Notice To Members 89-51

Proposed Amendments to Article III, Section 26, of the NASD Rules of Fair Practice Re: Cash and Noncash Concessions in Connection with the Retail Sale of Investment-Company Securities — Last Date for Comments: August 4, 1989

Published Date:

SUGGESTED ROUTING*

Internal Audit
Legal & Compliance
Mutual Fund
Operations
Training

*These are suggested departments only. Others may be appropriate for your firm.

EXECUTIVE SUMMARY

The NASD requests comments on proposed amendments to subsections (b)(7) — Definitions — and (I) — Dealer Concessions— of Article III, Section 26 of the Rules of Fair Practice. The proposed amendments would revise and simplify the current rule governing dealer concessions paid to members that retail investment-company shares. It would also add a requirement that members keep detailed records of noncash concessions received and paid to their associated persons.

BACKGROUND

Subsection (1), Article III, Section 26 of the NASD Rules of Fair Practice requires disclosure in the prospectus of an investment company of items of material value, cash and noncash, that members will receive from the underwriters for the retail sale of investment company securities. Descriptions of items that are and are not considered to be of material value are also included in the rule.

The rule also requires that underwriters pay concessions, cash and noncash, to members and not directly to associated persons of members.

When underwriters offer cash and noncash concessions to all members that retail their securities on a uniform basis, a general description of such compensation is permitted in prospectuses. When "special deals" or "special arrangements" are made with individual members that are not made available to all retailing members, the details of the arrangements and the names of the members must be included in the prospectus.

THE PROPOSED AMENDMENTS

Purpose

The proposed amendments aim to revise and simplify the current rule and to enhance member control over registered representatives by introducing a record-keeping requirement for noncash concessions.

The major requirement of the current rule, prospectus disclosure of compensation, cash and noncash, is retained, as are the disclosure requirements with respect to "special deals."

The requirement that a member must be given the opportunity to take cash in lieu of a noncash concession has been eliminated.

Subsection (b)(7) - Definitions

The current rule is narrowly drawn to apply to relationships between underwriters and other member firms and is headed "dealer concessions." This term was used originally to describe that portion of a front-end sales load reallowed to retail dealers by underwriters.

Currently, with the advent of other methods of financing the cost of sales and sales promotion, utilizing sources other than front-end sales loads, the provisions of the rule need to be broadened to apply to all compensation received by members for retailing investment-company securities.

It is proposed to achieve this by adopting the term "offeror" to broadly define any source of member income and to replace "dealer concessions" with the term "member compensation." The definitional section will also include separate definitions of "cash" and "noncash" compensation.

Subsection (1)(1)

This subsection is new. It will require members to keep detailed records of the amount and nature of all compensation, cash and noncash, received from offerors for the retail sale of investment-company securities and distribution of such to members' associated persons. This will enhance a member's ability to control and supervise its associated persons.

Subsection (1)(2)

This subsection is similar in intent to subsection (1)(2) in the current rule. It prohibits an associated person of a member firm from receiving any compensation, cash or noncash, for selling investment-company securities except from the member with which the associated person is affiliated.

Subsection (1)(3)

This subsection reiterates the prohibition in the current rule against member compensation in the form of securities of any kind.

Subsection (1)(4)

This subsection reiterates the requirements in the current rule governing disclosure in prospectuses of cash and noncash compensation.

Subsection (1)(5)

The current rule contains extensive descriptions of items that are and are not of material value. In the Board's opinion, it is not possible to describe all such items in a rule of general application.

The concept of an item of material value has, therefore, been eliminated from the rule. The Board proposes that there will be only two items of compensation that will not require prospectus disclosure provided that they are not conditioned on sales or the promise of sales.

First, the monetary limit on gifts by offerors to associated persons has been increased from $50 to $100 per person per annum. Such gifts must be approved by members but need not be recorded by the member firm.

Second, members may accept compensation from offerors to defray the costs associated with training or educational meetings held at locations appropriate to the purpose of such meetings. Such locations would normally be the offices of offerors or members or facilities located in the vicinity of such offices. No member may realize a profit from the receipt of such compensation.

Subsection (1)(6)

Subsections 6(a) and 6(b) reiterate exemptive provisions in the current rule. Subsection 6(c) has been rewritten to exclude from the provisions of the rule compensation arrangements between a member firm and its own associated persons.

The NASD encourages all members and other interested parties to comment on the proposed amendments to Article III, Section 26, of the NASD Rules of Fair Practice. Comments should be directed to:

Mr. Lynn Nellius, Secretary
National Association of Securities Dealers, Inc.
1735 K Street, NW
Washington, DC 20006

Questions concerning this notice should be directed to A. John Taylor, Vice President, Investment Companies/Variable Contracts, at (202) 728-8328.

PROPOSED AMENDMENTS TO ARTICLE III, SECTION 26 OF THE NASD RULES OF FAIR PRACTICE

(Note: New text is underlined; deleted text is in brackets.)

Definitions

(b)(7)["Associated persons 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.]

(b)(7)The terms "offeror," "cash compensation" and "non-cash compensation" as used in subsection (1) of this section shall have the following meanings:

"Offeror" shall mean an investment company, an adviser to an investment-company, an underwriter and persons associated with such entities and their affiliates.

"Cash compensation" shall mean compensation received by a member in cash, by check and by electronic means.

"Non-cash compensation" shall mean any form of compensation received by members that is not cash compensation, including but not limited to merchandise, gifts and prizes, and payment of travel expenses, meals and lodging.

[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 noncash 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 by 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 enroute 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 representative which is not conditioned on sales of shares of an investment company and is neither so frequent nor so extensive as to raise any 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) In connection with the retail sale and distribution of investment company securities:
(1) A member shall maintain records of all compensation, cash and noncash, received from offerors and the distribution by the member of any such compensation to its associated persons. The records shall include the names of the offerors, the names of the associated persons and the amount and nature of the compensation received and distributed.
(2) No associated person of a member shall accept any compensation, cash or noncash, from anyone other than the member with which the person is associated.
(3) No member shall accept any compensation from an offeror which is in the form of securities of any kind.
(4) Except as described in paragraph (5) of this subsection (1), no member shall accept any compensation, cash or noncash, from an offeror unless such is described in the current prospectus of the investment company. When special compensation arrangements are offered by an offeror to a member, which arrangements are not made available on the same terms to all members who distribute the investment company securities of the offeror, a member shall not enter into such arrangements unless the name of the member and the details of the arrangements are disclosed in the prospectus.
5) Notwithstanding the provisions of subsections (2) and (4) of this section, the following items of compensation are not required to be dis closed in a prospectus provided that they are not conditioned on sales or the promise of sales:
a) Gifts by an offeror to associated persons of members, with the approval of the member, that do not exceed $100 in value per annum, per person.
b) Payment or reimbursement by offerors to members in connection with training or education al meetings where the location is appropriate to the purpose of such meetings, which would ordinarily mean a business location where the offeror or the member has an office.
6) The provisions of this Section (1) shall not apply to:
a) Compensation arrangements between principal underwriters of the same security.
b) Compensation arrangements 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 between a member and its own associated persons.