Notice To Members 83-13

Request For Comments on Amendments to Appendix F Concerning Sales Incentives for Direct Participation Programs

Published Date:

TO: All NASD Members and Other Interested Persons

ATTENTION: Direct Participation Programs Department

The Association's Direct Participation Programs Committee ("Committee") has become concerned about the continuing proliferation of sales incentives provided by the sponsors of public direct participation programs. The Committee and the Board of Governors have approved a proposed amendment to Appendix F to Article III, Section 34 of the Rules of Fair Practice ("Appendix F") which would place additional restrictions on incentive programs. The purpose of this notice is to solicit public comment on that amendment.

BACKGROUND

Appendix F contains restrictions on two different types of sales incentives, those paid directly to salespersons by sponsors and those paid by sponsors to broker-dealers. Subsection 5(e) regulates direct payments to individual associated persons of members and limits those incentives to $50 per person per year. Any incentive item paid in connection with an offering must be counted as underwriting compensation and arrangements regarding its receipt must be disclosed in the offering materials.

Subsection 5(f) of Appendix F permits sales incentives to be provided by program sponsors to broker-dealers if certain criteria are met. In summary, a fair market value must be established for incentive items, the value of all items must be included as underwriting compensation, arrangements for payment of the items must be disclosed, the manner of disposition of the items must be controlled solely by the receiving member, and the value of the items must be reflected on the books and records of the recipient member as underwriting compensation.

Notwithstanding these restrictions, there has been a proliferation of incentive programs, many of which utilize direct appeals to salespersons with offers of trips to exotic locations or elaborate selections of merchandise. Because these programs offer prizes only in a non-cash form and use direct appeals, it is often difficult for broker-dealers to adequately control salespersons' participation in the programs. As a result, broker-dealers may have increased pressure to distribute programs which might otherwise be deemed unsuitable. Salespersons may also be tempted to place less emphasis on suitability considerations in recommending particular programs to their customers.

Although Appendix F requires recordation, there is some question as to whether the value of non-cash incentive items is reflected on the books and records of all broker-dealers as additional underwriting compensation. There is also concern about the adequacy of disclosure in prospectuses of the details on some programs.

For all of the above reasons, the Committee concluded that it is necessary to amend Appendix F as described below.

EXPLANATION OF PROPOSED AMENDMENTS

The proposed amendments to Appendix F would revise both Subsections 5(e) and (f). The amendment to Subsection 5(e) is technical in nature and is intended to clarify the subsection's present requirements.

The amendment to Subsection 5(f) would require that all sales incentives and bonuses be paid directly by a sponsor, affiliate, or program to a member and that such incentives and bonuses be paid only in the form of cash. Incentives and bonuses could be paid only if any distribution of the incentives or bonuses to associated persons is controlled solely by the recipient member. This provision is intended to permit broker-dealers to distribute sales incentives in any manner or to retain the incentives at the firm level. Broker-dealers would be free, however, to use the cash incentives to purchase trips or merchandise offered at group rates by sponsors.

The present requirement for disclosure of arrangements relating to the proposed payment of incentives would be made more explicit. Under the amendment, arrangements relating to the proposed payment of incentives or bonuses, including the formula or formulae used to determine the amount of the incentive or bonus would be required to be disclosed in the prospectus or offering document. Public investors will thus be informed as to the schedule by which salespersons and their firms are receiving incentives.

The remaining proposed changes to Subsection 5(f) are conforming in nature.

The text of the proposed changes is attached and is marked to indicate the amended language.

REQUEST FOR COMMENTS

The Association's Board of Governors is given the authority to adopt changes to Appendix F (without a vote of the membership) by Article III, Section 34 of the Rules of Fair Practice. The Board contemplates adopting the proposed amendments pursuant to that authority.

the amount of incentive or bonus, are disclosed in the prospectus or similar offering document; and

(4) the manner of receiving of such items and their Subsequent disposition, Whether to associated persons or otherwise, is controlled solely by the member in a manner which enable the member to properly supervise its associated person, and
(4)
(5) the value of all such items incentives and bonuses is reflected on the books and records of the recipient member as compensation received in connection with the offering.