropriately considered alternative approaches. The Commission does not disagree with the NASD's conclusion that, based on the NASD's experience in the last four years, a disclosure approach would not prove effective. Accordingly, the Commission believes it is appropriate to defer to the NASD's judgment that the proposed prohibition is necessary to restore to its members supervisory control over the participation of their associated persons in non-cash sales incentive programs.

The second objection voiced by the commentators was that the proposed amendment discriminates against independent sponsors and in favor of sponsors affiliated with members. 16 The com

13 Letter from Frank J. Formica, Vice President, Corporate Financing Department, National Association of Securities Dealers, Inc., to Michael J. Simon, Assistant Director, Division of Market Regulation, Securities and Exchange Commission, at 2.

14 Letter from Planners Financial Services, Inc., at 5-7. 15 SR-NASD-86-22, at 9.

16 See letters from: (1) JMB Realty Corporation, at 1-4; (2) Gaston Snow & Ely Bartlett, at 1-3; and (3) Skadden, Arps, Slate, Meagher & Flom, at 1-3.

17 See: (1) JMB letter, at 2; (2) Gaston, Snow letter, at 2; and (3) Skadden, Arps letter, at 2.

18 Telephone conversation between Suzanne E. Rothwell,

mentators' concern is premised on the view that: (1) the NASD will be unable to detect instances in which an affiliated sponsor contributes monetarily to, or otherwise influences, a member's inhouse sales incentive program; and (2) members will structure their sales incentive programs to reward associates for sales of proprietary products only, even if the affiliated sponsor is effectively prohibited from participating in the member's sales incentive program. 17

The essence of this objection is not that the proposed amendment, if enforced, would have a discriminatory impact; rather, the objection is that the proposed amendment is unenforceable. In this regard, the NASD has assured Commission staff that it intends to monitor member compliance with the proposal by policing the separation between the operations of its members and their affiliates to ensure that a sponsoring affiliate does not influence an in-house sales incentive program adopted by a member. 18 Indeed, the NASD has developed procedures to test the effectiveness of the procedures adopted by member firms to divorce the operations of the firms from those of the firms' affiliates. 19 Further, the NASD notes that the compensation structures of its members are not susceptible to the kind of abuse that could afford a competitive advantage to DPP products sponsored by affiliates of members. The NASD has found that the in-house sales incentive programs sponsored by its members are generally structured to reward associates for sales of a variety of products, not just for sales of the proprietary product sponsored by the member's affiliate. 20 The NASD has stated that:

[I]t is general industry practice among large general securities firms to provide non-cash compensation based on total sales of all securities products sold through the member rather than having compensation directly related to one type of security or product (emphasis added).21

Associate General Counsel, NASD, and Gordon K. Fuller, Special Counsel, Division of Market Regulation, SEC, on April 9, 1988.

19 See NASD, Final Report of the Regulatory Review Task Force, at 9 (March 1988).

20 As far as the NASD is aware, the only sales incentive programs designed to reward associates solely for the sales of proprietary DPPs, are those managed by members who sell only that proprietary DPP. These members necessarily award sales incentives only for the sale of that product. Telephone conversation between Suzanne Rothwell and Gordon Fuller, April 6, 1988.

21 SR-NASD-86-22, at 20.

lease No. 25636, May 2, 1988) and by publication in the Federal Register (53 FR 16486, May 9, 1988). No comment letters were received with respect to the proposed rule change.>

Background

The NASD developed the proposed rule change as part of a series of proposals respecting the use of non-cash sales incentives in connection with the sale of securities. Both the Direct Participation Programs and Real Estate committees of the NASD had expressed concern that the emphasis given to on-cash sales incentives undermines a member's ability to supervise its sales persons; therefore, they recommended that Appendix F be amended to prohibit the practice. In addition, the two committees believed that the proposed pro

hibition on the use of non-cash sales incentives in connection with the sales of DPPs, should be extended to other product areas and the issue was referred to the Investment Companies, Variable Contracts, and Corporate Financing committees. The present proposal would prohibit the use of non-cash sales incentives in connection with the sale of real estate investment trusts (“REITs”), and, debt or equity corporate offerings, which are not covered by the provisions of Appendix F, which governs the sale of DPPs.

The NASD believes that certain changes in the tax laws embodied in the Tax Reform Act of 1986 and other factors in the real estate market have led to a marked increase in the number of publicly offered REITs in late 1986 and in 1987 in comparison to DPPs. Further, sales of REITs are considered to be in competition with sales of DPPs. In many cases, REITs are sponsored by members or affiliates of members that previously confined their activities to the sale of DPPs. The sales incentives that have been utilized with respect to the distribution of REITs and DPPs are similar, although sales incentives are not used as frequently in connection with the sale of REITs. In comparison, sales incentives have not traditionally been employed in connection with the distribution of corporate debt and equity offerings. Although sales incentives do not currently appear to be a significant problem in connection

3 On the other hand, with respect to the NASD's proposal prohibiting the acceptance of non-cash sales incentives in connection with the sale of DPPs (SR-NASD-86-22), the Commission received 24 comment letters. The substance of these comment letters is discussed in the parallel order approving that proposal.

4 The first proposal, SR-NASD-86-22, governs the use of non-cash sales incentives in connection with the sale of

with the sale of corporate offerings, the NASD has determined to adopt the proposed rule change to avoid problems in the future with respect to corporate offerings and in light of several complaints that have been received from members with respect to sales incentive programs for REITs.

Moreover, the NASD believes that, as with its proposal regarding DPPs, the proposed rule change will strengthen the ability of members to supervise their associated persons by prohibiting the payment of non-cash sales incentives, lic. In addition, the NASD believes that it is thereby providing greater protection to the pubappropriate to establish a uniform policy regard

ing non-cash sales incentives across product lines to avoid such incentive programs being created for different products.

The Commission finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to the NASD, and in particular the requirements of Section 15A and the rules and regulations thereunder.

IT IS THEREFORE ORDERED, pursuant to Section 19(b)(2) of the Act, that the above-mentioned rule change be, and hereby is, approved. For the Commission, by the Division of Market Regulation, pursuant to delegated authority, 17 C.F.R. $200.30-3(a)(12).

Jonathan G. Katz Secretary

SECURITIES EXCHANGE ACT OF 1934 Release No. 34-26187/October 14, 1988 Admin. Proc. File No. 3-6610

In the Matter of the Application of WHITESIDE & COMPANY, INC. 1510 Avenue L

Lubbock, Texas

and

WILLIAM H. WHITESIDE

DPPs. See supra note 2. The NASD's Board of Governors also issued a Notice to Members (Notice to Members 88-17 (March 1, 1988)) proposing to amend Article III, Sections 25 and 29 of the NASD Rules of Fair Practice, to prohibit the receipt of non-cash compensation in connection with sales of investment company and variable contract securities. The NASD is reviewing the comments received in connection with the Notice to Members.

For Review of Disciplinary Action Taken by the NATIONAL ASSOCIATION OF

SECURITIES DEALERS, INC.

OPINION OF THE COMMISSION

REGISTERED SECURITIES

ASSOCIATION-REVIEW OF
DISCIPLINARY PROCEEDINGS

Violations of Rules of Fair Practice

Failure to Comply with Net Capital, Recordkeeping and Reporting Requirements

Where member firm of registered securities, association and its president failed to comply with net capital, recordkeeping and reporting requirements, held, association's findings of violation affirmed, and sanctions imposed sustained APPEARANCES:

William H. Whiteside, for Whiteside & Company, Inc. and pro se.

Andrew McR. Barnes and Eugene Bleier, for the National Association of Securities Dealers, Inc.

I

Whiteside & Company, Inc. ("the firm”), a member of the National Association of Securities Dealers ("NASD"), and William H. Whiteside ("Whiteside"), its president and registered financial and operations principal, appeal from disciplinary action taken against them by the NASD. The NASD found that applicants failed to comply with net capital, recordkeeping and reporting requirements. It censured applicants and fined them $10,000, jointly and severally. Our findings are based on an independent review of the record.

II

The NASD found that applicants failed to comply with net capital requirements at various times between April and October 1982.2 Applicants deny that the firm had net capital deficiencies on the dates in question.

A. The NASD found that the firm had net capital deficiencies on April 29, May 5 and May 20, 1982. However, applicants' computations show that on those dates the firm had, respectively, excess net

1The NASD also assessed costs.

2 See Rule 15c3-1 under the Securities Exchange Act. 3 We previously dismissed these proceedings with respect to CW, who died while this case was on appeal.

4 Voss & Co., Inc., Securities Exchange Act Release No. 21301 (September 10, 1984), 31 SEC Docket 459, 462; Robert S.C. Peterson, Inc., Securities Exchange Act Release No. 24688 (July 9, 1987), 38 SEC Docket 1372, 1375.

capital of $52,744, $31,532 and $29,314. In making those computations, applicants included an asserted "net capital contribution" of $58,425, which the NASD did not take into account.

Applicants claim that, in April 1982, Clarence K. Whiteside ("CW"), Whiteside's father and the firm's board chairman,3 contributed municipal bonds to the firm that had a value of $58,425 after deducting the haircut required by net capital provisions. A corporate minute, dated April 1982, states that CW granted the firm "the capital use" of certain bonds to be used by it "as necessary." According to applicants, the bonds were withdrawn from the firm's capital at the end of June, when the firm no longer needed them. As applicants admit, however, the firm's financial records do not reflect any such capital contribution. Applicants "bear a heavy evidentiary burden when they seek to impeach the accuracy of their own records."4 In our view, they have not met that burden here. Instead, the inference is compelling that the bonds assertedly given to the firm were not a valid contribution to capital but, at most, a temporary loan.5 Since the loan was not covered by a subordination agreement in accordance with net capital requirements, it cannot be recognized as capital under our rule.

As noted above, applicants' own computations show excess net capital figures of $52,744, $31,532 and $29,314 for April 29, May 5 and May 20, respectively. Adjusting those figures for the alleged capital contribution of $58,425 that we have disallowed, the firm had net capital deficiencies of $5,681, $26,893 and $29,111 on the dates in question.6

B. The NASD found that the firm also had a net capital deficiency on June 11, 1982. According to the NASD, the firm "parked" in CW's account on that date State of Illinois bonds and Cities Service Co. options which in fact were part of the firm's inventory. The NASD accordingly deducted net capital haircuts on the securities and an unrealized loss on the options.

The relevant facts are as follows. On June 11, 1982, a Friday, the firm purportedly “sold” Illi

5Cf. Lomasney & Company. 44 S.E.C. 453, 454 (1970). "It appears that applicants meant to include in their computations of excess net capital for May 5, and May 20 certain amounts relating to an account (the Foster account) that the NASD excluded. However, even if applicants are given the benefit of those amounts on the dates in question, the firm would still have net capital deficiencies on those dates.

nois bonds in the face amount of $80,000 and 35 Cities Service Co. options to CW, with same-day settlement. On the same day, it assertedly “bought” them back from CW at the same prices, with settlement the following Monday. Although the market price of the options was only 41⁄2, their purported "purchase" and "sale" by CW were at a price of 71⁄44.

Applicants assert that the sales to CW were bona fide, and that none of the securities were parked

in his account. We disagree. As the NASD found, the sales were contrived transactions designed to remove securities from the firm's inventory in order to avoid the required haircuts and deduction for unrealized loss on the options.

Applicants' own computation shows that, on June 11, the firm had excess net capital of $13,786. Because the bonds and options that were parked in CW's account were actually a part of the firm's inventory, the required haircuts were at least $11,845, and the deduction from net capital for the unrealized loss on the options was at least $9,625. Adjusting applicants' excess net capital figure by those amounts, the firm had a net capital deficiency of at least $7,684 on June 11.

Whiteside was responsible for the firm's compliance with net capital requirements.7 In light of the foregoing, we affirm the NASD's findings of violation by Whiteside and the firm with respect to the four dates set forth above.8

III

The NASD found that applicants failed to give telegraphic notice to regulatory authorities of the net capital deficiencies that we have found, 10 Applicants assert that they were not required to give such notice because they did not agree with the NASD that there were any deficiencies. They further state that it would have been impossible for them to give the required prompt notice since the NASD did not find the deficiencies until long after the dates in question.

We do not agree with applicants' position. A

7 See Article I, Section 5(a) of the NASD's Rules of Fair Practice, and Part II, Section (2)(b) of Schedule C to the NASD's By-Laws.

8 The NASD also found that the firm operated with net capital deficiencies on four other dates, and that Whiteside was responsible for those violations. However, on the basis of the record before us, we are unable to conclude that the firm had capital deficiencies on those dates. We accordingly set aside the NASD's findings of violation with respect thereto.

member firm is required to give immediate telegraphic notice of a net capital deficiency.11 The notification provision is designed to alert regulatory authorities quickly to the fact that a brokerage firm may be experiencing financial difficulties. When the NASD informed applicants that it had found capital deficiencies, they were required to give immediate telegraphic notice of the NASD's findings. Applicants were free to explain in that notice that they did not agree with those findings. But that disagreement did not relieve them of their responsibility for notification. 12 Nor were applicants excused from giving notice at that time because they had not given immediate notice when deficiencies arose, as required. Although the obligation to give telegraphic notice arises on the same day that a net capital deficiency occurs, an ongoing duty is created that continues until proper notification is given. 13

We accordingly affirm the NASD's findings of notice violations with respect to the net capital deficiencies that we have sustained.

IV

The NASD found that applicants failed to comply with recordkeeping and reporting requirements. As set forth above, we have affirmed the NASD's

determination that, on June 11, the firm parked Illinois bonds and Cities Service options in CW's account. The NASD also found that City of Lubbock (Texas) bonds were parked in CW's account in August 1982. On August 3, CW purportedly bought Lubbock bonds with a face value of $220,000 from the firm at 100. He allegedly resold $140,000 worth of those bonds to the firm at the same price from August 11 to August 20. On those same dates, the firm resold the bonds to customers at 1022. In each instance, the settlement date of CW's sale to the firm and the customer's purchase from the firm was the same. CW admitted that "[he was] buying the [Lubbock] bonds so we don't have to take the haircut on them." We agree with the NASD that this was a sham transaction designed to circumvent hair

"Notice to both this Commission and the NASD was required. See Rule 17a-11(f) under the Exchange Act. 10 We set aside the NASD's findings of violation based on the failure to give notice of the deficiencies that we have not sustained.

11 Rule 17a-11 under the Exchange Act.

12 Cf. Joseph J. Balint, Securities Exchange Act Release No. 20950 (May 10, 1984), 30 SEC Docket 769, 772. 13 See Management Financial, Inc., 46 S.E.C. 226, 229 (1976); Joseph J. Balint, supra.