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MAIL VOTE
EXECUTIVE SUMMARY
The NASD invites members to vote on a proposed amendment to Article III, Sections 26 and 29 of the NASD Rules of Fair Practice. The amendment would revise, simplify, and add a recordkeeping requirement to subsection (1) of Section 26, the Investment Company rule, and create subsection (h) of Section 29 to add a similar provision to the Variable Contracts rule.
BACKGROUND
In Notice to Members 91-25 (May 1991), the Board of Governors requested comment on a proposed amendment to Article III, Section 26(1) (the Investment Company rule) and on a proposed new Section 29(h) (the Variable Contracts rule) of the NASD Rules of Fair Practice that would (1) require that members maintain records of all cash and noncash compensation received from offerors and the distribution of the compensation to its associated persons; (2) prohibit associated persons from receiving any such compensation from anyone other than the member with which the person is associated; (3) prohibit a member from receiving securities from an offeror; and (4) prohibit receipt by a member of any type of compensation from the offeror unless such is described in the current prospectus of the investment company or variable contract. Notwithstanding the foregoing, the proposal would permit associated persons to receive gifts with a value not exceeding $100 per annum and permit offerors to pay or reimburse members for training and educational meetings at a business location where the offeror or member has its office or in the vicinity of such an office. Exceptions are also provided for, among others, compensation arrangements between a member and its associated persons.*
Twenty-one letters were received in response to the Notice to Members. Four commenters were opposed to members receiving noncash concessions from offerors for the sale of investment company shares. One commenter did not agree that compensation paid by a member to its own associated persons should be exempt from prospectus disclosure.
Most of the remaining commenters were generally in favor of the proposed amendment if certain changes are made to it. To respond to these commenters, the proposal published in Notice to Members 91-25 is modified as follows:
The $100 Gift Ceiling
The commenters suggested that gifts of not more than $100 per annum by an offeror to a registered representative should not be subject to the recordkeeping requirements in paragraphs (1)(1) and (h)(1) of the respective rules. The Board of Governors agrees, and subsections (1)(1) and (h)(1) have been amended to reflect this exemption.
One member suggested that the $100 maximum limit on gifts should be more flexible and related to any future increases in the Consumer Price Index. The proposal (subsections 5(a) in each rule) has been amended to give the authority to the Board of Governors to change the maximum amount in future years. This will be accomplished by use of a footnote to display the maximum gift allowance, which currently is $100.
Exception for Training and Educational Meetings
The current rule and the proposed amendment prohibit cash and noncash compensation from being received by members from offerors unless such is disclosed in the current prospectus of an investment company. Such disclosure would not be required when an offeror pays for a training or educational meeting attended by a member's associated persons where attendance is not conditioned on sales. In the amendment as proposed in Notice to Members 91-25, the location of such meetings would have been confined to places "where the offeror or the member has an office." Several members requested that the amendment be revised to eliminate this restriction. The Board of Governors does not agree that the restriction should be eliminated entirely, but it has broadened the language to include locations for such meetings that are in the vicinity of offices of a member or an offeror. Subsection (5)(b) in each rule has been amended.
Exception for a Member's Associated Persons
The current rule contains an exemption from the rules' provisions for compensation arrangements between a member and its own associated persons. Several commenters suggested that a non-member whose salespersons are registered representatives of a member that controls, is controlled by, or is under common control with that nonmember, should be afforded a similar exemption. The Board of Governors agrees, and a new paragraph (6)(d) has been added to each rule.
SUMMARY
The fundamental purpose of Article III, Sections 26(1) and 29(h) of the NASD Rules of Fair Practice is to require disclosure in prospectuses of cash and noncash compensation paid to members by offerors for the sale of investment company shares and variable contracts. The proposed amendment introduces a recordkeeping requirement that is designed to assist members in controlling the receipt of compensation, particularly noncash compensation, from offerors. The prohibition against associated persons receiving compensation directly from offerors without the knowledge and agreement of their member firms is retained.
REQUEST FOR VOTE
The NASD Board of Governors believes that this amendment to the two Rules of Fair Practice is necessary and appropriate and recommends that members vote their approval. Please mark the enclosed ballot according to your convictions and return it in the enclosed, stamped envelope to the Corporation Trust Company. Ballots must be postmarked no later than December 20, 1991.
Questions concerning this notice may be directed to A. John Taylor, Vice President, Investment Companies Department, at (202) 728-8328.
* Or a nonmember company and its sales personnel who are registered with an NASD member that controls, is controlled, or is under common control with the nonmember.
PROPOSED AMENDMENT TO ARTICLE III, SECTION 26 OF THE NASD RULES OF FAIR PRACTICE
(Note: New text is underlined; deleted text is in brackets.)
(a) Unchanged.
Definitions
(b)(1) — (6) Unchanged.
[(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.]
(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 under-writer and any affiliated person (as defined in Section 2(a)(3) of the Investment Company Act of 1940) of such entities.
"Cash compensation" shall mean compensation received by a member in cash, by check and by electronic means, and shall include loans and overrides.
"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.
* * * * *
(c) — (k) Unchanged.
[Dealer concessions]
Member Compensation
[(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 theater, 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 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.]
(1) In connection with the sale and distribution of investment company securities:
(1) Except for gifts as described in paragraph (1)(5)(a), a member shall maintain records of all compensation, cash and non-cash, 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) Except as described in paragraph (5), no associated person of a member shall accept any compensation, cash or non-cash, from anyone other than the member with which the person is associated.
(3) No member or person associated with a 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), no member shall accept any compensation, cash or non-cash, 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 may be accepted and are not required to be disclosed 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 an annual amount per person fixed periodically by the Board of Governors.1
(b) Payment or reimbursement by offerors to members in connection with training or educational meetings where the location is appropriate to the purpose of the meeting. A location appropriate to the purpose of a meeting shall mean an office of the offeror or the member or a facility located in the vicinity of such 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.
(d) Compensation arrangements between a non-member company and its sales personnel who are registered representatives of an NASD member which, directly or indirectly controls, is controlled by, or is under common control with that non-member company.
* * * * *
1 The current annual amount fixed by the Board of Governors is $100.
PROPOSED AMENDMENT TO ARTICLE III, SECTION 29 OF THE NASD RULES OF FAIR PRACTICE
(Note: New text is underlined.)
(a) Unchanged.
Definitions
(b)
(1) — (2) Unchanged.
(3) The terms "offeror," "cash compensation" and "non-cash compensation" as used in subsection (h) of this Section shall have the following meanings:
"Offeror" shall mean a separate account of an insurance company, an adviser to a separate ac-count of an insurance company, an underwriter and any affiliated person (as defined in Section 2(a)(3) of the Investment Company Act of 1940) of such entities.
"Cash compensation" shall mean compensation received by members in cash, by check and by electronic means and shall include loans and overrides.
"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.
* * * * *
(c) — (g) Unchanged.
Member Compensation
(h) In connection with the sale and distribution of variable contracts:
(1) Except for gifts as described in paragraph (h)(5)(a), a member shall maintain records of all compensation, cash and non-cash, 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) Except as described in paragraph (5), no associated person of a member shall accept any compensation, cash or non-cash, from anyone other than the member with which the person is associated. This requirement will not prohibit arrangements, agreed to by a member, where an 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.
(3) No member or person associated with a 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), no member shall accept any compensation, cash or non-cash, from an offeror unless such is described in the current prospectus of the variable contract. 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 variable contracts 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 may be accepted and are not required to be disclosed 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 an annual amount per person fixed periodically by the Board of Governors.1
(b) Payment or reimbursement by offerors to members in connection with training or educational meetings where the location is appropriate to the purpose of the meeting. A location appropriate to the purpose of a meeting shall mean an office of the offeror or the member or a facility located in the vicinity of such an office.
(6) The provisions of this Section (h) 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.
(d) Compensation arrangements between a non-member company and its sales personnel who are registered representatives of an NASD member which, directly or in-directly, controls, is controlled by, or is under common control with that non-member company.
* * * * *
1 The current annual amount fixed by the Board of Governors is $100.
