TO: All NASD Members and Other Interested Persons
LAST DATE FOR COMMENT: MARCH 31, 1988.
EXECUTIVE SUMMARY
The NASD requests comments on proposed amendments to the NASD Rules of Fair Practice that would generally prohibit members from accepting non-cash sales compensation in connection with the distribution of investment company and variable contract products.
The purpose of the amendments is to address the NASD Board of Governors' concern that members' ability to supervise their registered representatives is adversely affected when an outside entity offers and provides non-cash compensation.
The texts of the proposed amendments are attached.
BACKGROUND
In July 1986, the NASD Board of Governors approved amendments to Appendix F to Article III, Section 34 of the NASD Rules of Fair Practice that would prohibit members and their associated persons from receiving items of non-cash sales incentive compensation in conjunction with the sales of direct participation program securities if the value of such compensation exceeds $50 annually. The rule excluded internal non-cash sales incentive programs funded entirely by member firms. This proposal is currently on file with the Securities and Exchange Commission (SEC). The purpose of the proposal was to address a concern that members' ability to supervise their registered representatives is adversely affected when an outside entity offers and provides non-cash compensation, such as exotic trips and luxury merchandise, to the members' retail salespersons.
The NASD Board also approved a similar prohibition in conjunction with corporate offerings and real estate investment trusts. The NASD Board, through its Investment Companies and Variable Contracts Committees, surveyed sponsors and underwriters of these products and determined that, while fewer non-cash sales incentives are used in these areas than in the direct participation program area, relatively little opposition was expressed to eliminate such compensation programs. The NASD Board concluded that it was important to maintain consistency in regulating non-cash sales compensation with respect to the various securities products that may compete for salespersons' attention.
Therefore, at its January 1988 meeting, the Board voted to propose bans on the use of non-cash incentives in conjunction with sales of investment company and variable contract products, similar to the bans pending implementation for other products.
PROPOSED AMENDMENTS
Article III, Section 26
The proposed amendment to Article III, Section 26 that applies to investment companies would replace existing paragraph 1, which currently does not prohibit non-cash compensation but requires that members be given the opportunity to elect a cash equivalent and requires prospectus disclosure. The amendment would prohibit the payment of any non-cash compensation, including sales incentives and securities of any kind, with a value in excess of $50 per year to each associated person. The proposed rule would exclude non-cash compensation paid by a member to its own associated persons and payments relating to training or educational meetings held where the offeror's main office is located. The proposed rule would also establish requirements for the payment of cash compensation directly to member firms.
Article III, Section 29
Article III, Section 29 deals with variable contracts and currently does not address non-cash compensation. The proposed amendment would add prohibitions almost identical to those for investment company products. The only difference is that the variable contract rule would provide for arrangements where issuing insurance companies maintain commission accounts as ministerial services for member firms and pay commission checks directly to associated persons, as permitted by the SEC, under its interpretive release on the distribution of variable annuities. (See Securities Exchange Act Release No. 34-8389, dated August 29, 1968.)
REQUEST FOR COMMENTS
The NASD encourages all members and interested persons to comment on the proposed amendments. Comments should be directed to:
Mr. Lynn Nellius
Secretary
1735 K Street, N.W.
Washington, D.C. 20006-1506
Comments must be received no later than March 31, 1988. Comments received by this date will be considered by the NASD Board of Governors. If approved by the NASD Board, the proposal must be submitted to the membership for a vote. Thereafter, the proposal must be filed with and approved by the SEC before becoming effective.
Questions concerning this notice can be directed to A. John Taylor, Vice President, NASD Investment Companies/Variable Contracts, at (202) 728-8328, or T. Grant Callery, NASD Associate General Counsel, at (202) 728-8285.
Sincerely,
Frank J. Wilson
Executive Vice President and General Counsel
Attachments
PROPOSED AMENDMENTS TO SECTION 26 OF THE NASD RULES OF FAIR PRACTICE*
Investment Companies
Sec. 26.
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Definitions
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[(7) "Associated person of an underwriter," as used in subsection (1) of this section, shall include an issuer for which an underwriter is the sponsor or a principal underwriter, any investment adviser to such issuer, or any affiliated person (as defined in Section 2(a)(3) of the Investment Company Act of 1940) of such underwriter, issuer, or investment adviser.]
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[Dealer Concessions]
[(1)
(1) No underwriter or associated person of an underwriter shall offer, pay, or arrange for the offer or payment to any other member, in connection with retail sales or distribution of investment company securities, any discount, concession, fee or commission (hereinafter referred to as "concession") which:]
[(A) is in the form of securities of any kind, including stock, warrants or options;]
[(B) is in a form other than cash (e.g., merchandise or trips), unless the member earning the concession may elect to receive cash at the equivalent of no less than the underwriter's cost of providing the non-cash concession; or]
[(C) is not disclosed in the prospectus of the investment company. If the concessions are not uniformly paid to all dealers purchasing the same dollar amounts of securities from the underwriter, the disclosure shall include a description of the circumstances of any general variations from the standard schedule of concessions. If special compensation arrangements have been made with individual dealers, which arrangements are not generally available to all dealers, the details of the arrangements, and the identities of the dealers, shall also be disclosed.]
[(2) No underwriter or associated person of an underwriter shall offer or pay any concession to an associated person of another member, but shall make such payment only to the member.]
[(3)
(A) In connection with retail sales or distribution of investment company shares, no underwriter or associated person of an underwriter shall offer or pay to any member or associated person, anything of material value, and no member or associated person shall solicit or accept anything of material value, in addition to the concessions disclosed in the prospectus.]
[(B) For purposes of this paragraph (1)(3), items of material value shall include but not be limited to:
(i) gifts amounting in value to more than $50 per person per
year.
(ii) gifts or payments of any kind which are conditioned on the sale of investment company securities.
(iii) loans made or guaranteed to a non-controlled member or person associated with a member.
(iv) wholesale overrides (commissions) granted to a member on its own retail sales unless the arrangement, as well as the identity of the member, is set forth in the prospectus of the investment company.
(v) payment or reimbursement of travel expenses, including overnight lodging, in excess of $50 per person per year unless such payment or reimbursement is in connection with a business meeting, conference or seminar held by an underwriter for informational purposes relative to the fund or funds of its sponsorship and is not conditioned on sales of shares of an investment company. A meeting, conference or seminar shall not be deemed to be of a business nature unless: the person to whom payment or reimbursement is made is personally present at, or is en route to or from, such meeting in each of the days for which payment or reimbursement is made; the person on whose behalf payment or reimbursement is made is engaged in the securities business; and the location and facilities provided are appropriate to the purpose, which would ordinarily mean the sponsor's office.]
[(C) For purposes of this paragraph (1)(3), items of material value shall not include:
(i) an occasional dinner, a ticket to a sporting event or the theatre, or comparable entertainment of one or more registered representatives which is not conditioned on sales of shares of an investment company and is neither so frequent nor so extensive as to raise question of propriety.
(ii) a breakfast, luncheon, dinner, reception or cocktail party given for a group of registered representatives in conjunction with a bona fide business or sales meeting, whether at the headquarters of a fund or its underwriter or in some other city.
(iii) an unconditional gift of a typical item of reminder advertising such as a ballpoint pen with the name of the advertiser inscribed, a calendar pad, or other gifts amounting in value to not more than $50 per person per year.]
[(4) The provisions of this subsection (1) shall not apply to:
(A) Contracts between principal underwriters of the same security.
(B) Contracts between the principal underwriter of a security and the sponsor of a unit investment trust which utilizes such security as its underlying investment.
(C) Compensation arrangements of an underwriter or sponsor with its own sales personnel.]
Member Compensation
(1) (1) No member or person associated with a member shall accept, directly or indirectly, any non-cash compensation or non-cash sales incentive, including but not limited to travel expenses, board and lodging, merchandise, awards or prizes, from any underwriter, investment company, adviser to an investment company ("collectively offerors") oF affiliates of such offerors, in connection with the retail sale or distribution of investment company securities. For purposes of this paragraph, the term "non-cash compensation" shall include securities of any kind.
(2) Notwithstanding the prohibition against the acceptance by members of non-cash compensation in paragraph (1)(1), the following practices with respect to the utilization of non-cash compensation are permitted:
(A) The provision of non-cash compensation by a member to its own associated persons, provided that no offeror and, specifically, no offeror affiliated with a member, participates in or contributes to the provision of such non-cash compensation.
(B) The acceptance of non-cash compensation by a person associated with a member from an offeror, provided that the total value of such compensation does not exceed $50 per annum to each associated person.
(C) Payment by offerors for travel expenses, including board and lodging, incurred by members and their associated persons when attending training or educational meetings held in the city or place where the main office of an offeror is located.
(3) No member shall accept any cash compensation from an offeror unless all the following conditions are satisfied;
(A) All cash compensation is paid directly to the member who shall have sole control over the distribution of any of such compensation to its associated persons.
(B) The arrangements between offerors and members with respect to cash compensation are disclosed in the current prospectus of the investment company. When special cash compensation arrangements that differ from the standard compensation schedule are made with individual members, the names of such members and details of the arrangements must also be disclosed in the prospectus.
(C) The amount of cash compensation received is entered in the books and records of the member as compensation received in connection with an offering of investment company securities.
(D) No cash compensation received by a member from an offeror is related in any way to any non-cash compensation or sales incentive items provided by a member to its associated persons.
PROPOSED AMENDMENTS TO ARTICLE ID, SECTION 29 OF THE NASD RULES OF FAIR PRACTICE*
Variable Contracts of an Insurance Company
Sec. 29.
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Member Compensation
h (l) No member or person associated with a member shall accept, directly or indirectly, any non-cash compensation or non-cash sales incentive, including but not limited to travel expenses, board and lodging, merchandise, awards or prizes, from any underwriter, issuer of variable contracts, adviser to an issuer of variable contracts (collectively "offerors") or affiliates of such offerors in connection with the retail sale or distribution of variable contracts. For purposes of this paragraph, the term "non-cash compensation" shall include securities of any kind.
(2) Notwithstanding the prohibition against accepting non-cash compensation in paragraph h (1), the following practices with respect to the utilization of non-cash compensation are permitted.
(A) The provision of non-cash compensation by a member to its own associated persons, provided that no offeror and, specifically, no offeror affiliated with a member, participates in or contributes to the provision of such non-cash compensation.
(B) The acceptance of non-cash compensation by a person associated with a member from an offeror, provided that the total value of such non-cash compensation does not exceed $50 per annum to" each such associated person.
(C) Payment by offerors for travel expenses, including board and lodging, incurred by members and their associated persons when attending training or educational meetings held in the city or place where the main office of an offeror is located.
(3) No member shall accept any cash compensation from an offeror unless all of the following conditions are satisfied:
(A) All cash compensation is paid directly to the member who shall have sole control over the distribution of any such compensation to its associated persons. This requirement will not prohibit arrangements, agreed to by a member, where an issuing insurance company maintains a commission account as a ministerial service for a member and, on behalf of the member, pays commission checks from such an account directly to associated persons of the member.
(B) The arrangements between offeror and members with respect to cash compensation are disclosed in the current prospectus of the variable contract. When special cash compensation arrangements that differ from the standard compensation schedule are made by offerors with individual members, the names of such members and the details of arrangements must also be disclosed in the current prospectus.
(C) The amount of cash compensation received, including that paid directly to a member's associated persons under 3(A) above, is entered in the books and records of a member as compensation received in connection with an offering of variable contracts.
(d) No cash compensation received by a member from an offeror is related in any way to any non-cash compensation or sales incentive items provided by a member to its associated persons.
*New language is underlined; deleted language is in brackets.
*New language is underlined.
