Notice To Members 85-17

Request for Comments on Proposed Amendment 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 Board of Governors has approved a proposed amendment to Appendix F to Article III, Section 34 of the Rules of Fair Practice which would prohibit sponsors of direct participation programs from offering non-cash sales incentives to NASD members and their associated persons. The purpose of this notice is to solicit public comment on the proposed amendment. The proposed amendment is the result of a long-standing Association concern relating to such incentive programs and a number of complaints the Association has received from members and sponsors of direct participation programs.

Background

Subsection 5(e) of Appendix F regulates direct payments of non-cash items to individual associated persons of members by limiting the value of those incentives to $50 per person per year, and requiring that the incentive item be counted as underwriting compensation and information regarding its receipt be disclosed in the offering materials. Subsection 5(f) of Appendix F, as amended on April 11, 1984, permits sales incentives in excess of $50 to be provided by program sponsors to members only if certain criteria are met. In summary, all sales incentives and bonuses must be paid directly to the member in cash, distribution (if any) of incentives to associated persons must be controlled solely by the member, the incentives must be reflected on the books and records of the recipient member and included as compensation received in connection with an offering, and the arrangements relating to the proposed payment of incentives or bonuses must be disclosed in the prospectus or similar document.

The April, 1984 amendment to Section 5(f) was intended to ensure that members retain control over the amount and form of compensation received by their registered representatives and, it was believed, would tend to discourage the non-cash sales incentive form of compensation. Notwithstanding the amendment, non-cash sales incentive programs appear to have become more prevalent and more aggressive, involving trips to exotic locations and selections of luxury merchandise. In light of this and the fact that many sponsors utilize direct appeals to registered representatives, the Association has become concerned that supervisory control of registered representatives has become a serious problem. Because sponsors often utilize direct appeals to registered representatives, it is often difficult for members to adequately control the participation of its registered representatives in non-cash sales incentive programs.

The Association believes that the ability of members to supervise their registered representatives is severely impacted when an outside entity offers and provides exotic trips and luxury merchandise to the member's retail sales force. The Association, therefore, has concluded that any further modifications to the existing rule which attempted to control sales incentives, short of a prohibition, would not be effective.

The Association also considered whether a prohibition on non-cash sales incentives in connection with the sale of direct participation programs should be extended to in-house sales incentive programs of member firms. Concern was expressed that it would be inequitable to prohibit incentive programs involving sponsors' non-cash incentives to members without also prohibiting members' internal non-cash incentive programs to their own registered representatives. However, the Association has determined that the rationale underlying the concerns relating to sales incentives are not present in the context of an in-house sales incentive program. Where an in-house program is involved, the member has control over the suitability of the particular program, is responsible for the sales methods utilized to sell the offering and is in a position to exercise control over its sales force. It is the influence of an outside entity over a member's sales force which has the effect of undermining the member's ability to supervise. Therefore, the Association has determined not to prohibit members in-house non-cash sales incentive programs.

Proposed Amendment

The Association is publishing for comment a proposed amendment to Section 5(e) of Appendix F which would prohibit a sponsor, affiliate of a sponsor (other than a member dealing with persons associated with that member) or a program from directly or indirectly offering or providing non-cash compensation in the form of sales incentive items to any NASD member or its associated persons including but not limited to travel bonuses, prizes and awards. In addition, members and their associated persons would be prohibited from accepting such non-cash compensation. Section 5(e) would also be clarified to indicate that souvenir-type sales incentives given by any sponsor directly to a person associated with a member may not exceed $50 per year per associated person for all programs of that sponsor. Section 5(f) is proposed to be eliminated.

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

Request for Comments

The Association is requesting comments on the proposed amendment prior to final Board consideration. All comments received during this comment period will be reviewed by the Direct Participation Programs and Real Estate Committees and changes to the amendment will be recommended as deemed appropriate. The Board of Governors will then reconsider the amendment. If the Board approves the amendment or an amended version, it must be filed with, and approved by, the Securities and Exchange Commission before it becomes effective.

All written comments should be addressed to the following:

James M. Cangiano, Secretary
National Association of Securities Dealers, Inc.
1735 K Street, N.W.
Washington, D.C. 20006

All comments must be received by April 15, 1985. All comments received will be made available for public inspection.

Any questions regarding this notice should be directed to Suzanne E. Rothwell or Richard J. Fortwengler of the Corporate Financing Department at (202) 728-8258.

Sincerely,

Frank J. Wilson
Executive Vice President
Legal and Compliance

Attachment

Proposed Amendment to Sections 5(e) and 5(f) of Appendix F to Article III, Section 34 of the Rules of Fair Practice*

Section 5 Organization and Offering Expenses

(e) No sponsor, affiliate of a sponsor (other than a member dealing with persons associated with that member), or program shall directly or indirectly offer or provide any non-cash compensation or sales incentive items including, but not limited to, travel bonuses, prizes, and awards to a member or a person associated with a member and no member or person associated with a member shall agree to accept such compensation. This section shall not prohibit a sponsor, affiliate of a sponsor, or program from providing non-cash sales incentive items directly to a person associated with a member unless where:
(1) the aggregate value of all such items to be received paid by any sponsor or affiliate of a sponsor to each associated person during any year does not exceed $50;
(2) the value of all such items to be made available in connection with an offering is included as compensation to be received in connection with the offering for purposes of paragraph (b)(l) of this section; and
(3) the proposed payment or transfer of all such items are disclosed in the prospectus or similar offering document.
(f) NO sponsor, affilate of a sponsor, or program shall provide compensation to a member in the form of sales incentive items including, but not limited to, travel bonuses, prizes, and awards unless all ef the following conditions are satistieds
(1) a fair market dollar value ef the incentive items has been established;
(2) the value of all sueh items to be made available in eenneetien with an offering is ineluded as compensation to be received in connection with the offering for purposes of subsectien (b) of this sectien;
(3) arrangements relating to the proposed payment or transfer of all such items are disclosed in the prospectus or similar offering document;
(4) the manner of receiving all such items and their supsequent disposition, whether to associated persons or otherwise, is controlled solely by the member in a manner whieh enables the member to properly supervise its associated persons; and
(5) the value of all such items is reflected on the books and records of the recipient member as compensatien received in connection with the offering.

* New language is underlined; deleted language is stricken.