35822 Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices

2See supra note 1. 3 17 CFR 200.30–3(a)(12).

1On June 14, 1996, the NASD filed Amendment

No. 1 with the Commission. Amendment No. 1

addresses the relationship of the proposed rule

change to industry initiatives concerning

compensation practices, expands the scope of the

proposed rule change to govern all sales targets,

whether or not previously specified and replaces

the term ‘‘variable contract securities’’ with the

term ‘‘variable contract.’’ See Letter from John M.

Ramsay, Deputy General Counsel, NASD to

Katherine A. England, Assistant Director, Division

of Market Regulation, SEC (June 14, 1996).

2NASD Manual, Rules of the Association,

Conduct Rules (CCH), Rules 2820, 2830.

fines for violation of trading conduct

and decorum policies established under

CBOE Rule 6.20, and states that the

specific dollar amount that may be

imposed as fines thereunder will be

distributed to the membership

periodically. The Exchange has

previously issued Regulatory Circular

95–37, which sets forth fines for most of

the trading conduct and decorum

policies established under Rule 6.20,

but does not include fines for violation

of the firm quote requirements of Rule

8.51, which are deemed to be violations

of Rule 6.20(b).2 Proposed Regulatory

Circular 96–yy cures this omission for

violations of the firm quote rule in the

OEX crowd by setting forth the specific

dollar amounts that may be imposed as

summary fines for such violations. As

noted above, the fines that may be

imposed for refusal to take the other

side of an OEX trade entitled to

execution under the firm quote rule

when directed to do so by Floor

Officials range from $1,000 to $5,000,

which places them at the high end of

the scale under Rule 17.50. This is

intended to remove any economic

incentive for a market maker to refuse

to obey the directions of Floor Officials

to comply with firm quote requirements.

The Exchange believes that by

clarifying the obligations of market

makers and floor brokers in the OEX

crowd under the firm quote rule and by

specifying the fines that may be

imposed for failure to honor these

obligations, the proposed regulatory

circulars will serve to promote just and

equitable principles of trade and to

protect investors and the public interest,

in furtherance of the objectives of

section 6(b)(5) of the Act.

B. Self-Regulatory Organization’s

Statement on Burden on Competition

The Exchange does not believe that

the proposed rule change will impose

any inappropriate burden on

competition.

C. Self-Regulatory Organization’s

Statement on Comments on the

Proposed Rule Change Received From

Members, Participants, or Others

No written comments were solicited

or received with respect to the proposed

rule change.

III. Date of Effectiveness of the

Proposed Rule Change and Timing for

Commission Action

Because the foregoing rule change

constitutes a stated policy with respect

to the meaning, administration, or

enforcement of an existing rule, it has

become effective pursuant to Section

19(b)(3)(A) of the Act and Rule 19b–4

thereunder. At any time within 60 days

of the filing of the proposed rule change,

the Commission may summarily

abrogate such rule if it appears to the

Commission that such action is

necessary or appropriate in the public

interest, for the protection of investors,

or otherwise in furtherance of the

purposes of the Act.

IV. Solicitation of Comments

Interested persons are invited to

submit written data, views, and

arguments concerning the foregoing.

Persons making written submissions

should file six copies thereof with the

Secretary, Securities and Exchange

Commission, 450 Fifth Street, N.W.,

Washington, D.C. 20549. Copies of the

submission, all subsequent

amendments, all written statements

with respect to the proposed rule

change that are filed with the

Commission, and all written

communications relating to the

proposed rule change between the

Commission and any person, other than

those that may be withheld from the

public in accordance with the

provisions of 5 U.S.C. 552, will be

available for inspection and copying in

the Commission’s Public Reference

Section, 450 Fifth Street, N.W.,

Washington, D.C. 20549. Copies of such

filing will also be available for

inspection and copying at the principal

office of the CBOE. All submissions

should refer to the File No. SR–CBOE–

96–31 and should be submitted by July

29, 1996.

For Commission, by the Division of Market

Regulation, pursuant to delegated authority.3

Jonathan G. Katz,

Secretary.

[FR Doc. 96–17251 Filed 7–5–96; 8:45 am]

BILLING CODE 8010–01–M

[Release No. 34–37374; File No. SR-NASD–

95–61]

Self-Regulatory Organizations; Notice

of Filing of Proposed Rule Change by

National Association of Securities

Dealers, Inc. Relating to the Regulation

of Cash and Non-Cash Compensation

in Connection With the Sale of

Investment Company Securities and

Variable Contracts

June 26, 1996.

Pursuant to Section 19(b)(1) of the

Securities Exchange Act of 1934

(‘‘Act’’), 15 U.S.C. 78s(b)(1), notice is

hereby given that on December 22,

1995,1 the National Association of

Securities Dealers, Inc. (‘‘NASD’’ or

‘‘Association’’) filed with the Securities

and Exchange Commission (‘‘SEC’’ or

‘‘Commission’’) the proposed rule

change as described in Items I, II, and

III below, which Items have been

prepared by the NASD. The

Commission is publishing this notice to

solicit comments on the proposed rule

change from interested persons.

I. Self-Regulatory Organization’s

Statement of the Terms of Substance of

the Proposed Rule Change

The NASD proposes to amend NASD

Rules 2820 and 2830 (formerly Article

III, Sections 29 and 26 of the Rules of

Fair Practice) to revise existing rules

applicable to the sale of investment

company securities and establish new

rules applicable to the sale of variable

contracts.2 Below is the text of the

proposed rule change. Proposed new

language is italicized; proposed

deletions are in brackets.

Rules of the Association

Conduct Rules

* * * * *

Variable Contracts of an Insurance

Company

Rule 2820.

* * * * *

Definitions

(b)

* * *

(3) The terms ‘‘affiliated member’’,

‘‘cash compensation’’, ‘‘non-cash

compensation’’ and ‘‘offeror’’ as used in

paragraph (h) shall have the following

meanings:

‘‘Affiliated Member’’ shall mean a

member which, directly or indirectly,

controls, is controlled by, or is under

common control with a non-member

company.

‘‘Cash compensation’’ shall mean any

discount, concession, fee, service fee,

commission, loan or override received

in connection with the sale and

distribution of variable contracts. ‘‘Noncash compensation’’ shall mean any

form of compensation received in
Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices 35823

3The current annual amount fixed by the Board

of Governors is $100.

connection with the sale and

distribution of variable contracts that is

not cash compensation, including but

not limited to merchandise, gifts and

prizes, and payment of travel expenses,

meals and lodging.

‘‘Offeror’’ shall mean an insurance

company, a separate account of an

insurance company, an adviser to a

separate account of an insurance

company, a fund administrator, an

underwriter and any affiliated person

(as defined in Section 2(a)(3) of the

Investment Company Act of 1940) of

such entities.

* * * * *

Member Compensation

(h) In connection with the sale and

distribution of variable contracts:

(1) Except as described below, 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. This requirement will not

prohibit arrangements where a nonmember company pays compensation

directly to associated persons of the

member, provided that:

(a) the arrangement is agreed to by the

member;

(b) the member relies on an

appropriate rule, regulation, interpretive

release, interpretive letter, or ‘‘noaction’’ letter issued by the Securities

and Exchange Commission that applies

to the specific fact situation of the

arrangement;

(c) the receipt by associated persons

of such compensation is treated as

compensation received by the member

for purposes of NASD rules; and

(d) the recordkeeping requirement in

subparagraph (h)(2) is satisfied.

(2) Except for items as described in

subparagraphs (h)(3)(a) and (b), a

member shall maintain records of all

compensation, cash and non-cash,

received by the member or its associated

persons from offerors. The records shall

include the names of the offerors, the

names of the associated persons, the

amount of cash, the nature and, if

known, the value of non-cash

compensation received.

(3) No member or person associated

with a member shall directly or

indirectly accept any non-cash

compensation offered or provided to

such member or its associated persons,

except as provided in this provision.

Notwithstanding the provisions of

subparagraph (h)(1), the following items

of non-cash compensation may be

accepted:

(a) Gifts to associated persons of

members that do not exceed an annual

amount per person fixed periodically by

the Board of Governors 3 and are not

preconditioned on achievement of a

sales target.

(b) An occasional meal, a ticket to a

sporting event or the theater, or

comparable entertainment for persons

associated with a member and, if

appropriate, their guests, which is

neither so frequent nor so extensive as

to raise any question of impropriety and

is not preconditioned on achievement of

a sales target.

(c) Payment or reimbursement by

offerors in connection with meetings

held by an offeror or by a member for

the purpose of training or education of

associated persons of a member,

provided that:

(i) the recordkeeping requirement in

subparagraph (h)(2) is satisfied;

(ii) associated persons obtain the

member’s prior approval to attend the

meeting and attendance by a member’s

associated persons is not

preconditioned by the member on the

achievement of a sales target or any

other non-cash compensation

arrangement permitted by paragraph

(d);

(iii) the location is appropriate to the

purpose of the meeting, which shall

mean an office of the offeror or the

member, or a facility located in the

vicinity of such office, or a regional

location with respect to regional

meetings;

(iv) the payment or reimbursement is

not applied to the expenses of guests of

the associated person; and

(v) the payment or reimbursement by

the offeror is not preconditioned by the

offeror on the achievement of a sales

target or any other non-cash

compensation arrangement permitted

by paragraph (d).

(d) Non-cash compensation

arrangements between a member and its

associated persons or a non-member

company and its sales personnel who

are associated persons of an affiliated

member, provided that:

(i) the member’s or non-member’s

non-cash compensation arrangement, if

it includes variable contracts, is based

on the total production of associated

persons with respect to all variable

contracts distributed by the member;

(ii) the non-cash compensation

arrangement requires that the credit

received for each variable contract

security is equally weighted;

(iii) no unaffiliated non-member

company or other unaffiliated member

directly or indirectly participates in the

member’s or non-member’s organization

of a permissible non-cash compensation

arrangement; and

(iv) the recordkeeping requirement in

subparagraph (h)(2) is satisfied.

(e) Contributions by a non-member

company or other member to a non-cash

compensation arrangement between a

member and its associated persons,

provided that the arrangement meets

the criteria in paragraph (d).

(4) No person associated with a

member shall accept any cash

compensation offered or provided to

such person that is preconditioned on

such person achieving a sales target,

except that the following arrangements

are permitted:

(a) Cash compensation arrangements

preconditioned on the achievement of a

sales target between a member and its

associated persons or a non-member

company and its sales personnel who

are associated persons of an affiliated

member, provided that:

(i) the member’s or non-member’s

arrangement, if it includes variable

contracts, is based on the total

production of associated persons with

respect to all variable contracts

distributed by the member;

(ii) the arrangement requires that the

credit received for each variable

contract security is equally weighted;

(iii) no unaffiliated non-member

company or other unaffiliated member

directly or indirectly participates in the

member’s or non-member’s organization

of a permissible arrangement; and

(iv) the recordkeeping requirement in

subparagraph (h)(2) is satisfied.

(b) Contributions by a non-member

company or other member to a cash

compensation arrangement

preconditioned on the achievement of a

sales target between a member and its

associated persons, provided that the

arrangement meets the criteria in

paragraph (a).

Investment Companies

Rule 2830

* * * * *

(b)

[(1) ‘‘Associated person of an

underwriter,’’ as used in paragraph (l),

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.] The terms ‘‘affiliated member’’,

‘‘cash compensation’’, ‘‘non-cash

compensation’’, and ‘‘offeror’’ as used

in paragraph (l) shall have the following

meanings:

‘‘Affiliated Member’’ shall mean a

member which, directly or indirectly,

controls, is controlled by, or is under
35824 Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices

common control with a non-member

company.

‘‘Cash compensation’’ shall mean any

discount, concession, fee, service fee,

commission, asset-based sales charge,

loan, or override received in connection

with the sale and distribution of

investment company securities.

‘‘Non-cash compensation’’ shall mean

any form of compensation received in

connection with the sale and

distribution of investment company

securities that is not cash

compensation, including but not limited

to merchandise, gifts and prizes, and

payment of travel expenses, meals and

lodging.

‘‘Offeror’’ shall mean an investment

company, an adviser to an investment

company, a fund administrator, an

underwriter and any affiliated person

(as defined in Section 2(a)(3) of the

Investment Company Act of 1940) of

such entities.

* * * * *

[Dealer concessions]

[(l)(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 subparagraph

(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 subparagraph

(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 paragraph

(l) 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

(l) In connection with the sale and

distribution of investment company

securities:

(1) Except as described below, 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. This requirement will not

prohibit arrangements where a nonmember company pays compensation

directly to associated persons of the

member, provided that:

(a) the arrangement is agreed to by the

member;

(b) the member relies on an

appropriate rule, regulation, interpretive

release, interpretive letter, or ‘‘noaction’’ letter issued by the Securities

and Exchange Commission or its staff

that applies to the specific fact situation

of the arrangement;

(c) the receipt by associated persons

of such compensation is treated as

compensation received by the member

for purposes of NASD rules; and

(d) the recordkeeping requirement in

subparagraph (l)(3) is satisfied.

(2) 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.

(3) Except for items described in

subparagraphs (l)(5)(a) and (b), a

member shall maintain records of all

compensation, cash and non-cash,

received by the member or its associated

persons from offerors. The records shall

include the names of the offerors, the

names of the associated persons, the

amount of cash, the nature and, if

known, the value of non-cash

compensation received.

(4) No member shall accept any cash

compensation from an offeror unless

such compensation is described in a

current prospectus of the investment

company. When special cash

compensation arrangements are made

available by an offeror to a member,

which arrangements are not made
Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices 35825

4The current annual amount fixed by the Board

of Governors is $100.

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. Prospectus disclosure

requirements shall not apply to cash

compensation arrangements between:

(a) principal underwriters of the same

security; and

(b) the principal underwriter of a

security and the sponsor of a unit

investment trust which utilizes such

security as its underlying investment.

(5) No member or person associated

with a member shall directly or

indirectly accept any non-cash

compensation offered or provided to

such member or its associated persons,

except as provided in this provision.

Notwithstanding the provisions of

subparagraph (l)(1), the following items

of non-cash compensation may be

accepted:

(a) Gifts to associated persons of

members that do not exceed an annual

amount per person fixed periodically by

the Board of Governors 4 and are not

preconditioned on achievement of a

sales target.

(b) An occasional meal, a ticket to a

sporting event or the theater, or

comparable entertainment for persons

associated with a member and, if

appropriate, their guests, which is

neither so frequent nor so extensive as

to raise any question of propriety and is

not preconditioned on achievement of a

sales target.

(c) Payment or reimbursement by

offerors in connection with meetings

held by an offeror or by a member for

the purpose of training or education of

associated persons of a member,

provided that:

(i) the recordkeeping requirement in

subparagraph (l)(3) is satisfied;

(ii) associated persons obtain the

member’s prior approval to attend the

meeting and attendance by a member’s

associated persons is not

preconditioned by the member on the

achievement of a sales target or any

other non-cash compensation

arrangement permitted by paragraph

(d);

(iii) the location is appropriate to the

purpose of the meeting, which shall

mean an office of the offeror or the

member, or a facility located in the

vicinity of such office, or a regional

location with respect to regional

meetings;

(iv) the payment or reimbursement is

not applied to the expenses of guests of

the associated person; and

(v) the payment or reimbursement by

the offeror is not preconditioned by the

offeror on the achievement of a sales

target or any other non-cash

compensation arrangement permitted

by paragraph (d).

(d) Non-cash compensation

arrangements between a member and its

associated persons or a non-member

company and its sales personnel who

are associated persons of an affiliated

member, provided that:

(i) the member’s or non-member’s

non-cash compensation arrangement, if

it includes investment company

securities, is based on the total

production of associated persons with

respect to all investment company

securities distributed by the member;

(ii) the non-cash compensation

arrangement requires that the credit

received for each investment company

security is equally weighted;

(iii) no unaffiliated non-member

company or other unaffiliated member

directly or indirectly participates in the

member’s or non-member’s organization

of a permissible non-cash compensation

arrangement; and

(iv) the recordkeeping requirement in

subparagraph (l)(3) is satisfied.

(e) Contributions by a non-member

company or other member to a non-cash

compensation arrangement between a

member and its associated persons,

provided that the arrangement meets

the criteria in paragraph (d).

(6) No person associated with a

member shall accept any cash

compensation offered or provided to

such person that is preconditioned on

such person achieving a sales target,

except that the following arrangements

are permitted:

(a) Cash compensation arrangements

preconditioned on the achievement of a

sales target between a member and its

associated persons or a non-member

company and its sales personnel who

are associated persons of an affiliated

member, provided that:

(i) the member’s or non-member’s

arrangement, if it includes investment

company securities, is based on the total

production of associated persons with

respect to all investment company

securities distributed by the member;

(ii) the arrangement requires that the

credit received for each investment

company security is equally weighted;

(iii) no unaffiliated non-member

company or other unaffiliated member

directly or indirectly participates in the

member’s or non-member’s organization

of a permissible arrangement; and

(iv) the recordkeeping requirement in

subparagraph (l)(3) is satisfied.

(b) Contributions by a non-member

company or other member to a cash

compensation arrangement

preconditioned on the achievement of a

sales target between a member and its

associated persons, provided that the

arrangement meets the criteria in

paragraph (a).

* * * * *

II. Self-Regulatory Organization’s

Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule

Change

In its filing with the Commission, the

NASD included statements concerning

the purpose of and basis for the

proposed rule change and discussed any

comments it received on the proposed

rule change. The text of these statements

may be examined at the places specified

in Item IV below. The NASD has

prepared summaries, set forth in

Sections (A), (B), and (C) below, of the

most significant aspects of such

statements.

(A) Self-Regulatory Organization’s

Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule

Change

(a) Purpose of Proposed Rule Change

Introduction

The NASD is proposing to amend

Rule 2820 (‘‘Variable Contracts Rule’’)

and Rule 2830 (‘‘Investment Company

Rule’’) to establish new rules applicable

to the sale of variable contracts and

revise existing rules applicable to the

sale of investment company securities.

Generally, the proposed rule change

would: (1) Adopt definitions of the

terms ‘‘affiliated member,’’ ‘‘cash

compensation,’’ ‘‘non-cash

compensation’’ and ‘‘offeror’’; (2)

prohibit, except under certain

circumstances, associated persons from

receiving any compensation, cash or

non-cash, from anyone other than the

member with which the person is

associated; (3) require that members

maintain records of compensation

received by the member or its associated

persons from offerors; (4) with respect to

the Investment Company Rule, prohibit

receipt by a member of cash

compensation from the offeror unless

such arrangement is described in the

current prospectus; (5) retain the

prohibition, only with respect to the

Investment Company Rule, against a

member receiving compensation in the

form of securities; (6) prohibit, with

certain exceptions, members and

persons associated with members from

accepting, directly or indirectly, any
35826 Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices

5 In Notice to Members 94–14 (March 1994), the

NASD clarified the obligations of members in

complying with the compensation disclosure

requirements for investment companies in

Subsection 26(l)(1)(C) to Article III of the Rules of

Fair Practice. See also Notice to Members 94–41

(May 1994).

non-cash compensation in connection

with the sale of investment company

securities and variable contracts; and (7)

prohibit, with certain exceptions, a

person associated with a member from

accepting, directly or indirectly, any

cash compensation in connection with

the sale of investment company

securities and variable contracts.

The exceptions from the non-cash

compensation prohibition would

permit: (1) Gifts of up to $100 per

associated person annually; (2) an

occasional meal, ticket to a sporting

event or theater, or entertainment for

associated persons and their guests; (3)

payment or reimbursement for training

and education meetings held by a

broker-dealer or a mutual fund or

insurance company for associated

persons of broker-dealers, as long as

certain conditions are met; (4) in-house

sales incentive programs of brokerdealers for their own associated persons;

(5) sales incentive programs of mutual

funds and insurance companies for the

associated persons of an affiliated

broker-dealer; and (6) contributions by

any non-member company or other

member to a broker-dealer’s permissible

in-house sales incentive program.

The exceptions from the cash

compensation prohibition would

permit: (1) In-house sales incentive

programs of broker-dealers for their own

associated persons; (2) sales incentive

programs of mutual funds and insurance

companies for the associated persons of

an affiliated broker-dealer; and (3)

contributions by any non-member

company or other member to a brokerdealer’s permissible in-house sales

incentive program.

Background

The proposed rule change is the latest

in a series of NASD determinations

designed to control the use of non-cash

compensation in connection with a

public offering of securities. Previous

rule filings amending the NASD’s rules

established restrictions on non-cash

compensation in connection with

transactions in direct participation

program securities (‘‘DPPs’’), real estate

investment trusts (‘‘REITs’’), and

corporate debt and equity offerings.

When the DPP rule was first

proposed, commenters urged that if

non-cash incentives were inappropriate

in connection with the sale of DPPs,

they are also inappropriate in

connection with the sale of investment

company securities and variable

contracts. However, the NASD

recognized that DPP and investment

company securities are treated

differently in many regulatory areas

including marketing standards,

advertising rules, net capital

requirements, fidelity bonding,

corporate finance requirements,

membership in SIPC, qualification

examination requirements and the

application of the Investment Company

Act of 1940 (‘‘1940 Act’’). Similarly,

variable contracts are also subject to a

separate scheme of regulation under the

NASD’s advertising rules and corporate

financing requirements, net capital

requirements, fidelity bonding,

membership in SIPC, qualification

examination requirements, and are

regulated under the 1940 Act. In 1992,

the NASD submitted to the SEC

proposed rule change SR-NASD–92–36

which proposed recordkeeping and

disclosure requirements on the receipt

of non-cash compensation in connection

with the sale of investment company

securities and variable contracts. As a

result of SEC staff concerns regarding

that proposal, the NASD withdrew SRNASD–92–36 in April 1994.

In developing the proposed rule

change, the Investment Companies and

Insurance Affiliated Member

Committees of the NASD (the

‘‘Committees’’) have considered the

current environment in which

investment company securities and

variable contracts are sold. The

Committees did not find that the

manner in which non-cash

compensation is offered and paid to

members and their associated persons

indicates a level of supervisory

problems similar to that present in

connection with the sale of DPPs which

led the NASD to adopt a prohibition on

non-cash compensation in connection

with such securities in 1988. The

Committees believe, however, that the

increased use of non-cash compensation

for the sale of investment company

securities and variable contracts

heightens the potential for loss of

supervisory control over sales practices

and increases the possibility for

perception of impropriety, which may

result in a loss of investor confidence.

The Committees determined, therefore,

that the adoption of limitations on noncash compensation for the sale of

investment company securities and

variable contracts is appropriate at this

time.

The NASD is aware of a broad range

of cash compensation practices by

which investment company securities

and variable contract issuers or their

affiliates provide either incentives or

rewards to individual broker-dealers

and their registered representatives for

selling the issuers’ products. The NASD

believes that the increased use of such

practices, which create an incentive to

favor one product over another, may

compromise the ability of securities

salespersons to render advice and

services that are in the best interests of

customers.

The NASD issued Notice to Members

94–14 (March 1994), reminding

members, among other things, of

prospectus disclosure obligations

regarding their acceptance of cash and

non-cash compensation for the sale of

investment company products, and

Notice to Members 95–80 (September

26, 1995), reminding members, among

other things, that recommendations of

investment company securities must be

suitable given the investor’s investment

objectives and not based on incentives

received by a registered representative.

Given the recent proliferation of such

compensation practices and dramatic

increase of public interest in the

purchase of investment company

securities and variable contracts, the

NASD believes it is appropriate to adopt

limitations on non-cash compensation

and certain types of incentive-based

cash compensation for the sale of

investment company securities and

variable contracts.

A complete discussion of the

background of the proposed rule change

is set forth in NASD Special Notice to

Members 94–67 (‘‘NTM 94–67’’),

attached to this filing as Exhibit 2, and

in an addendum containing background

information (referenced in NTM 94–67),

attached to this filing as Exhibit 3.

These documents are available to the

public from the NASD’s Office of

General Counsel.

Description of the Proposed Rule

Change

The current requirements of

paragraph (l) of the Investment

Company Rule regulate the disclosure

and form of dealer concessions between

principal underwriters and retail dealers

of investment company securities.

These provisions prohibit dealer

concessions in the form of securities,

require that members be able to elect to

receive cash in lieu of the receipt of

non-cash compensation, and prohibit

the payment of concessions directly to

associated persons of a member. The

provisions also set forth requirements

with respect to the disclosure of

compensation arrangements between

underwriters and dealers in the

investment company’s prospectus.5
Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices 35827

6There are no current similar terms in the

Variable Contracts Rule.

7The term is significantly different from the term

‘‘person associated with a member’’ as used

throughout the NASD’s rules and regulations. Any

reference to persons associated with an NASD

member firm is defined by the definition of ‘‘person

associated with a member’’ or ‘‘associated person of

a member’’ in Article I, Section (m) to the NASD

By-Laws.

8Closed-end management companies also are

regulated under The Corporate Financing Rule in

Rule 2710 and currently are subject to the

prohibition on non-cash compensation contained in

subparagraph (c)(6)(ix) thereof. Rule 2710(b)(8)(C)

provides an exemption from compliance with

Section 44 for securities of investment companies

registered under the 1940 Act, except for securities

of a closed-end management company as defined in

Section 5(a)(2) of the 1940 Act.

With respect to the regulation of

variable contracts, the requirements of

Rule 2820 currently do not contain

similar provisions regulating dealer

concessions. Thus, the proposed

amendments to the Investment

Company Rule would modify current

requirements and the proposed

amendments to the Variable Contracts

Rule would establish new requirements

that address compensation

arrangements between an offeror and

any member participating in the

distribution of the company’s securities.

The discussion below addresses each

proposed provision in the Investment

Company Rule and its counterpart in

the Variable Contracts Rule.

Definitions

Affiliated Member—The NASD is

proposing to adopt a definition of the

term ‘‘affiliated member’’ for both the

Investment Company and Variable

Contracts Rules to include a member

which, directly or indirectly, controls, is

controlled by, or is under common

control with a non-member company.

The term is used in the sections of the

proposed rule change which address

incentive compensation arrangements in

order to identify a common type of

relationship existing in the investment

company securities and variable

contracts industries whereby a nonmember owns or controls one or more

subsidiary broker-dealer member firms

used for underwriting and/or wholesale

and retail distribution services.

Cash Compensation—As proposed to

be defined in the Investment Company

Rule, this term would include any

discount, concession, fee, service fee,

commission, asset-based sales charge,

loan or override received in connection

with the sale and distribution of

investment company securities. This

term would encompass compensation

arrangements currently covered under

the Investment Company Rule in

subparagraph (l)(1), as well as assetbased sales charges and service fees as

currently defined in subparagraph (b)(9)

of the Investment Company Rule. As a

result, the proposed new term would

apply to all compensation arrangements

that would be covered under the current

provisions of the Investment Company

Rule, with the addition of asset-based

sales charges and service fees. The

Variable Contracts Rule’s proposed

definition of cash compensation would

have a similar scope with respect to the

sale of variable contracts, but does not

include asset-based sales charges in

recognition of the different structure of

compensation arrangements with

respect to such products.

Non-Cash Compensation—This

definition is proposed to be identical in

applicability for both the Investment

Company and Variable Contracts Rules

and would encompass any form of

compensation received by a member in

connection with the sale and

distribution of investment company

securities and variable contracts that is

not cash compensation, including, but

not limited to, merchandise, gifts and

prizes, and payment of travel expenses,

meals and lodging. Thus, the definition

of ‘‘non-cash compensation’’

encompasses payments of cash to

reimburse costs incurred by a member

or person associated with a member in

connection with travel, meals and

lodging. Certain of the proposed rule

language is drawn from the current

provisions of subparagraph (l)(3)(B) of

the Investment Company Rule which

identifies items of material value.

Offeror—The NASD is proposing to

define the term ‘‘offeror’’ in the

Investment Company Rule to include an

investment company, an adviser to an

investment company, a fund

administrator, an underwriter and any

affiliated person of such entities, and in

the Variable Contract rule to include an

insurance company, a separate account

of an insurance company, an adviser to

a separate account of an insurance

company, a fund administrator, an

underwriter and any affiliated person of

such entities. With the exception of

‘‘fund administrator,’’ the enumerated

entities included in the proposed

definition of ‘‘offeror’’ in the Investment

Company Rule are currently included in

the definition of ‘‘associated person of

an underwriter,’’ which is proposed to

be deleted.6 That definition

encompasses the issuer, the

underwriter, the investment advisor to

the issuer, and any affiliated person of

such entities.7 The term ‘‘affiliated

person’’ in the proposed definition of

‘‘offeror’’ is defined in accordance with

Section 2(a)(3) of the 1940 Act. The term

‘‘underwriter’’ is defined in Section

2(a)(40) of the 1940 Act and is intended

to refer to the principal underwriter

through which the investment and

insurance company distributes

securities to participating dealers for

sale to the investor.

The NASD does not believe that the

inclusion of ‘‘fund administrator’’ in the

definition of ‘‘offeror’’ in the proposed

rule is overbroad as a result of the fact

that affiliates of fund administrators

would now be included in the

definition of offeror. Affiliates of fund

administrators are most likely entities

already specified in the definition of

‘‘offeror,’’ the definition of which is

further circumscribed by the

requirement that payments of cash or

non-cash compensation be made in

connection with the sale of investment

company securities or variable

contracts.

The adoption of this new definition of

offeror would change the applicability

of paragraph (l) of the Investment

Company Rule and paragraph (h) of the

Variable Contract rule from focusing on

the distribution relationship of the

principal underwriter to the retail

dealers to focusing on the distribution

relationship of the offeror to any

participating broker-dealer firm.

Regulation of the Receipt of Cash and

Non-Cash Compensation

Introduction—The NASD is proposing

to adopt as paragraph (l) of the

Investment Company Rule (replacing

the current provisions of that section)

and paragraph (h) of the Variable

Contracts Rule new provisions

governing the receipt of cash and noncash compensation by members and

associated persons of members. The

proposed amendments would apply to

both variable annuity and variable life

products under the Variable Contracts

Rule. With respect to the Investment

Company Rule, the proposed

amendments would apply to sales of

securities of an investment company

registered under the 1940 Act. Thus, the

proposed rules would apply to sales of

securities by a face-amount certificate

company, a unit investment trust, and

open-end and closed-end management

companies.8

The preamble to the new rules

provides that such compensation must

be received ‘‘in connection with the sale

and distribution’’ of investment

company securities or variable

contracts, as applicable. The preamble is

intended to clarify that the provisions

only relate to cash and non-cash

compensation received in connection
35828 Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices

9See, e.g., Wiley, Rein & Fielding (Oct. 16, 1991);

Traditional Equinet (Jan. 8, 1992).

10Securities Exchange Act Rel. No. 8389 states

that the Commission would not recommend

enforcement action where the insurance company

makes payments directly to its life insurance agents

who are also persons associated with the insurance

company’s subsidiary broker/dealer, so long as: (1)

Such payments are made as a purely ministerial

service and properly reflected on the books and

records of the broker/dealer; (2) a binding

agreement exists between the insurance company

and the broker dealer that all books and records are

maintained by the insurance company as agent on

behalf of the broker/dealer and are preserved in

conformity with the requirements of Rules 17a-3

and 17a-4 under the Act; (3) all such books and

records are subject to inspection by the Commission

in accordance with Section 17(a) of the Act; and (4)

the subsidiary broker/dealer has assumed full

responsibility for the securities activities of all

persons engaged directly or indirectly in the

variable annuity operation.

11See Chubb Securities Corporation (Nov. 24,

1993) (financial institutions were permitted to make

commission payments to dual employees of the

financial institution and a broker-dealer). 12See supra n. 5.

with the sale and distribution of the

security covered by the rule, but not to

other forms of payment that are not for

sales and distribution activities.

Subparagraphs 2820(h)(1) and

2830(h)(1): Limitation on Receipt of

Compensation by Associated Persons,

and Exception from Limitations—The

NASD is proposing in new

subparagraph (l)(1) of the Investment

Company Rule and new subparagraph

(h)(1) of the Variable Contract rule to

generally prohibit a person associated

with a member from accepting any

compensation from any person other

than the member with which the person

is associated. The provision is based on

current subparagraph (l)(2) of the

Investment Company Rule.

An exception from this general

prohibition is proposed which would

allow the receipt of commissions by an

associated person directly from a nonmember if the arrangement is agreed to,

and the amount of commission

determined, by the member, the receipt

is treated as compensation received by

the member for purposes of NASD rules,

the recordkeeping requirement in the

proposed rule change is satisfied, and

the member relies on an appropriate

rule, regulation, interpretive release or

applicable ‘‘no-action’’ or exemptive

letter issued by the Commission or its

staff. It would only be necessary for a

member to obtain from the Commission

an interpretation or no-action position

in the event that no current rule,

regulation, interpretive release, or noaction or exemptive letter applied to the

member’s fact situation. Also, the

proposed rule change clarifies that the

member must treat such direct

payments to associated persons as

compensation in order to ensure that the

member views such payments in the

same manner as payments made directly

to the member for purposes of NASD

rules and posts such payments to the

member’s books.

The proposed exception is

particularly intended to recognize

current practice, commonly referred to

as insurance networking, which relies

on certain Commission interpretations

or staff no-action letters that permit,

under limited circumstances, associated

persons to receive compensation for the

sale of variable annuity products from

an insurance company or licensed

insurance agency.9 The exception

reflects the view of the Commission in

Securities Exchange Act Release No.

8389 (August 29, 1968) that, under

certain circumstances, such commission

payments to associated persons may be

made by an insurance company or

insurance agency acting on behalf of a

broker-dealer.10

Although the need to recognize such

direct payments arose in connection

with the sale of variable contract

products, the Investment Company Rule

includes the same exception in order to

recognize Commission staff no-action

positions that permit direct payments by

certain non-members to associated

persons of broker-dealers for the sale of

investment company shares.11

Subparagraph 2830(l)(2): Securities as

Compensation—The NASD is proposing

to retain as new subparagraph (l)(2) of

the Investment Company Rule the

provision currently in subparagraph

(l)(1)(A) that prohibits members and

associated persons of members from

receiving compensation in the form of

securities of any kind. The Variable

Contracts Rule does not contain this

prohibition, as the prohibition is

intended to reflect circumstances that

are limited to the sale of investment

company securities.

Subparagraphs 2820(h)(2) and

2830(l)(3): Recordkeeping

Requirement—The NASD is proposing

to adopt as new subparagraph (l)(3) of

the Investment Company Rule and

subparagraph (h)(2) of the Variable

Contracts Rule the general requirement

that members maintain records of all

compensation, cash and non-cash,

received from offerors. The records must

include the names of the offerors, the

names of the associated persons, and the

amount of cash and the nature and, if

known, the value of non-cash

compensation received.

With respect to the requirement that

the actual value of non-cash

compensation be recorded, if it is

known, the NASD believes that the

value of a non-cash item is usually not

known where unaffiliated third parties

contribute to a training and education

program sponsored by a member. In this

case, it would be appropriate to only

include a description of the nature of

the non-cash item of compensation. In

comparison, the value of non-cash items

provided by member firms and/or their

affiliates is generally readily known or

determinable.

The recordkeeping requirement is not

applicable to two types of de minimis

non-cash compensation allowable under

subparagraphs (l)(5)(a) and (b) of the

Investment Company Rule and

subparagraphs (h)(3)(a) and (b) of the

Variable Contracts Rule, discussed more

fully below under the exceptions to the

prohibition on non-cash compensation.

Subparagraph 2830(l)(4): Prospectus

Disclosure of Cash Compensation—The

NASD is proposing to adopt as new

subparagraph (l)(4) in the Investment

Company Rule the requirement

currently in subparagraph (l)(1)(C) that

prohibits the acceptance of cash

compensation by a member from an

offeror unless such compensation is

disclosed in a prospectus. In the case

where special cash compensation

arrangements are made available by an

offeror to a member, which

arrangements are not made available on

the same terms to all members to

distribute the securities, the disclosure

shall include the name of the recipient

member and the details of the special

arrangements. The provision has been

modified to reference only ‘‘cash

compensation’’ because non-cash

compensation is proposed to be

prohibited in a manner that would not

require disclosure of any such non-cash

compensation.12

The proposed rule change includes

two exceptions from the prospectus

disclosure requirement in the

Investment Company Rule. The two

exceptions in paragraphs (a) and (b)

track the language in current

subparagraphs (l)(4)(A) and (B) of the

Investment Company Rule, with minor

language changes for clarification. These

two provisions provide an exception

from disclosure for compensation

arrangements between: (1) Principal

underwriters of the same security; and

(2) the principal underwriter of a

security and the sponsor of a unit

investment trust which utilizes such

security as its underlying investment.

By their terms, these provisions describe

arrangements that would not trigger the

proposed recordkeeping requirements.

The NASD is not proposing to amend

the Variable Contracts Rule to adopt a

similar prospectus disclosure
Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices 35829

13A member holding a training or education

meeting for its associated persons (in comparison to

the associated persons of another member) would

not be required to comply with this provision if the

member does not receive a payment or

reimbursement from an offeror for the expenses of

the meeting. In this event, the member would not

be prohibited from permitting offerors to make a

presentation at the meeting.

requirement. Unlike the Investment

Company Rule, there is currently no

provision in the Variable Contracts Rule

requiring disclosure of compensation

received by NASD members in

connection with the distribution of

variable contracts. Arrangements by

insurance companies for compensating

salespersons for variable contract sales

are generally part of a total

compensation package based on the sale

of non-securities insurance products as

well as variable contracts. Further, the

Securities Act of 1933 and rules adopted

thereunder do not require such

disclosure in the prospectus for variable

life and annuity products. As a result,

there is no practice for disclosure of any

item of compensation in connection

with variable life and annuity products,

such as commissions and expense

reallowances. The NASD believes that

insurance companies would be required

to make significant modifications to

their automated systems in order to

separate in some manner compensation

for sales of securities products from

total compensation for all insurance

products. The NASD has determined,

therefore, that before proposing new

rules to require the disclosure of all cash

compensation for the sale of variable

contracts, more information should be

gathered regarding the different kinds of

compensation that are paid to brokerdealers for the sale of variable contracts

and the form of any required disclosure.

The NASD intends to gather such

information in the course of conducting

a general study of cash compensation

practices in connection with investment

company securities and variable

contracts, as more fully set forth below.

Subparagraphs 2830(l)(5) and

2820(h)(3): Prohibition on Non-Cash

Compensation—The NASD is proposing

to adopt as new subparagraph (l)(5) of

the Investment Company Rule and new

subparagraph (h)(3) of the Variable

Contracts Rule a general prohibition,

with certain exceptions, on the receipt

of non-cash compensation. The new

provisions would prohibit a member or

person associated with a member from

directly or indirectly accepting any noncash compensation offered or provided

to such member or its associated

persons unless such non-cash

compensation is permitted under the

provisions. Implicit in the prohibition

on the ‘‘acceptance’’ of non-cash

compensation is the requirement that a

member may not make a payment of

compensation to another member and

its associated persons that results in a

violation of the rule by the recipients.

The proposed rule change contains

several exceptions from the general

prohibition on the receipt of non-cash

compensation.

Subparagraphs 2820(h)(3)(a) and (b)

and 2830(l)(5)(a) and (b): The NASD is

proposing to adopt exceptions that

would permit an associated person to

accept from a person other than its

member-employer: (1) Gifts that do not

exceed an annual amount per person

fixed periodically by the Board of

Governors, which is currently $100 per

person; and (2) an occasional meal, a

ticket to a sporting event or the theater,

or comparable entertainment for persons

associated with a member and, if

appropriate, their guests, which is

neither so frequent nor so extensive as

to raise any question of propriety. These

provisions are based on the current

provisions of subparagraph (l)(3)(B) of

the Investment Company Rule. The

latter exception has been revised from

the current language of the Investment

Company Rule to reflect that

entertainment for associated persons

will usually include a spouse or guest

of the person and that payment for a

guest is permissible, but adds

cautionary language that the

entertainment should not be ‘‘so

frequent nor so extensive as to raise any

question of propriety.’’ Since such gifts

and entertainment are considered noncash items, they are not required to be

disclosed in the prospectus.

Additionally, these two forms of noncash compensation are specifically

excepted from the recordkeeping

requirement of the proposed rules.

The proposed provisions would

require that the receipt of such non-cash

items not be preconditioned on the

achievement by the associated person of

a sales target. This language replaces the

current requirement in subparagraph

(l)(3)(B)(v) of the Investment Company

Rule that entertainment ‘‘not be

conditioned on sales of shares of

investment companies.’’ The revised

language is intended to clarify that such

gifts and entertainment are permitted to

be provided as recognition for past sales

or as encouragement for future sales, but

shall not be part of an incentive program

or plan which requires that the recipient

reach a sales goal as a prior condition

to receive the entertainment or gift.

The proposed exceptions for $100

gifts and entertainment permits the

continuation of long-established, normal

business practices, while preventing an

investment or insurance company from

providing the gift or entertainment as

part of a non-cash sales incentive

program. The exceptions also recognize

that the NASD has not detected or been

aware of any history of abuses in

connection with the receipt of such

items of compensation by associated

persons of a member firm in connection

with the sale of investment company

securities or variable contracts.

Subparagraphs 2820(h)(3)(c) and

2820(l)(5)(c): The NASD is proposing an

exception to the prohibition on noncash compensation for training and

education meetings in subparagraph

(l)(5)(c) of the Investment Company

Rule and subparagraph (h)(3)(c) of the

Variable Contracts Rule. The proposed

exception would, under certain

conditions, permit payment or

reimbursement by offerors in

connection with meetings held by the

offeror or by a member for the purpose

of training or education of associated

persons of a member.13 It is not unusual

for offerors to pay for such meetings in

order to discuss their products and to

reimburse certain expenses related to

the member’s meeting in exchange for

the opportunity to make a presentation

to the associated persons of the member

on a particular training or education

topic.

This provision is intended to continue

to permit members and offerors to hold

training or education meetings for

associated persons of one or more

members, where an offeror or a number

of offerors pay for or reimburse the

expenses of the meeting. Because

investment company securities and

variable contract products are

continuously offered, it is particularly

important that associated persons

receive education opportunities with

respect to the investment company

securities and variable contract

industries generally, updates on any

portfolio changes or structural changes

to a current product, and explanations

of new products.

Since the proposed prospectus

disclosure provision requires disclosure

of cash compensation only, the

proposed exception would not trigger

the disclosure requirements because the

payment or reimbursement of expenses

by an offeror for a member’s training

and education meeting is considered to

be non-cash compensation. The

proposed exception would, however,

continue to be subject to the prohibition

on an associated person accepting any

compensation from anyone other than

its member-employer.

The NASD anticipates that the agenda

of a bona fide training or education
35830 Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices

meeting will reflect the business

purpose of the meeting. In order to

establish circumstances that will

encourage such a business purpose, the

NASD is proposing that the exception

for training or education meetings be

available only if five conditions are met,

which conditions are intended to ensure

that the meeting is for the purpose of

training and education and is not, in

fact, a prohibited non-cash sales

incentive trip or entertainment. The first

condition is that the payment or

reimbursement by offerors in

connection with such meetings is

subject to the proposed recordkeeping

requirement in subparagraph (l)(3) of

the Investment Company Rule and

subparagraph (h)(2) of the Variable

Contracts Rule in order that information

on such payments and reimbursements

is in the records of the member and,

therefore, capable of examination and

regulatory oversight by the NASD.

The second condition is that

associated persons must obtain the

member’s prior approval to attend the

meeting. It is anticipated that members

will establish a procedure so that their

records reflect that appropriate approval

has been provided to associated persons

in connection with such meetings. This

provision assists members in

maintaining supervisory control over

their associated persons. Moreover, the

second condition also requires that

attendance by the member’s associated

persons may not be based by the

employer-member on the achievement

of a sales target or any other non-cash

compensation arrangement that is

permitted in reliance on paragraph (d)

of the proposed rule. That provision

would permit non-cash compensation

arrangements between a member and its

associated persons or between a nonmember company and its sales

personnel who are associated persons of

an affiliated member, as more fully

discussed below. This condition is

intended to ensure that the member

does not treat a training or education

meeting as a non-cash incentive item.

The provision is not, however, intended

to prevent a member from designating

persons to attend a meeting held by the

member or by an offeror to recognize

past performance or encourage future

performance, so long as attendance at

the meeting is not earned through a

member’s in-house sales incentive

program or through the sales incentive

program of the member’s non-member

affiliate or through the achievement of

a sales target.

The third condition is that the

location of the meeting must be

appropriate to its purpose. A showing of

appropriate purpose is demonstrated

where the location is the office of the

offeror or the member, or a facility

located in the vicinity of such office. In

order to address meetings where the

attendees are from a number of offices

in a region of the country, the meeting

location may be in a regional location.

The fourth condition is that the

payment or reimbursement by an offeror

must not be applied to the expenses of

guests of the associated person.

The fifth and final condition is that

the payment or reimbursement by the

offeror must not be conditioned by the

offeror on the achievement of a sales

target or any other non-cash

arrangement permitted by proposed

subsection (l)(5)(d) of the Investment

Company Rule or proposed subsection

(h)(3)(d) of the Variable Contracts Rule.

This requirement is intended to ensure

that the offeror making the payment or

reimbursement does not participate in

any manner in a member’s decision as

to which associated persons will attend

a member’s or offeror’s meeting.

The fifth condition should be

compared to the second provision that

prohibits a member from basing the

associated person’s attendance at a

training or education meeting on

achievement of a sales target or a

permissible in-house non-cash incentive

arrangement. Taken together, the second

and fifth conditions are intended to

clarify that attendance at a training or

education meeting by an associated

person is permitted to be approved by

a member as a recognition for past sales

or as an encouragement for future sales,

but shall not be part of a member’s or

offeror’s incentive program or plan

which requires that the recipient or the

member reach a sales goal as a prior

condition to attending the training or

education meeting.

Subparagraphs 2820(h)(3) (d) and (e)

and 2830(l)(5) (d) and (e): The NASD is

proposing to adopt for the Investment

Company Rule and the Variable

Contracts Rule exceptions from the

prohibition on non-cash compensation

that will permit: (1) Non-cash

compensation arrangements between a

member and its associated persons, (2)

non-cash compensation arrangements

between a non-member company and its

sales personnel who are associated

persons of an affiliated member, and (3)

contributions by a non-member

company or other member to a non-cash

compensation arrangement between a

member and its associated persons.

The three permissible arrangements

are subject to four conditions. The

conditions that must be met are that: (1)

The member’s or non-member’s noncash compensation arrangement, if it

includes investment company or

variable product securities, must be

based on the total production of

associated persons with respect to all

investment company or variable product

securities distributed by that member,

(2) the credit received for each

investment company or variable product

security must be equally weighted, (3)

no unaffiliated non-member company or

other unaffiliated member may directly

or indirectly participate in the member’s

or non-member’s organization of a

permissible non-cash compensation

arrangement; and (4) the member must

maintain records of all compensation,

cash and non-cash, received by the

member or its associated persons from

offerors. However, the applicability of

the total production and equal

weighting requirements to variable

contract securities does not require that

variable annuity and variable life

products be combined in the same

incentive arrangement. Because of the

substantially different commission

structure of each product, the NASD

intends that subparagraph (h)(3)(d) of

the Variable Contracts Rule apply to

each variable contract product type—

variable annuity or variable life.

The NASD believes that the proposed

rule change distinguishes between noncash incentives that act at the point-ofsale to the investor and those that do

not. Point-of-sale non-cash incentive

programs reward associated persons

only if they sell a certain number of

shares of a specific investment company

securities or variable contract. Such

incentive programs by an offeror or a

member will affect the point-of-sale

relationship of associated persons with

the investor because they influence the

salesperson to sell a specific investment

company securities or variable contract

or the products of only one offeror. In

addition, point-of-sale non-cash

incentives offered by third-parties to the

associated persons of a member firm

have the potential to undermine the

supervisory control of the member over

the sales practices of its associated

persons.

The phrase ‘‘point-of-sale incentives’’

is intended to distinguish between

different sales incentive structures on

the basis of the potential impact of the

sales incentive on the recommendation

of the associated person at the point of

sale to the customer. Where a sales

incentive is structured as a ‘‘point-ofsales incentive,’’ the associated person’s

recommendation of a specific product is

motivated by the prospect of receiving

the sales incentive rather than the desire

to match the investment needs of the

customer with the most appropriate

investment product. An example of this

is an incentive program that will
Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices 35831

14As set forth above, arrangements by insurance

companies for compensating salespersons for

variable product sales are generally part of a total

compensation package based on the sale of nonsecurities insurance products as well as variable

contracts.

15See Report of the Committee on Compensation

Practices, April 10, 1995 (‘‘Tully Report’’), at 13.

provide a trip to an exotic location or a

cash bonus to an associated person who

sells $X million of ABC mutual fund

over a three-month period. Such an

incentive would have the effect of

influencing an associated person to

recommend ABC mutual fund over its

competitors to customers. In

comparison, an incentive program

without a point-of-sale impact would be

a program organized by the employer

broker-dealer of an associated person

that would provide for the same trip to

the exotic location or a cash bonus for

the sale of $X million of mutual fund

products, with the sale of all mutual

fund products being equally-weighted.

In this case, the incentive program

should not impact the point-of-sale

recommendation of the associated

person, who would focus on matching

the appropriate investment needs of the

customer in order for the associated

person’s recommendation to result in a

sale.

The NASD’s proposed rule change,

therefore, limits non-cash sales

incentives to situations where such noncash incentives do not contain the

potential to impact the point-of-sale

recommendation by an associated

person to a customer or to undermine

the supervisory control of the member

firm with respect to its associated

persons.

The NASD is proposing to eliminate

the point-of-sale impact of non-cash

sales incentives on the sales practices of

an associated person with respect to the

sale of investment company securities

and variable contracts by prohibiting

third-party non-cash sales incentive

programs and by requiring that all

securities of the product type be

included in the member’s (or its

affiliate’s) in-house incentive program

and be equally weighted. The proposed

rule change, therefore, would prohibit a

third-party offeror from conducting a

non-cash sales incentive program for

associated persons of member firms, as

such programs only provide incentives

that will act at the point-of-sale to

influence a salesperson to sell the

proprietary products of the offeror and

have the potential to undermine the

supervisory control of the member with

respect to its associated persons, thereby

increasing the possibility for a

perception of impropriety which may

result in a loss of investor confidence.

The proposed rule change would,

however, continue to permit non-cash

incentive programs by a member for its

associated persons or by an insurance or

investment company for the associated

persons of an affiliated member, under

the four conditions discussed more fully

below. The NASD determined that, in

both cases, the non-cash compensation

arrangement is internal to the employeremployee relationship and, therefore,

does not raise the supervisory concerns

that are present in the compensation

arrangements between a non-member

and the associated persons of

unaffiliated broker-dealers selling its

product.

The exception permitting a nonmember affiliate to grant non-cash

incentives to the associated persons of

its affiliated broker-dealer for the sale of

investment company securities and

variable contracts recognizes the

practice that is particularly present in

the life insurance industry of a nonmember insurance company holding a

non-cash sales incentive program for its

sales personnel who are also associated

persons of the non-member’s affiliated

broker-dealer. Such sales persons are

dual-licensed to sell non-securities

insurance products and variable

contracts. It is particularly a common

practice for a member’s parent life

insurance company to award ‘‘points’’

for the sale of all insurance products—

including securities—toward attendance

at the insurance company’s annual

‘‘leadership conference.’’ 14 Moreover,

the exception recognizes that, as a

practical matter, an insurance company

or investment company affiliated with a

broker-dealer is in a position through

intra-corporate transfers to contribute to

and through its relationship to affect the

structure of its affiliated broker-dealer’s

in-house incentive program.

The permissible in-house non-cash

arrangements by a member or its

affiliate are subject, moreover, to the

first two conditions which are intended

to ensure that a non-cash sales incentive

earned by a member’s associated person

is on a delayed basis and does not

influence the associated person’s pointof-sale relationship with the investor.

The first two conditions require that a

member’s or its affiliate’s non-cash sales

incentive program, if it includes

investment company securities or

variable contracts, must be based on the

total production of associated persons

with respect to the sale of all investment

company securities or variable contracts

distributed by that member and the

credit received for the sale of each

investment company security or

variable contract must be equally

weighted.

The NASD believes that the intent of

first two conditions, by focusing on total

production and equal weighting rather

than point-of-sale incentives, is to align

the interests of associated persons,

broker-dealers and investors. Thus, the

proposed provisions would allow for

sales incentive programs based on such

measures as overall gross production,

new accounts opened or assets under

management. Such measures are not

precluded by the proposed rule

language and are based on the same

intent to align the interests of associated

persons, broker-dealers and investors.

The concept of total production, for

example, is not necessarily restricted to

total sales production, but could include

total activity in investment company

securities, thus allowing for incentive

contests based on assets gathered or

assets maintained under management.15

In proposing the second condition

requiring equal weighting, the NASD

recognizes that differential payouts at

all levels is common industry practice

and that current methods for

determining contest credits vary,

including measurements based on gross

production to the firm or net

commissions to the associated person.

The NASD believes that either practice,

as well as other arrangements, would be

acceptable so long as the concept of

‘‘equal weighting’’ is met and not

skewed by disparate commission,

payout or reallowance structures for

individual products. The condition of

equal weighting requires a good faith

effort by a member to comply and the

test of whether a particular equal

weighting methodology is acceptable is

whether the contest is still skewed

toward a particular product or products.

It is believed that these requirements

will ensure that members and their

affiliates selling proprietary investment

company securities and variable

contracts products do not structure inhouse non-cash arrangements that are

biased in favor of their proprietary

products or any one specific product.

A member’s or its affiliate’s non-cash

compensation arrangement is also

subject to the restriction that no

unaffiliated non-member entity (usually

an offeror) or another member can

participate directly or indirectly in the

member’s or its affiliate’s organization

of a permissible non-cash sales

incentive program. This provision is

intended to ensure that third-party

offerors are not involved in and do not

influence the organization of a

permissible non-cash sales incentive

program by a member or a member’s

affiliate. The restriction on participation

is not, however, intended to prevent a
35832 Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices

16The provision would also permit a member’s

affiliate to contribute to the member’s in-house noncash incentive program. 17See supra note 12.

non-member company from making a

presentation on its products at a

member’s or its affiliate’s in-house sales

incentive meeting at the member’s or

affiliate’s request.

Finally, the non-cash incentive

program of a member or its affiliate for

a member’s associated persons is also

subject to the recordkeeping

requirements of the proposed rule.

Thus, in the case where the member or

its associated persons is in receipt of

payments or non-cash sales incentives

from its affiliated entity, such payments

or non-cash sales incentives must be

recorded on the books and records of

the member firm.

The NASD is also proposing in

subparagraph (l)(5)(e) of the Investment

Company Rule and subparagraph

(h)(3)(e) of the Variable Contracts Rule

that any non-member entity (usually an

offeror) or another member continue to

be permitted to contribute to any

member’s in-house non-cash sales

incentive program, so long as: (1) The

in-house program is based on total

production of the investment company

securities or variable contract products;

(2) each sale receives equal weighting;

(3) no entity (other than a member’s

affiliate) directly or indirectly

participates in the member’s

organization of its permissible non-cash

incentive compensation program; and

(4) the member maintains records of

such contributions. This provision is

intended to permit third-party offerors,

and their affiliates, to contribute to the

non-cash incentive program of a

member in order to benefit the

associated persons of the member that

sell the offeror’s securities.16 The

proposed rule change does not similarly

permit third party entities to make

contributions to the non-cash incentive

program of an affiliate of a member

because such non-member affiliates are

not subject to the recordkeeping

requirements of the proposed rule

change. Thus, contributions by third

parties for a non-cash incentive program

for associated persons of a member firm

may be made only directly to the

member.

Relationship of the In-House NonCash Incentive Exceptions for Members

and Their Affiliates to the Training or

Education Exception: The NASD

believes that training/education

meetings are important to the

investment company/variable contract

industries and it is, therefore, important

that the NASD’s rules continue to

permit such meetings. The structure of

the training or education provision

permits members to recognize high

producers by attendance at such

meetings, but prohibits a member from

requiring achievement of a specified

sales target or any other in-house noncash arrangement to attend the meeting.

Since the proposed rule change would

permit members and their affiliates to

have an in-house non-cash incentive

program for sales of investment

company securities and variable

contracts (and offerors may contribute to

such in-house incentive programs), it is

important to clarify the difference

between attending a training/education

meeting as a permissible ‘‘recognition’’

and attending it as an impermissible

‘‘non-cash sales incentive program.’’

The issue arises only where a member

is in receipt of any payment or

reimbursement for the costs of a meeting

or a third-party offeror (or any of its

affiliates) pays for any of the costs of a

meeting which is attended by associated

persons of a member.17 One clear

demarcation is that any meeting held by

a member or its affiliate only for the

member’s associated persons (where

contributions are made by a third-party

offeror) may be covered either by the

exception for in-house non-cash

incentives or the exception for a training

and education meeting, whereas any

meeting held by a third-party offeror

must comply with the training/

education requirements (because a

third-party offeror cannot conduct a

non-cash incentive program).

Subparagraphs 2820(h)(4) and

2830(l)(6): Prohibition on Certain Types

of Incentive-Based Cash

Compensation—The NASD is proposing

to adopt as new subparagraph (l)(6) of

the Investment Company Rule and new

subparagraph (h)(4) of the Variable

Contracts Rule a prohibition, with

certain exceptions, on the receipt of

incentive-based cash compensation. The

new provision would prohibit a person

associated with a member from directly

or indirectly accepting any cash

compensation preconditioned on the

achievement of a sales target offered or

provided to such person or the member

with the person is associated, unless

such compensation is permitted under

the provision. Implicit in the

prohibition on the ‘‘acceptance’’ of such

incentive-based cash compensation is

the requirement that a member may not

make a payment of compensation to

another member and its associated

persons that results in a violation of the

rule by the recipients.

The inclusion of this provision for the

prohibition of incentive-based cash

compensation is intended to ensure that

offerors do not circumvent the non-cash

incentive prohibition through the

offering of cash incentives directly to

associated persons. This is consistent

with the NASD’s intention to prohibit

incentives that act as point-of-sale

inducements that could influence the

advice of a salesperson. The cash

incentive prohibition is focused only on

cash sales incentive contests that could

be used by offerors to reward associated

persons of a broker-dealer for the sale of

a particular investment company or

variable contract security and does not

encompass payments at the entitybroker-dealer level that are not passed

on to the associated person. Thus, the

focus of the prohibition does not

include other cash revenue-sharing

arrangements intended to be covered by

the NASD’s study of cash compensation

practices, as more fully set forth below.

In particular, the proposed provision

would not prohibit the practice of

paying higher sales charges for reaching

increasing sales targets. Also, it is

important to note that payments of cash

compensation that would be permitted

under this provision would not be

subject to the proposed disclosure

provisions above.

The proposed rule change contains

exceptions from the prohibition on the

receipt of incentive-based cash

compensation.

Subsections 26(l)(6) (a) and (b) and

29(h)(4) (a) and (b): The NASD is

proposing to adopt for the Investment

Company Rule and the Variable

Contracts Rule exceptions from the

prohibition on incentive-based cash

compensation that, consistent with the

non-cash sales incentive prohibition,

will permit: (1) Compensation

arrangements between a member and its

associated persons; (2) compensation

arrangements between a non-member

company and its sales personnel who

are associated persons of an affiliated

member; and (3) contributions by a nonmember company or other member to a

cash compensation arrangement

between a member and its associated

persons.

The three permissible arrangements

are subject to four conditions. The

conditions that must be met are that: (1)

The member’s or non-member’s

compensation arrangement, if it

includes investment company or

variable product securities, must be

based on the total production of

associated persons with respect to all

investment company or variable product

securities distributed by that member;

(2) the credit received for each

investment company or variable product

security must be equally weighted; (3)
Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices 35833

18 15 U.S.C. § 78o–3.

no unaffiliated non-member company or

other unaffiliated member may directly

or indirectly participate in the member’s

or non-member’s organization of a

permissible compensation arrangement;

and (4) the member must maintain

records of all compensation, cash and

non-cash, received by the member or its

associated persons from offerors.

Finally, as with proposed provisions

for non-cash compensation

arrangements above, the applicability of

the total production and equal

weighting requirements to variable

contract securities does not require that

variable annuity and variable life

products be combined in the same cash

incentive arrangement. Again, because

of the substantially different

commission structure of each product,

the NASD intends that subparagraph

(h)(4)(a) of the Variable Contracts Rule

apply to each variable contract product

type—variable annuity or variable life.

In order to fully understand the

applicability of the proposed rule

change with respect to training or

education meetings and in-house noncash incentive programs, a chart and

five narrative examples are included as

Exhibit 5. Copies of these documents are

available to the public from the NASD.

Relationship of the Proposed Rule

Change to the Tully Report: The Tully

Report reviewed industry compensation

practices in connection with the sale of

all forms of securities for associated

persons of members, identified conflicts

of interests inherent in such practices

and identified the ‘‘best practices’’ used

in the industry to eliminate, reduce, or

mitigate such conflicts of interest. The

rule change proposed herein is limited

to addressing certain compensation

issues only in connection with the sale

of investment company securities and

variable contracts. The NASD believes

that the proposed rule change is

consistent with the characteristics of

‘‘best practices’’ identified in the Tully

Report in that the requirements in the

proposed rule for the receipt of noncash and cash incentives eliminates the

point-of-sale impact of such incentives

on the sales practices of an associated

person, thereby helping to align the

interests of associated persons, brokerdealers and investors with respect to the

sale of investment company securities

and variable contracts.

Separate from the proposed rule

change, however, the Board of Directors

of NASD Regulation, Inc. (‘‘NASDR’’)

has agreed that NASDR, acting through

its standing committees, should review

the Tully Report recommendations and

determine what initiatives, if any, the

organization should undertake. NASDR

will be collecting the views of the

Committees later this year for

consideration by the NASD National

Business Conduct Committee (‘‘NBCC’’).

Proposed Implementation of New Rules

The NASD is proposing that the

amendments to the Investment

Company and Variable Contracts Rules

be implemented in the following

manner. The proposed rule change will

be effective on the date stated in a

Notice to Members announcing

Commission approval, which Notice

will be issued no later than 60 days after

Commission approval. The date stated is

the date of the issuance of that Notice.

As of that date, members will be

required to comply with the proposed

rule change. With respect to the noncash and cash sales incentive

provisions, no new sales incentive

programs may be commenced after the

announced effective date. Sales

incentive programs that are currently

on-going on the date of effectiveness

will be permitted to continue for a

period not to exceed six months

following the announced effective date.

Thus, during the six-month

implementation period, no new

incentive programs may commence and

sales may continue to be applied to

existing incentive programs. However,

non-cash and cash sales incentives

earned by associated persons will be

permitted to be received for a period not

to exceed twelve months following the

expiration of the six-month

implementation period in the next

calendar year after approval of the

amendments by the SEC. Thus, during

the calendar year 1996, members and

their associated persons would be

permitted to receive non-cash sales

incentives earned prior to January 1,

1996.

(b) Statutory Basis for Proposed Rule

Change

The NASD believes that the proposed

rule change is consistent with the

provisions of Section 15A(b)(6) 18 of the

Act, which require that the Association

adopt and amend its rules to promote

just and equitable principles of fair

trade, and generally provide for the

protection of investors and the public

interest in that the proposed rule change

is designed: (1) To adopt new

regulations with respect to the sales of

variable contracts in Rule 2820 that will

regulate the direct payment of

compensation to associated persons by

persons other than the member with

which a person is associated, establish

recordkeeping requirements, and

regulate the receipt of non-cash

compensation by members and their

associated persons; (2) amend current

regulations with respect to the sale of

investment company securities in Rule

2830 that will clarify the circumstances

under which associated persons may

receive direct payments of

compensation from persons other than

the member with which a person is

associated with, establish recordkeeping

requirements, retain current disclosure

requirements and a prohibition on the

receipt of securities as compensation,

and regulate the receipt of non-cash

compensation by members and their

associated persons and the receipt of

cash incentives by associated persons.

Moreover, the proposed rule change is

designed to minimize the point-of-sale

impact of non-cash sales incentives on

the recommendations of associated

persons to their customers with respect

to the sale of investment company

securities and variable contracts and

eliminate any potential that third party

non-cash incentives may undermine the

supervisory control of the member with

respect to their associated persons,

which would increase the possibility for

the perception of impropriety which

may result in a loss of investor

confidence.

(B) Self-Regulatory Organization’s

Statement on Burden on Competition

Comments received on the proposed

rule change in response to NTM 94–67

raised a number of concerns regarding

the potential discriminatory impact of

the proposed rule change as published

for comment on issuers of investment

company securities and variable

contracts and on members not affiliated

with an issuer. Because the rule change

proposed for comment in NTM 94–67

has been significantly amended to

address the arguments of comments

with respect to its discriminatory

impact, the NASD’s discussion of the

proposed rule change’s burden on

competition is set forth below in

connection with the comments received

on the proposed rule change. On the

basis of the discussion set forth below

in connection with the comments

received, the NASD does not believe

that the proposed rule change will result

in any burden on competition that is not

necessary or appropriate in furtherance

of the purposes of the Act, as amended.

(C) Self-Regulatory Organization’s

Statement on Comments on the

Proposed Rule Change Received From

Members, Participants, or Others

The proposed rule change was

published for comment in NTM 94–67.

43 comments were received in response

thereto. Of the 43 comment letters
35834 Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices

received, 25 were supportive of the

overall goal of the proposed rule change

to more closely regulate incentive

compensation arrangements, 8 were

opposed, and 10 were neither explicitly

for nor against the proposal. The rule

change published for comment did not

include the proposed prohibition on the

receipt of cash incentives by associated

persons of a member.

Deferral of Cash Compensation Issues

At the time the non-cash

compensation proposal was published

for comment company securities and

variable contracts, and not with respect

to disclosure of various forms of cash

compensation. A number of commenters

raised issues as to whether the

requirements of the current Investment

Company Rule and the proposed new

Variable Contracts Rule would require

disclosure of various forms of cash

compensation arrangements (e.g.,

‘‘revenue sharing’’ and ‘‘soft dollar’’

arrangements) as ‘‘special

compensation’’ or as ‘‘cash

compensation,’’ that are increasingly

being provided to members in

connection with the sale of investment

company securities and variable

contracts. Other commenters expressed

concerns regarding the possibility that

members may provide a disparate cash

payout to representatives with respect to

sales of proprietary products.

A connected issue concerning the

disclosure of such revenue sharing

arrangements is whether such disclosed

compensation is subject to the sales

charge limitations of paragraph (d) of

the Investment Company Rule. In a

letter dated November 22, 1994, the

Division of Investment Management of

the SEC requested advice from the

NASD as to whether the current

disclosure requirements of the

Investment Company Rule apply to such

revenue sharing arrangements.

Specifically, the SEC asked whether

such cash compensation and revenue

sharing arrangements are a ‘‘discount,

commission, fee or concession’’ for

purposes of paragraph (l) that are

subject to disclosure and should be

limited as ‘‘sales charges described in

the prospectus’’ for purposes of

paragraph 2830(d). In connection with

the SEC’s request, the NASD Board of

Governors approved the proposed rule

change to be filed with the SEC but

agreed to defer resolution of the revenue

sharing issues until a later date. The

NASD believes that it should not

attempt to determine the applicability of

the proposed amendments to the variety

of revenue sharing issues without first

gathering information about the scope of

revenue sharing payments and also

addressing jurisdictional questions.

Thus, the NASD has deferred issues

regarding revenue sharing arrangements

until a study is conducted by NASD

staff of members that engage in the sale

of investment company securities and

variable contracts in order to develop a

greater understanding of the different

forms of revenue sharing arrangements

and to provide information for policymaking by the Committees. It is

anticipated that, as a result of the study,

the NASD will develop rule proposals

with respect to the disclosure of revenue

sharing items that will be filed with the

SEC and published for comment prior to

adoption. Therefore, the NASD will not

address at this time issues raised by

commenters in response to NTM 94–67

regarding special cash compensation,

revenue sharing, soft dollar payments or

certain other forms of cash

compensation payments made in

connection with the sale of investment

company securities and variable

contracts.

The discussion set forth below of the

comments received on the proposed

rule change includes the specific

comments received with respect to

revenue sharing and other cash

compensation issues that will be

covered by the NASD’s study of such

arrangements.

Original Proposal

In connection with the sale of

investment company securities and

variable contracts, the amendments as

originally proposed would have: (1)

Prohibited, with certain exceptions,

members and persons associated with

members from accepting any non-cash

compensation from an offeror in

connection with the sale of investment

company securities and variable

contracts; (2) prohibited associated

persons from receiving any

compensation from anyone other than

the member with which the person is

associated, unless permitted by the rule;

(3) prohibited receipt by a member of

cash compensation from the offeror

unless such arrangement is described in

the current prospectus; and (4) required

that members maintain records of

compensation received from offerors.

The amendments also would have

retained the prohibition, in connection

with the sale of investment company

securities, against a member receiving

compensation in the form of securities

from an offeror.

The exceptions from the non-cash

compensation prohibition would have

permitted: (1) In-house sales incentive

programs of broker-dealers for their own

associated persons; (2) sales incentive

programs of investment companies and

insurance companies for the associated

persons of a broker-dealer subsidiary;

(3) payment or reimbursement for

training and education meetings held by

a broker-dealer or an investment or

insurance company for associated

persons of broker-dealers; (4) gifts of up

to $100 per associated person annually;

and (5) an occasional meal, ticket to a

sporting event or theater, or

entertainment for associated persons

and their guests.

As a result of member comments, the

rule language of the proposed

amendments published in NTM 94–67

was significantly modified by the Board

of Governors. The following is a

discussion of member comments in

response to NTM 94–67.

General Comments

Rationale for New Rules. Certain

commentators opposed to the proposed

rule change questioned the necessity for

the proposed rule given that both the

Insurance Affiliated Members

Committee and the Investment

Companies Committee did not find that

the manner in which non-cash

compensation is offered and paid to

members and their associated persons

indicates a level of supervisory and

compliance problems similar to those

experienced by the DPP industry in the

late 1980s (Massachusetts Mutual Life

Insurance Co. (‘‘MML’’), New England

Funds (‘‘New England’’), Wood Logan).

One commentator (MML) requested that

any final rules be accompanied by a

clear and forthright explanation of the

abuses which the proposed rules are

attempting to correct. Another

commentator stated that the possibility

of the perception of impropriety is

greater in the sale of investment

company securities since such

securities, unlike variable products, are

not subject to state insurance regulation,

and expressed concern about

broadening the non-cash compensation

rules to include variable products

without any evidence of actual or

potential abuse (ITT Hartford). The

commentator expressed concern about

extending non-cash prohibitions to

variable products solely on the basis of

a perception of impropriety.

There were 25 commentators in

support of the proposed rule change that

provided specific comments in favor of

the proposal (ACLI, A.G. Edwards &

Sons (‘‘AG Edwards’’), American Funds

Distributors, Inc., Bridgeway, Calvert

Securities Corp. (‘‘Calvert’’), Edwards &

Angell, Equity Services, Inc., FNIC,

Fidelity Investments, IAFP, ICI, IM&R,

ML Stern & Co. (‘‘ML Stern’’), Mariner,

Merrill Lynch, Mutual Service

Corporation (‘‘Mutual Service’’),
Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices 35835

Nuveen, PNMR, Prudential, Putnam

Investments, Raymond James, State of

New York, T. Rowe Price, Thornburg

Securities (‘‘Thornburg’’), Titan). The

NASD was urged to adopt a policy

regarding the treatment of non-cash

compensation that is applied ‘‘more or

less even-handedly’’ across businesses

within the securities industry. It was

stated that the potential is present that

the abuses identified by the NASD with

respect to DPPs in the 1980s may occur

with respect to investment company

securities and variable contracts. It was

pointed out that in many cases the same

registered representatives that sell DPPs

also sell investment company securities

and variable contracts. It was argued

that the perception of impropriety may

lead to a loss of investor confidence. In

this connection, it was pointed out that

there had been recent unfavorable

media coverage of non-cash incentives

in the sale of investment company

securities (Edwards & Angell).

Another commentator stated that the

proposal will contribute to ethical

business practices among registered

representatives, instill a greater

disclosure responsibility on sponsors

and provide an enhanced regulatory

effort for the protection of the consumer

(Raymond James) and that the proposal

on the whole is excellent and will serve

to provide full and fair disclosure of all

compensation to the public and

necessary guidance to members as to

acceptable forms of compensation (AG

Edwards).

Other commentators stated that

prohibiting non-cash compensation will

strengthen the ability of member firms

to supervise their registered

representatives (Merrill Lynch) and that

the entire investment community is best

served by removing any incentive a

registered representative may have to

sell a particular product other than one

for the clients’ best interests

(Thornburg). It was also stated that the

proposal will provide NASD members

with greater control over compensation

offered to their registered

representatives (Mutual Service).

Finally, commentators stated that the

proposal protects and enhances investor

confidence (IAFP), and decreases the

possibility, as well as the consumer’s

perception of, representatives’

impropriety (Calvert).

Other General Comments. One

commentator thought the proposed

rules were unduly complicated and

might unnecessarily penalize members

who have creative compensation

approaches (Mutual Service). The

commentator stated that a simpler way

to accomplish the objectives of the

proposed rule change would be to

require only that all compensation be

disclosed in the prospectus, all cash

compensation be paid to the member

firm, and all incentive compensation be

based on gross production of all

products. As set forth above, the NASD

will review the current forms of cash

compensation received by members in

connection with the sale of investment

company securities and variable

contracts in order to develop rules that

will address disclosure of compensation

in the prospectus. With respect to the

second request that all cash

compensation be paid to the member

firm, there is a long history of SEC

interpretive positions and no-action

letters permitting third-parties to make

direct payments of cash compensation

to associated persons under certain

circumstances. The NASD believes it is

appropriate that the proposed rule

change recognizes these SEC positions.

With respect to the third comment, as

set forth below, the NASD is revising

the proposal published for comment to

require that a member’s or its affiliate’s

in-house incentive program must be

based on total production of associated

persons with respect to sales of

investment company securities and

variable contracts and that the credit

received for the sale of each security is

equally weighted. These provisions are

discussed more fully below.

Another commentator requested

general clarification on the relationship

between Rules 2820 and 2830 (Fidelity).

As stated in paragraph 2820(a), Rule

2820 applies to member’s activities in

connection with the sale of variable

contracts in lieu of Rule 2830. Thus,

variable contracts are regulated solely

by Rule 2820—not Rule 2830.

Relationship to Rules for Direct

Participation Program Securities. One

commentator recommended that if the

proposed rule with respect to non-cash

sales incentives is adopted that the

NASD implement conforming changes

with respect to the NASD’s rules for

direct participation program securities

in Rule 2810. It was stated that to

regulate the DPP and investment

company/variable contracts industries

differently would give a competitive

advantage to one over another (Edwards

& Angell). Another commentator stated

that Rule 2810(b)(4)(E) does not contain

a similar carve-out for in-house

compensation arrangements by affiliates

of a broker-dealer and the proposed

rule, if adopted, would therefore

discriminate against broker-dealers

which are not subsidiaries of an

investment company or insurance

company (Titan II).

The NASD’s Direct Participation

Programs Committee will review the

proposed rule change in light of the

current provisions of the non-cash

incentive rule of Rule 2810.

Specific Comments

Definitions of Cash and Non-Cash

Compensation

Cash Compensation Definition. In the

explanation of the provisions of the

proposed rule in NTM 94–67, the NASD

stated that the proposed definition of

‘‘cash compensation’’ in paragraph

(b)(7) of the Investment Company Rule

‘‘encompasses cash compensation

arrangements covered under the current

provisions of the Investment Company

Rule.’’ One commentator stated that this

description appears to be inconsistent

with the proposed new definition of

‘‘cash compensation,’’ which includes,

among other things, asset-based sales

charges (Fidelity). The commentator

suggested that the NASD either

eliminate asset-based sales charges from

the coverage of the definition or explain

more clearly the reasons for its

inclusion and the scope of its

applicability. The commentator

suggested that the NASD also explain

the scope of the counterpart definition

of cash compensation in subparagraph

(b)(3) of the Variable Contracts Rule.

The NASD believes that the definition

of ‘‘cash compensation’’ in the

Investment Company Rule should

include coverage of ‘‘asset based sales

charges’’ and that they are encompassed

in the current Investment Company

Rule as a ‘‘fee.’’ In comparison to the

proposed definition in NTM 94–67, the

term ‘‘asset based sales charge’’ has been

deleted from the definition of ‘‘cash

compensation’’ in the Variable Contracts

Rule since there is no provision in the

current Variable Contracts Rule for such

charges.

One commentator urged that although

the proposal appropriately places limits

on non-cash compensation, the NASD

should go further and only allow, with

limited exceptions, the reallowed sales

charges in the prospectus (Nuveen). The

NASD believes it is appropriate to

permit different forms of cash

compensation, so long as such

compensation arrangements are not

contrary to the concepts of fairness and

reasonableness under Article III, Section

1 of the NASD’s Rules of Fair Practice—

the NASD’s basic ethical rule. In the

course of conducting a study of cash

compensation arrangements, the

fairness and reasonableness of such

arrangements will be considered.

Non-Cash Compensation. The

definition of ‘‘non-cash’’ compensation

in Subparagraphs (b)(7) of the

Investment Company Rule and (b)(3) of
35836 Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices

the Variable Contracts Rule includes

payments of cash to reimburse members

for the costs of travel, meals and

lodging. One commentator stated that if

cash payments are to be included within

the term ‘‘non-cash compensation,’’ the

term ‘‘non-cash compensation’’ should

be recharacterized (MML). The NASD

believes it is appropriate to treat cash

payments for non-cash items as ‘‘noncash compensation,’’ because the receipt

of non-cash items of compensation

should be regulated in the same manner

regardless of whether the item is

received or payment is made for the cost

of the item.

However, the NASD believes that

there is an issue of whether excess cash

payments for training and education

meetings meet the definition of noncash compensation and will seek to

clarify in its study on cash

compensation whether payments

exceeding actual reimbursements fit

within the definition of non-cash

compensation, and whether any such

excess is received in connection with

sale or distribution practices.

Special Cash Compensation. The

proposed change does not contain a

definition of the term ‘‘special cash

compensation’’ that is used in the

current and proposed disclosure

provision of the Investment Company

Rule (subparagraph (l)(4) of the

Investment Company Rule) and the

disclosure provision that was originally

proposed in subparagraph (h)(3) of the

Variable Contracts Rule. One

commentator suggested, for purposes of

the Variable Contracts Rule, defining the

phrase as ‘‘any cash compensation that

exceeds the maximum compensation

disclosed in the prospectus,’’ which

would enable a member to accept less

than the maximum disclosed

commission without having to force the

disclosure in the prospectus of all

members who were paid no more than

the maximum commission (ITT

Hartford).

As set forth above, the NASD has

amended the proposed rule change to

the Variable Contracts Rule to delete the

disclosure provision. The NASD

intends, nonetheless, to reconsider the

definitions in the proposed rule change

with respect to the Investment Company

Rule and Variable Contracts Rule and

the text of the disclosure provision

being proposed herein with respect to

the Investment Company Rule

(including the requirement for

disclosure of ‘‘special compensation

arrangements’’) as a part of the study of

cash compensation arrangements,

referenced above.

Preamble—‘‘In Connection With’’

The preambles to the proposed rule

change in the Investment Company Rule

and the Variable Contracts Rule begin

with the phrase ‘‘In connection with the

sale and distribution of investment

company securities [variable

contracts].’’ Commentators stated that

there is no guidance to illustrate the

meaning of the phrase and requested

NASD clarification as to the scope of the

phrase and whether it applies to inhouse non-cash compensation not

intended to serve as a sales incentive

such as, for example, compensation

paid as a reward to phone

representatives for a stellar attendance

record or exceptional phone demeanor

(MML, Nuveen, T. Rowe Price). Another

commentator requested that the final

rules clearly state what compensation

arrangements are acceptable and

suggested that language be incorporated

in the final rule clarifying what specific

types of compensation are unrelated to

sales and distribution, and therefore not

covered by the rules (New England).

One commentator identified various

current investment company ‘‘payment’’

practices which are not tied to specified

sales levels of the broker-dealer, but are

intended instead to ‘‘solidify the

relationship between the broker-dealer

and the mutual fund complex,’’ such as

when a mutual fund complex: (1) Gives

‘‘‘unrestricted’’’ funds to some of the

broker-dealers in its selling group; (2)

Gives books to some of its brokerdealers on ‘‘‘how to sell mutual funds’’’

for distribution to its registered

representatives; (3) pays for the cost of

preparing broker-dealer training

materials; (4) pays for advertising in a

broker-dealer’s internal newsletter

(MML). The commentator emphasized

that a literal reading of the phrase could

cover all of the above examples and,

absent clarification, the phrase will be

interpreted liberally by some firms and

narrowly by others. The commentator

recommended that the phrase be deleted

in its entirety or clarified to ensure its

uniform interpretation and

implementation.

The NASD is aware that members and

their associated persons receive

compensation for the sale of nonsecurities products from insurance

companies and receive other forms of

payments from investment and

insurance companies that are not for

sales and distribution activities. The

preamble is not intended to cover

compensation and payment

arrangements that are clearly not in

connection with the sale and

distribution of investment company

securities or variable contracts. The

extent to which any specific cash

payments are considered to be made in

connection with the sale of securities

will be further considered and clarified

as a result of the NASD’s study of cash

compensation arrangements, as set forth

above.

Subparagraphs 2820(h)(1) and

2830(l)(1)—The Ministerial Exception

Proposed subparagraph (l)(1) of the

Investment Company Rule and

proposed subparagraph (h)(1) of the

Variable Contracts Rule would codify

the so-called ‘‘ministerial exception,’’

which permits a non-member, under

certain circumstances, to maintain a

commission account as a ministerial

service for a member and, on behalf of

the member, pay commission checks

directly to associated persons of the

member.

One commentator stated that, contrary

to the assertion in NTM 94–67 that the

ministerial exception only recognizes

either the conditions set forth in

Securities Exchange Act Release No.

8389 or no-action positions on how to

comply with conflicting requirements of

state insurance and securities laws,

there are additional no-action letters

from the Commission authorizing other

direct payment exceptions based on

theories wholly different from either the

ministerial exception or state law

conflict (MML). The commentator

requested modification of the proposed

rules to explicitly recognize the

existence and validity of such no-action

letters. The commentator’s

recommendation was to add rule

language to the end of subparagraphs

(l)(1) of the Investment Company Rule

and (h)(1) of the Variable Contracts Rule

published for comment stating ‘‘or

where such payments are authorized by

a no-action letter issued by the staff of

the Securities and Exchange

Commission.’’

One commentator requested that the

final rule clarify that an NASD member

firm can rely on any no-action position

or opinion of counsel without having to

obtain its own no-action position in

order to take advantage of the

ministerial exception (NAVA). Another

commentator stated that the ministerial

exception should be allowed to be used

in all states, regardless of whether a

state law impediment exists (PNMR).

The NASD agrees that it was not the

intention of the ministerial exception to

limit the ability of a member to rely on

any applicable SEC interpretations or

no-action letters that would permit

direct payment of commission checks to

associated persons. At the same time,

the NASD believes it is necessary to

ensure that members rely only on SEC
Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices 35837

19Chubb Securities Corporation (Nov. 24, 1993).

positions that are issued (in comparison

to telephone advice) and that are

applicable to the specific fact situation

under which such direct payments will

be made. Thus, it should only be

necessary for a member to obtain from

the SEC an exemptive, interpretive or

no-action letter in the event that no

current rule, regulation, interpretive

release, or no-action position that

applies to the member’s fact situation.

Additionally, the NASD believes it is

necessary to ensure that direct payments

to associated persons are treated as

payments directly to the member for

purposes of NASD rules.

Therefore, the rule language set forth

in subparagraphs (l)(1) and (h)(1) of the

Investment Companies and Variable

Contracts Rules, respectively, in NTM

94–67 has been revised to clarify that

associated persons may be compensated

by certain non-members provided: (1)

The arrangement is agreed to and the

amount of commission determined by

the member; (2) the member relies on an

appropriate rule, regulation,

interpretation or applicable no-action or

exemptive letter issued by the SEC or its

staff; (3) the payments are treated as

compensation received by the member

for purposes of the rules of the NASD;

and (4) the payments are subject to the

proposed rule’s recordkeeping

requirements. The NASD also revised

rule language to recognize the SEC

staff’s recent no-action letter to Chubb

Securities Corporation that permits

commission payments by financial

institutions directly to associated

persons of member firms under certain

circumstances.19

The NASD does not believe it is

appropriate, as recommended by one

commenter, to amend the rule to

recognize an opinion of counsel,

standing alone, as the basis for a

member’s reliance on the ministerial

exception. This position does not

preclude a member from obtaining an

opinion of counsel that the member has

based its determination to permit direct

payments by a third-party to its

associated persons on an appropriate

rule, regulation, interpretation, or noaction or exemptive letter of the SEC or

its staff and that such rule, regulation,

interpretation, or no-action or

exemptive letter applies to the specific

fact situation of the member.

Subparagraphs 2820(h)(2) and

2830(l)(3)—Recordkeeping

Requirement

Subparagraph (l)(3) of the Investment

Company Rule and subparagraph (h)(2)

of the Variable Contracts Rule, proposed

in NTM 94–67 require member firms to

keep records, with certain exceptions, of

all cash and non-cash compensation

received from offerors.

One commentator suggested that the

NASD should consider requiring

member firms to file a brief report to the

NASD on a standard form each time a

program to provide incentives is

adopted (Edwards & Angell). Unless

specifically required otherwise by law,

the NASD allows members to devise

their own specific methods and

procedures for maintaining various

records required to be kept under the

rules and regulations of the Association

and the SEC. It is not believed necessary

for the NASD to monitor compliance

with the proposed rule change through

such a filing method. The NASD will

review member’s compliance with the

proposed prohibition on the receipt of

non-cash compensation in the course of

its normal examination of the records of

member firms.

In order to avoid duplicative

recordkeeping, another commentator

suggested including an additional

exception to the record keeping

requirement to allow records of

compensation to be kept on behalf of a

member by a member’s control person,

such as, for example, the investment

adviser of a no-load fund complex (T.

Rowe Price). The proposed provision

does not address the identity of the

entity that maintains the member’s

records. The recordkeeping requirement

proposed by the NASD is applicable to

the member, regardless of the entity

relied on by the member to maintain its

records, and it is the obligation of the

member to ensure that its records

comply with all applicable rules. Any

records maintained by a third-party

entity for a member must be maintained

in accordance with all applicable law

and be immediately accessible for

examination and other regulatory

purposes.

Another commentator recommended

that the NASD add the phrase ‘‘by the

member or its associated persons’’ after

the word ‘‘received’’ in the first

sentence of the recordkeeping

requirement subsections so that the

requirement applies to compensation

received by both members and

associated persons (MML). The NASD

agrees that the proposed rule should be

clarified to indicate that the

recordkeeping requirement applies to

compensation received by members and

associated persons and has modified the

rule language in subparagraphs (l)(3)

and (h)(2) of the Investment Company

and Variable Contracts Rules,

respectively, accordingly. This

amendment is consistent with the

proposed amendments to the

‘‘ministerial’’ exception permitting

direct payments to associated persons.

Subparagraph 2830(l)(4)—Disclosure

Requirements

The version of the proposed rule

change published for comment in NTM

94–67 contained disclosure obligations

in both the Investment Company Rule

and the Variable Contracts Rule which

required that all cash compensation

arrangements, including special cash

compensation arrangements, be

specifically described in the prospectus,

with the exception of, among other

things, arrangements between a nonmember company and its sales

personnel who are associated persons of

an affiliated member firm.

The Proposed Disclosure Requirement

for Variable Contracts. Two

commentators stated that any

commission/compensation disclosure

requirements should be applied equally

to both investment company securities

and variable annuities since the

products are so similar in nature and

there is no reasonable basis to do

otherwise (Raymond James, New

England). Another commentator stated

the proposed requirement in the

Variable Contracts Rule to disclose nonstandard compensation in a variable

contract prospectus would result in

irrelevant and misleading compensation

information and would be financially

and functionally burdensome,

especially during a period of rapid

growth where the daily prospectus

amendments could be required (PEN).

Another commentator suggested

deleting proposed subparagraph (h)(3)

of the Variable Contracts Rule (Lincoln

National).

Unlike the Investment Company Rule,

there is currently no provision in the

Variable Contracts Rule requiring

disclosure of compensation received by

NASD members in connection with the

distribution of variable contracts.

Arrangements by insurance companies

for compensating salespersons for

variable product sales are generally part

of a total compensation package based

on the sale of non-securities insurance

products as well as variable contracts.

As discussed above, the NASD believes

that, before requiring disclosure of all

cash compensation for the sale of

variable product securities, more

information should be gathered

regarding the kinds of compensation

that are included in payment for the sale

of variable products and the form of any

required disclosure. Further, regardless

of the few comments received opposed

to this provision in the Variable

Contracts Rule, the NASD believes it is
35838 Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices

apparent from the lack of discussion in

the comments that the full potential

impact of the proposed disclosure

provision in its entirety on the sale of

variable contract products has not been

fully understood by industry

commenters. Therefore, the NASD has

modified the language of the Variable

Contracts Rule to delete the requirement

for disclosure of cash compensation in

subparagraph (h)(3) in the Variable

Contracts Rule published for comment

in NTM 94–67, pending the gathering of

more information and industry input,

and the Variable Contracts Rule has

been renumbered accordingly.

Discriminatory Impact of Exception

for Payments to Sales Personnel. A

number of commentators indicated that

the exception proposed in subparagraph

(l)(4)(c) of the Investment Company

Rule and subparagraph (h)(3)(c) of the

Variable Contracts Rule in NTM 94–67

to the disclosure obligation requirement

for proprietary issuers with captive sales

forces was unduly burdensome for, and

unfairly discriminatory against, member

firms selling only ‘‘non-proprietary’’

products, anti-competitive, and/or

misleading to a retail public expecting

full disclosure (IM&R, FNIC, AG

Edwards, Stern, Associated, Mariner,

Mutual Service, Cadaret/Grant, Security

Life, IAFP, LPL, Putnam, Titan II, PEN).

The commentators emphasized that

required disclosures should be the same

whether the products are proprietary or

non-proprietary, and that failure to

require uniform disclosure not only

frustrates any attempt to achieve a level

playing field but also leads to

recommendations to customers which

are not objective or suitable. Other

commentators stated that non-uniform

disclosure requirements increases,

rather than decreases, the possibility for

the perception of impropriety

(American Growth Fund Sponsors,

Titan II, State of New York, Wood

Logan). It was recommended that the

exception be deleted. (IAFP, Titan II).

The NASD believes that the exception

to which the commentators object was

intended to clarify that, since any

payments of cash compensation directly

to associated persons under the

ministerial exception are required to be

disclosed in any event by the member

employing the associated persons, such

direct payments need not be disclosed

twice, i.e., as part of the member’s

receipt of compensation from its

affiliated offeror and separately as direct

payments to associated persons by an

affiliated offeror. The purpose of the

exception was to avoid: (1) Duplicate

disclosure of compensation received by

members affiliated with an offeror; and

(2) disclosure of the member’s

reallowance to associated persons when

it is paid by an offeror affiliated with the

member.

Because of the considerable confusion

caused by the provision, proposed

subparagraph (l)(4) of the Investment

Company Rule was revised to delete the

exception provision. At the same time,

the ministerial exception (as set forth

above) is proposed to be revised to make

it clear that direct payments to

associated persons are treated as

compensation received by a member for

purposes of NASD rules. Taken

together, these changes clarify that

direct payments to associated persons

must be combined with any other

compensation received directly by the

member and are subject to the

disclosure requirements of the proposed

rule.

Revenue Sharing Disclosure. A

number of commentators stated there is

a growing practice of ‘‘revenue sharing’’

between investment company advisers

and retail sellers of investment company

shares, whereby the advisers, in either

formal or informal agreements with the

retailer, agree to pay fees to retailer

members—over and above Rule 12b-1

fees—in exchange for, among other

things, (1) The placement of the funds

onto the retailer’s ‘‘preferred’’ list, (2)

the retailer agreeing to sell the fund’s

shares at all, (3) ‘‘due diligence’’

payments for a member’s examination of

an offeror’s products, (4) inclusion of

fund data in a member’s computerized

hypothetical system, and (5) access to a

member’s E-mail system (Wilmer/

Cutler, State of New York, Nuveen).

One of the commentators stated that

such practices are required to be

disclosed under the proposed and

existing language of paragraph (l) of the

Investment Company Rule, and that the

NASD should address this issue directly

and immediately by clarifying and

affirming that such arrangements must

be disclosed in a fund’s prospectus

(Wilmer/Cutler). The commentator

stated that such clarification is essential

to fulfill the purpose of paragraph (l) of

the Investment Company Rule and the

larger goal of investor protection.

Another commentator noted that the

NASD’s definition of ‘‘sales charges’’ in

subparagraphs (d)(1) and (2) of the

Investment Company Rule seem

sufficiently inclusive to reach and

govern revenue sharing practices as well

as non-cash compensation (State of New

York). The same commentator stated

that both principles of agency law and

securities anti-fraud statutes and rules

provide a basis for requiring brokers to

disclose all financial and economic

incentives in connection with a

securities recommendation (State of

New York). Finally, one commentator

stated that such ‘‘revenue sharing

practices’’ should be prohibited

(Nuveen).

As more fully set forth above, the

NASD will defer action on issues

regarding revenue sharing and other

cash compensation arrangements until a

study conducted by NASD staff of

members that engage in the sale of

investment company securities and

variable contract products in order to

develop a greater understanding of the

different forms of revenue sharing

arrangements and to provide

information to the NASD for policy

making.

Disclosure of Special Cash

Compensation. One commentator

requested that specific details of special

cash compensation arrangements, such

as member names and amounts, should

only be required to be disclosed where

the standards for the receipt of such

special cash compensation are not

uniformly applicable (American Funds

Distributors). Another commentator

stated that the customers are not harmed

by special cash compensation

arrangements, since the limit of the

customer’s costs has already been

disclosed in the prospectus, and

suggested deleting proposed

subparagraph (h)(3) of the Variable

Contracts Rule (Lincoln National).

One commentator stated that the

prospectus disclosure requirements

would force issuers with nonproprietary sales forces to disclose in

prospectuses the terms of each new

selling agreement signed as soon as the

agreement is signed, thus requiring

prospectuses to be stickered sometimes

as often as every week (Security Life).

The commentator stated that the

benefits of such a burden would be de

minimis, and suggested that the

proposed rule be redrafted to only

require the disclosure, for both

proprietary and non-proprietary firms,

of the maximum amount of cash

compensation.

As set forth above, the NASD will

defer action on issues regarding special

compensation arrangements until a

study of cash compensation

arrangements is conducted in order to

develop a greater understanding of the

different forms of special cash revenue

sharing arrangements and to provide

information to the NASD for policy

making.

Burden of Compliance. One

commentator objected to the proposed

rule’s disclosure requirements on the

basis that it places the burden of

compliance oversight for ensuring

proper disclosure on individual member

firms rather than on the funds and their
Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices 35839

20The rule language states ‘‘No member shall

accept any cash compensation from an offeror

unless such compensation is described in a current

prospectus of the investment company.’’

affiliated underwriter (Merrill Lynch).

The commentator stated that this

burden places each broker-dealer in the

difficult position of having to

independently evaluate the quality of

fund disclosure, and recommended that

the NASD either reaffirm the rule’s

current prohibition on underwriters and

their associated persons from paying

cash compensation that is not disclosed

in the prospectus or, in the alternative,

modify the rule language so that both

broker-dealers and underwriters have

responsibility for compliance with the

proposed rule.

With respect to participating brokerdealers that are not the principal

underwriter for an investment company,

the language of the provision places the

burden of ensuring adequate disclosure

on each individual member only with

respect to the compensation that the

member is receiving.20 Such a

participating member does not have an

obligation to ensure disclosure of

compensation received by other member

firms.

However, the principal underwriter is

responsible for the disclosure of

compensation with respect to all

members with whom they have entered

into dealer agreements. This obligation

arises as a result of the disclosure

requirements of SEC Registration

Statement Form N–1A. In Notice to

Members 93–12 (February 1993), in

Question 35, the NASD stated that

investment companies should provide

disclosure in a manner sufficient for

member firms to prove that they can sell

the fund’s shares in compliance with

NASD rules. Because the principal

underwriter enters into all dealer

agreements, the principal underwriter

must be responsible for ensuring

adequate disclosure of the

compensation received by all

participating dealers.

Treatment of Payments for Training

or Education Meetings; Potential

Discriminatory Impact. Offerors from

time to time hold and pay for training

and/or educational meetings with

different members to differing degrees,

resulting in disparate payment levels to

members. One commentator, assuming

that such payments could be regarded as

special cash compensation, stated that

the NASD should clarify that such

situations do not require any special

prospectus disclosure (Prudential).

Other commentators stated that if a nonproprietary fund family’s contribution

toward an unaffiliated broker-dealer’s

cost of a public seminar (i.e., training or

education meeting) is considered cash

compensation requiring prospectus

disclosure, then such unaffiliated

broker-dealers will be placed at a

significant competitive disadvantage

when marketing to the public compared

to proprietary funds/firms which would

not have to disclose such compensation

under the proposed rule (FNIC, Stern).

Payments made by offerors for

training and education meetings which

meet all the requirements for training

and education meetings set forth under

subparagraphs (l)(5)(c) or (h)(3)(c) of the

Investment Company and Variable

Contracts Rules, respectively, are not

required, as non-cash compensation, to

be disclosed in the prospectus. Thus,

there is no discriminatory impact on

unaffiliated broker-dealers, as such

firms are not required to disclose

payments received as reimbursements

for their costs in conducting a training

or education meeting. Such payments

will, however, along with other cash

payments be reconsidered in connection

with the NASD’s study of the cash

compensation arrangements in

connection with the sale of investment

company securities and variable

contracts.

Other Comments. The proposed rule

does not specifically address the

payment practice of ‘‘overcredits,’’

which is a payment made by an offeror

to a member firm over and above the

reallowance in a full dealer reallowance

offering. One commentator criticized the

proposed rule for failing to require that

the practice of awarding overcredits be

included as a disclosure item

(Thornburg). Such payments will,

however, along with other cash

payments be reconsidered in connection

with the NASD’s study of the cash

compensation arrangements in

connection with the sale of investment

company securities and variable

contracts.

Two commentators stated that the

NASD exceeds its authority in

mandating disclosure requirements

which fall within the jurisdiction of the

SEC (Cadaret/Grant, New England

Funds). The NASD does not believe it

exceeds its authority by imposing rules

on its members with respect to

disclosure of compensation or any other

information to investors, so long as such

disclosure requirements are not contrary

to the rules and regulations of the SEC.

The proposed disclosure requirements

do not change, and do not attempt to

change, in any way the existing

prospectus disclosure requirements

under the registration and disclosure

provisions of the Securities Act of 1933

or the Investment Company Act of 1940.

Subparagraphs 2820(h)(3) and

2830(l)(5)—Prohibition on Non-Cash

Compensation

General Comments on Prohibition.

One commentator stated that the

proposed prohibition on non-cash

compensation as published for comment

in NTM 94–67 ought not to prohibit an

offeror from reimbursing a member firm

for all or a portion of the expenses

incurred in conducting a seminar for the

benefit of potential investors, because

no public policy interest is served by

prohibiting such arrangements (AG

Edwards). The NASD believes that a

‘‘road show’’ or seminar for investors is

not the same as a training or education

meeting that is intended only for

associated persons of member firms nor

is it a non-cash sales incentive trip that

was intended to be prohibited by the

proposed rule. Thus, it appears

appropriate to interpret the proposed

rule to not prohibit reimbursements of

the expenses of members for road shows

for the benefit of investors. Such

payments will, however, along with

other cash payments be reconsidered in

connection with the NASD’s study of

the cash compensation arrangements in

connection with the sale of investment

company securities and variable

contracts.

Another commentator suggested that

an additional exemption be added from

the prohibition on non-cash

compensation for due diligence

meetings sponsored and paid for by an

offeror on behalf of selected registered

representatives of the offeror’s selling

group broker-dealer who were invited

by the offeror on the basis of the amount

of assets generated or procured the reps

for the offeror’s funds (Thornburg). Such

meetings, the commentator stated, are

specifically for the purpose of clarifying

detailed fund portfolio and investment

information so that registered

representatives will be able to answer

sophisticated client queries concerning

such matters. Due diligence meetings, as

‘‘due diligence’’ is referenced in Section

11 of the Securities Act of 1933, are

attended by the due diligence personnel

of a broker-dealer firm for the sole and

narrow purpose of ensuring the

adequacy and accuracy of the

information in the offering document.

Such meetings would be held at a

location appropriate to the conduct of

due diligence, such as the issuer’s

offices. NASD staff are not aware of

such meetings in the investment

company securities or variable contract

context. The commenter’s description of

‘‘due diligence’’ meetings does not

comport with the narrow purpose of

ensuring the adequacy and accuracy of
35840 Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices

21The SEC approved in Securities Exchange Act

Release No. 35862 (June 19, 1995) a change to Rule

2710 that amended its non-cash incentive provision

to change the gift exception from $50 to $100.

the offering document. Instead, it

appears that the meeting being

described is a training and education

meeting, which would be required to

comply with the exception for training

or education meetings. To the extent

bona fide due diligence meetings are

held, as may occur in the case of a new

investment company, the proposed

prohibition on non-cash sales incentives

does not prohibit such meetings and the

expenses related to such meetings are

considered expenses of the offeror.

De Minimis Exceptions. One

commentator stated that the protections

contained in proposed subparagraph

(l)(5) of the Investment Company Rule,

which would prohibit members and

their associated persons from accepting

any non-cash compensation, are illusory

since the proposed rule does not require

any recordkeeping and accountability

for the acceptance of de minimis gifts

and entertainment in paragraphs (a) and

(b) (State of New York). Another

commentator suggested that these

exceptions retain the current language

of the Investment Company Rule which

would require that such gifts and

entertainment ‘‘conditioned on sales of

share’’ to clarify that, contrary to the

explanation in NTM 94–76 (p. 433),

such gifts should not even be permitted

as rewards, since rewards in effect

invariably become a de facto sales

incentive program (Nuveen).

The NASD agrees with the general

premise of the commenters that any

item of value given by an offeror to an

associated person has some influence on

that person. The issue is, however,

whether the $100 gift exception and the

entertainment exception provide for

items of value that are sufficient to

influence the sales practices of the

recipient associated person. The

exemptions for gifts and entertainment

have long been in the Investment

Company Rule and are particularly

appropriate in the context of a

continuously-offered security, when it

should be anticipated that offerors will

want to maintain a business relationship

with associated persons of member

firms. The NASD is not aware of any

abuse of these exemptions and believes

that they represent such a de minimis

activity that they do not have the ability

to undermine investor protection. The

NASD has, nonetheless, amended the

language of the first two exceptions to

modify the phrase ‘‘not preconditioned

on achievement of a specified sales

target’’ to clarify that the sales target

cannot be ‘‘previously specified.’’ The

NASD believes that this requirement as

well as the de minimis nature of the gift

or entertainment proposed in

subparagraphs (l)(5)(a) and (b) and

(h)(3)(a) and (b) of the proposed rule

change are sufficiently restrictive in

scope and amounts to allay concerns

that such gifts and gratuities may

become substantial de facto incentive

programs that have the potential to

undermine investor protection.

Another commentator suggested

deleting in its entirety the meals and

entertainment exception since such de

minimis payments have never posed

serious non-cash compensation

problems and the subjective language of

the subsection makes it unenforceable

(Titan). The proposed exception for

meals and entertainment is drawn from

the current language of the Investment

Company Rule and has not previously

presented an enforcement problem.

While the requirement that such meals

and entertainment be ‘‘neither so

frequent nor so extensive as to raise any

question of propriety’’ is subjective, it is

believed that such a standard is not

inconsistent with and is no more

subjective than the Article III, Section 1

standard that members are required to

‘‘observe high standards of commercial

honor and just and equitable principles

of trade’’ which allows the NASD to

take a broad regulatory approach on a

case-by-case basis if necessary. It is

believed that the proposed rule language

provides sufficient specificity to put the

membership on notice of the need to

exercise appropriate discretion when

relying on the exception.

One commentator stated that it is

unclear whether the exceptions for $100

gifts and entertainment would be

available if a fund sponsor makes such

payments available to a broker-dealer in

connection with the firm’s internal sales

campaign, which campaign is based on

all of the firm’s products during a

specific period of time rather than

specified sales targets for particular

funds (MML). The NASD believes that

this comment reflects the proposed

structure of the rule change published

for comment which would have

prohibited third-party offerors from

contributing to a member’s in-house

incentive program. Regardless of how

the broker-dealer’s in-house

compensation program is structured, the

exceptions for $100 gifts and

entertainment cannot be combined with

the member’s in-house incentive

program because the third-party offeror

would be participating in the

organization of the member’s program

which is proposed to be prohibited. As

amended, the proposed rule change

would permit, however, third-party

offerors to make cash contributions to

the member’s in-house incentive

program.

Another commentator suggested that

the $100 gift exception be revised to

replace the subsection’s fixed dollar

limitation with the language ‘‘neither so

frequent nor so extensive as to raise any

question of propriety’’ found in

subparagraph (h)(4)(b) of the Variable

Contracts Rule (ITT Hartford). The

commentator reasoned that the standard

of propriety is more appropriate than a

fixed dollar limitation in the context of

variable contracts. The $100 exemption

is consistent with Article III, Section 10

of the Rules of Fair Practice which

allows such gifts between a member and

the personnel of another firm and with

the Corporate Financing and DPP Rules

which permit an issuer to provide up to

$100 of non-cash sales incentives to

associated persons annually in

connection with the sale of corporate

equities, real estate investment trusts,

closed-end funds, debt, and DPP

offerings.21 The NASD believes it

appropriate to provide a fixed dollar

amount as proposed.

Exception for Training and Education

Meetings. It was pointed out by

commentators that a discrepancy may

exist between the text of proposed

subparagraph (l)(5)(c)(v) of the

Investment Company Rule (which

specifies that sponsors cannot

contribute to the training/educational

meetings if the payment or

reimbursement is conditioned on sales

or the promises of sales) and its

counterpart in the Variable Contracts

Rule, and the explanation of the

subsection on page 434 in NTM 94–67,

which appears to go further than the

actual rule language in saying that

members cannot condition attendance at

their training meetings through

satisfaction of in-house sales incentive

requirements, regardless of whether

they accept offeror contributions (MML,

Mutual Service). Both commentators

expect the literal rule language to

govern, and one (MML) requested

clarification of this expectation in the

final release. Similarly, commenters

stated that, contrary to the NASD’s

interpretation, example #4 in NTM 94–

67 should not be interpreted as

preventing a product sponsor from

contributing to the expenses a member

incurs for awarding a trip based on an

in-house, total products sales contest

(Calvert, LPL). Such sponsor

contributions, one of the commenters

argued (LPL), are payments for the

opportunity to address and educate

registered representatives, not rewards
Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices 35841

for product-specific sales performances.

Another commenter stated that the

proposed rule appears to prohibit

certain fact-specific situations that

ought not to be prohibited, such as a

broker-dealer’s incentive offer of a

business development conference/

meeting/trip to any of its associated

persons (and guests) as an award for

achieving a specific sales target

(measured by either ‘‘commissions

earned’’ or ‘‘assets raised’’) where the

majority of the costs of the conference/

meeting/trip are paid for by invited

investment and insurance companies

who also help to conduct some of the

training and educational presentations

(Raymond James). The commenter

stated further that such incentive

contests and their variants ought to be

specifically exempted from the

proposed rule’s prohibitions since they

satisfy the general intent of the

proposed rules and help to increase the

level of education and training in the

fund industry. Finally, other

commentators stated that the proposed

non-cash restrictions would be

detrimental to the variable product

marketplace (NAVA) and variable

product consumers and urged the NASD

to amend its proposal to permit

continued product sponsor support of

legitimate educational and training

seminars, without limitation on the

methodology used by insurers to invite

agent attendees (PEN).

The NASD believes that training/

education meetings are important to the

investment company/variable contract

industries and it is, therefore, important

that the NASD’s rules continue to

permit such meetings without problems

of enforcing the non-cash incentive

prohibition. It was anticipated when the

training and education meeting

exception was developed that members

would recognize high producers by

attendance at such meetings. Because

members are permitted to have an inhouse non-cash incentive program for

sales of investment company securities

and variable contract products (and

offerors may contribute to such in-house

incentive programs), it is important to

appropriately clarify the difference

between attending a training/education

meeting as a permissible ‘‘recognition’’

and attending it as an impermissible

‘‘non-cash sales incentive program.’’ In

order to prevent a member from

combining a permitted in-house sales

incentive program with a training/

education meeting held by an offeror,

the NASD has revised proposed

subparagraphs (l)(5)(c)(ii) of the

Investment Company Rule and

(h)(3)(c)(ii) of the Variable Contracts

Rule to specify that attendance of

associated persons at bona fide training/

education meetings must not be based

by the member on achievement of a

sales target or any other non-cash

compensation arrangement permitted

under paragraph (d) (which permits inhouse non-cash arrangements by a

member or its affiliate). When this

requirement is taken together with the

requirement that the offeror cannot

condition its payment or reimbursement

on sales or the promise of sales, these

two requirements clarify that attendance

at a training or education meeting by an

associated person is permitted to be

approved by a member as a recognition

for past sales or as an encouragement for

future sales, but shall not be part of a

member’s or offeror’s incentive program

or plan which requires that the recipient

or the member reach a specific sales

goal as a prior condition to attending the

training or education meeting.

Other commentators suggested that

the NASD should make explicit in the

proposed rule language for

subparagraph (l)(5)(c)(v) of the

Investment Company Rule that

attendance at a member’s training

meeting cannot be earned through a

member’s in-house product-specific

sales incentive contest, but only through

generic in-house sales criteria (FNIC,

Stern). The NASD has, as set forth

above, amended the training or

education exception to clarify that

attendance at any training or education

meeting where a member’s costs of the

meeting are paid for or reimbursed by a

third-party offeror cannot be earned

through any in-house incentive

contest—even though such contest is in

compliance with the proposed rule. If a

member holds a training or education

meeting for its own associated persons

and offerors or other third-parties pay or

reimburse the costs of the meeting, the

meeting must comply with the training

or education meeting exception. If no

third-party pays or reimburses the

expenses of a member in connection

with its internal training or education

meeting, the meeting need not comply

with the training or education exception

as the member is not in receipt of noncash compensation. Further, in the latter

instance, the member is not prevented

from inviting a third-party offeror to be

a speaker at the meeting.

One commentator objected to having

any limitations at all imposed on the

ability of fund groups and product

sponsors to participate, both financially

and in terms of product content, in

national or regional training, education

and compliance meetings, particularly

where the right to attendance at the

meetings is earned by product sales

(IM&R). The NASD disagrees with the

position of the commentator and

believes that it is appropriate to regulate

the manner in which training or

education meetings are held to ensure

that such meetings are not prohibited

non-cash incentive meetings.

Another commentator suggested that

the NASD clarify that the limitations

imposed for training and education

meetings apply to an offering of new

funds as well as existing funds

(Prudential). The requirements for

training or education meetings apply to

any meeting considered a training or

education meeting with respect to new

or existing funds. As set forth above,

however, investor seminars and bona

fide due diligence meetings (which are

more likely to occur in the case of a new

fund) are not considered training or

education meetings.

A commenter also stated that payment

or reimbursement by offerors to

members for the cost of educational

meetings should be strictly limited to

expenses actually incurred by the

member in connection with the meeting,

and that such payments not exceed the

annual amount per person fixed

periodically by the Board of Governors

under proposed subparagraph (l)(5)(a) of

the Investment Company Rule (Nuveen).

The NASD is not proposing, at this time,

to limit the payments for educational

meetings to the expenses actually

incurred by the member in connection

with the meeting. Payments of a

member’s meeting expenses that exceed

the costs of the meeting will, however,

along with other cash payments be

considered in connection with the

NASD’s study of the cash compensation

arrangements in connection with the

sale of investment company securities

and variable contracts.

According to some commenters, the

proposed rule’s provision regarding the

site for training and education meetings

is excessively harsh and unrealistic,

because it restricts site location to a

specific region for non-affiliated brokerdealers while permitting a national

brokerage firm to choose any location

(Nike, Capital Analysts). Another

commenter stated that the proposed rule

language should be expanded to state

that a national meeting may be held at

a national location (Fidelity). Another

commenter stated that since every

location in the United States, or the

world for that matter, could be viewed

as a ‘‘regional location,’’ it is uncertain

what regulatory purpose is served by

putting such an ambiguous and virtually

limitless requirement in the proposed

rules (MML).

With respect to the first comment,

without a restriction with respect to the
35842 Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices

location of a training/education

meeting, it is probable that offerors will

compete for sales of their products on

the basis of the location of the training/

education meeting that they are willing

to hold for associated persons of brokerdealers. Members, on the other hand,

would be in a position to negotiate with

offerors for reimbursement of expenses

of training/education meetings in exotic

locations on the basis of the sales they

have generated. Thus, it appears

important that a restriction be included

with respect to the location of the

meeting.

While the second commenter is

correct that members with an

international business are not subject to

any location limitation, it is important

to note that the agenda for such

meetings must be appropriately focused

on training and education. As a

practical matter, certain business

structures give a natural advantage to

some members. It is believed that if the

focus of the meeting is training or

education, that the meeting is most

likely to be within the 48 contiguous

states.

The NASD determined not to include

express limits on the location of

national training and education

meetings. The establishment of objective

standards to limit national meetings

would require precise definitions of the

terms and phrases ‘‘office of the offeror

or member,’’ ‘‘facility located in the

vicinity of such office,’’ and ‘‘regional

location.’’ Because members’ business

lines and distribution systems are

structured in myriad and sometimes

substantially dissimilar ways, especially

with respect to physical location,

precise definitions of such terms may

deprive some members of the needed

flexibility to structure their meetings.

Thus, it would be very difficult to

establish any objective geographical

standards without avoiding what might

appear to be discriminatory effects on

certain members. The NASD believes

that whether a particular location is

appropriate for a training and education

meeting will be dependant, to a

significant extent, on the facts and

circumstances of each situation.

Furthermore, the NASD believes that

the limitations proposed for the nature

of educational meetings in the proposed

rule will discourage sponsors from

holding training and education meetings

in exotic places. Because the burden is

now on members to show that a training

and education meeting is bona fide, the

NASD anticipates that members will

generally avoid excessively expensive

and lavish training and education

settings that would be difficult to justify

under the strictures of the proposed

rule.

Another commenter suggested

limiting issuer-sponsored trips to the

corporate headquarters of the issuer for

educational purposes only, and to

substantiate the purpose of such trips

with records of the meeting agendas

(LPL). The NASD agrees with the

comment that the purpose of training or

education meetings should be

substantiated by the member on the

basis of the meeting agenda, but does

not believe it necessary to limit

meetings to the corporate headquarters.

Exception for In-House Sales

Incentives. The major comments on the

exceptions in the version of the

proposed rule change in NTM 94–67

permitting in-house sales incentive

arrangements argued that allowing

direct payments by an affiliated offeror

to a member’s permissible in-house

program discriminated between

members that sell proprietary products

and members that do not, and between

investment/insurance companies with

and without an affiliated broker-dealer.

In particular, smaller members were

concerned regarding the disparate

impact of the sales incentive prohibition

because the largest broker-dealers also

generally sell proprietary products.

Commenters also expressed particular

concern regarding the ability of an

affiliated investment company or

insurance company (or other nonmember affiliate, such as a bank) to

contribute to a member’s in-house

incentive program, whereas nonaffiliates were prohibited by the

proposal from making similar

contributions.

Two commentators stated that the

reasons offered for the proposed rule

change, namely, to prevent the

increasing potential for loss of

supervisory control and to preempt the

possibility of perception of impropriety

and loss in investor confidence, were

less than compelling justifications for

regulation that not only discriminates

against certain firms but also encourages

the sale of unsuitable products to the

investing public (Security Life, Wood

Logan). One commentator stated that the

exception in NTM 94–67 permitting inhouse non-cash compensation

eviscerates the goal of aligning the

salesperson’s interest with the client’s

interest (State of New York).

Commentators stated that proposed

subparagraph (h)(5) of the Variable

Contracts Rule in NTM 94–67, by

allowing non-cash compensation

programs for insurance companies with

proprietary products and sales forces,

creates an uneven playing field in favor

of ‘‘proprietary providers’’ over

‘‘independent providers’’ and is anticompetitive (Skandia, Capital Analysts,

Security Benefit, American Growth

Fund Sponsors). Some commentators

suggested either deleting subparagraph

(h)(5) of the Variable Contracts Rule

entirely or expanding it to allow

independent providers to offer non-cash

compensation programs on the same

basis as proprietary providers (Skandia,

PNMR).

The NASD was concerned about the

disparate impact of the rule proposal

that would result from a member firm

with proprietary products conducting

an in-house contest which includes

direct or indirect economic support and

funding through sales of its proprietary

products, and was sympathetic to the

comments of those members without

proprietary products who argued that

they would be unable to afford in-house

contests without the economic support

of outside issuers. In addition, the

NASD was concerned regarding the

potential disparate impact of the rule

proposal on affiliated investment or

insurance companies that did not have

an affiliated member distributing their

products and would not be permitted to

contribute to the in-house incentive

program of unaffiliated members.

The NASD focused on three

provisions in subparagraphs (l)(6) and

(h)(5) of the Investment Company and

Variable Contracts Rules, respectively,

as proposed in NTM 94–67. These are:

(1) The language in the introduction

which permitted a non-member

(including offerors) to provide a sales

incentive program for its salespersons

that are associated persons of an

affiliated broker-dealer; (2) paragraph (a)

of subparagraphs (l)(6) and (h)(5) which

required that the member’s in-house

incentive program must be multiproduct type oriented or, for single

product type firms, based on the gross

production of the associated person; and

(3) paragraph (b) of subparagraphs (l)(6)

and (h)(5) which prohibited an

unaffiliated non-member (including

offerors) or other member from

participating in and contributing to a

member’s in-house incentive program.

In general, the NASD determined that

the goal of prohibiting non-cash

incentives for the sale of a particular

investment company’s securities would

not be compromised if non-member

entities and other members are allowed

to contribute to any member’s in-house

program, so long as restrictions are

imposed on the structure of the in-house

program. The NASD believes that the

proposal should distinguish between

incentives that act at the point-of-sale to

influence the salesperson’s

recommendation to the investor and
Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices 35843

22See supra discussion explaining the NASD’s

rationale underlying the proposed non-cash

compensation provisions in Subsections 26(l)(5)

and 29(l)(3) of the Investment Company and

Variable Contract Rules, respectively.

incentives which do not have such

effect. Non-cash incentive programs by

an offeror that involve only a single

product (regardless of whether the

product is proprietary) affect the pointof-sale relationship with the investor

and are more likely to influence the

salesperson to sell a specific investment

company’s securities or variable

contract. The NASD believes that

contributions by a non-member to a

member’s in-house incentive program

that includes all variable annuity or

variable life or investment company

products does not have the same

‘‘incentive’’ effect because the member’s

in-house incentive is a reward for total

production—not for the sale of a

specific variable annuity or variable life

contract product or investment

company security.22

The NASD has modified and

restructured the provisions proposed in

subparagraphs (l)(6) of the Investment

Company Rule and (h)(5) of the Variable

Contracts Rule in NTM 94–67. The

subparagraphs have been renumbered in

the proposed rule change as

subparagraphs (l)(5)(d) and (e) and

(h)(3)(d) and (e). Subparagraph (d) of the

Investment Company Rule and of the

Variable Contracts Rule permits all

members and non-member affiliates of

members to hold in-house incentive

programs so long as certain conditions

are met which are for the purpose of

avoiding the point-of-sale impact of the

incentives, and subparagraph (e)

permits any non-member company and

other member to contribute to, but not

to hold or organize, a permissible inhouse non-cash sales incentive program

between a member and its associated

persons so long as the same conditions

for subparagraph (d) are met. By its

limiting language, permissible

contributions under subparagraph (e)

may only be given to an in-house noncash sales incentive program held by a

member firm; such contributions may

not be given to an in-house non-cash

sales incentive program held by a nonmember affiliate because the nonmember affiliate is not required by

NASD rules to maintain records of the

receipt of such contributions.

With respect to the second condition

on the structure of a member’s or

affiliate’s in-house incentive program

proposed in subparagraph (l)(6)(b) of the

Investment Company Rule in NTM 94–

67, two commentators observed that

since almost all proprietary firms have

investment company securities and

cloned variable products, an incentive

program could be based on just two

product types, and recommended either

deleting the exception for in-house sales

entirely or changing the language of the

provision to make in-house sales

incentive programs available only if

based on gross production of all

products (FNIC, Stern). Another

commentator recommended that the

‘‘multi-product type’’ condition be

revised to make clear that the test is not

satisfied by selecting one security of

each product type, for example, a

proprietary investment company and a

proprietary variable product (Wood

Logan).

The conditions applicable to the

member’s and its affiliate’s permissible

non-cash sales incentive programs in

subparagraphs (l)(5)(d) and (e) of the

Investment Company Rule and (h)(3)(d)

and (e) of the Variable Contracts Rule

were modified from those proposed in

NTM 94–67 in the following manner: (1)

The member’s in-house non-cash

incentive program, when it includes

investment company securities or

variable contracts, must include the

total production of associated persons

with respect to all investment company

securities and variable annuity or life

contracts distributed by the member,

which modifies the ‘‘multi-product

type’’ rule language in NTM 94–67; (2)

the credit received for each variable

contract (i.e., variable annuity or

variable life) must be equally weighted,

which is a new provision that was not

included in the language of NTM 94–67;

and (3) no non-member company or

other member may directly or indirectly

participate in the organization of a

permissible non-cash compensation

arrangement, which modified the

corresponding provision in NTM 94–67

by deleting the words ‘‘or contributes

to’’ in order to allow contributions to

permissible non-cash programs by

outside unaffiliated non-members or

other members as long as their

involvement is limited only to such

contributions under new paragraph (e).

The fourth requirement, the

recordkeeping requirement, was not

modified from the language of NTM 94–

67.

The NASD believes that these changes

to the non-cash compensation

provisions proposed in subparagraphs

(l)(5)(d) and (e) of the Investment

Company Rule and subparagraphs

(h)(3)(d) and (e) of the Variable

Contracts Rule eliminate the point-ofsale impact of non-cash sales incentives

on the sales practices of an associated

person with respect to the sale of

investment company securities and

variable contracts by prohibiting thirdparty non-cash sales incentive programs

and by requiring that all securities of the

product type be included in the

member’s (or its affiliate’s) in-house

incentive program and be equally

weighted. At the same time, the NASD

believes that any potential

discriminatory impact that is not in

furtherance of the Act is addressed by

permitting non-members and other

members to contribute to a member’s inhouse incentive program.

III. Date of Effectiveness of the

Proposed Rule Change and Timing for

Commission Action

Within 35 days of the date of

publication of this notice in the Federal

Register or within such longer period (i)

as the Commission may designate up to

90 days of such date if it finds such

longer period to be appropriate and

publishes its reasons for so finding or

(ii) as to which the self-regulatory

organization consents, the Commission

will:

A. by order approve such proposed

rule change, or

B. institute proceedings to determine

whether the proposed rule change

should be disapproved.

IV. Solicitation of Comments

Interested persons are invited to

submit written data, views, and

arguments concerning the foregoing.

The Commission requests that, in

addition to any general comments

concerning whether the proposed rule

change is consistent with Section

15A(b)(6) of the Act, commentators

specifically address the following

issues:

1. The proposed rule change would

continue to permit an associated person

to accept gifts from offerors if the total

value of gifts from an offeror to an

associated person does not exceed $100

per person per year and if such gifts are

not preconditioned on meeting a sales

target. Associated persons also could

continue to accept an occasional meal,

a ticket to a sporting event or the

theater, or comparable entertainment

from offerors if the entertainment is

neither so frequent nor so extensive as

to raise any question of propriety and is

not preconditioned on meeting a sales

target. The NASD states that it is not

aware of any abuse of these exemptions

and believes that they represent such a

de minimis activity that they do not

have the ability to undermine investor

protection. Should members be required

to keep records of such gifts or

entertainment to enable the NASD to

surveil effectively for abuse?

2. The proposed rule change would

permit a member or an associated
35844 Federal Register / Vol. 61, No. 131 / Monday, July 8, 1996 / Notices

person to accept payment or

reimbursement from an offeror for

expenses incurred in connection with

meetings held by the offeror for the

purpose of training or educating

associated persons of a member. Such

meetings can be held at or near an office

of the offeror or an office of the member

or a regional location with respect to

regional meetings)—a third-party offeror

with a regional business may not

conduct a meeting outside that region

unless the member has a more

widespread business. The provision

would permit offerors to hold training

meetings in resort locales if that offeror

or the member has an office in that

resort locale.

The NASD states that it ‘‘believes that

the limitations proposed for the nature

of educational meetings in the proposed

rule will discourage sponsors from

holding training and education meetings

in exotic places. Because the burden is

now on members to show that a training

and education meeting is bona fide, the

NASD anticipates that members will

generally avoid excessively expensive

and lavish training and education

settings.’’ Are the recordkeeping

requirements proposed by the NASD

sufficient to support determinations of

whether such meetings will be bona

fide?

3. The NASD states in its filing that

a member holding a training or

education meeting for its associated

persons would not be required to

comply with the conditions imposed

with respect to training and education

meetings held by offerors or unaffiliated

members ‘‘if the member does not

receive a payment or reimbursement

from an offeror for the expenses of the

meeting. In any event, the member

would not be prohibited from

permitting offerors to make a

presentation at the meeting.’’ The

proposed rule change establishes three

separate levels of regulation of training

and education meetings depending

upon whether a member or an offeror

holds a training and education meeting

and depending upon whether a member

who holds a training and education

meeting accepts reimbursement from an

offeror.

a. If an offeror holds a training and

education meeting, that meeting must

comply with the training and education

exception.

b. If a member holds training and

education meeting, and accepts

reimbursement from an offeror for

certain expenses, the meeting must

comply with either the training and

education exception or the in-house

sales incentive exception (permitting

contributions by offerors).

c. If a member holds a training and

education meeting for its own

associated persons and accepts no

reimbursement from offerors, the

proposed rule change does not regulate

that meeting because the meeting is not

in connection with the sale or

distribution of investment company/

variable contract securities.

Commenters are asked to address

whether a training and education

meeting should constitute non-cash

compensation subject to the proposed

rule change if an offeror participates in

organizing the meeting even though an

identical meeting would not be subject

to the proposed rule change if organized

by the member for its own associated

persons.

4. The Tully Committee identified the

practice of payment of higher

commissions to registered

representatives for proprietary products

than for non-proprietary products as an

arrangement that can create conflicts of

interest. The proposed rule change

would not prohibit or regulate this

practice. The NASD has stated that ‘‘it

has generally not been the practice for

the NASD to regulate the internal

compensation arrangements between a

member and its associated persons.’’

The proposed rule change would,

however, prohibit contests granting cash

awards if the contest gives greater

weight to certain securities than others.

Commenters are invited to address

whether the proposed rule change

should be extended to cover ordinary

compensation practices in addition to

incentive compensation practices.

Persons making written submissions

should file six copies thereof with the

Secretary, Securities and Exchange

Commission, 450 Fifth Street, N.W.,

Washington, D.C. 20549. Copies of the

submission, all subsequent

amendments, all written statements

with respect to the proposed rule

change that are filed with the

Commission, and all written

communications relating to the

proposed rule change between the

Commission and any person, other than

those that may be withheld from the

public in accordance with the

provisions of 5 U.S.C. 552, will be

available for inspection and copying in

the Commission’s Public Reference

Room. Copies of such filing will also be

available for inspection and copying at

the principal office of the NASD. All

submissions should refer to the file

number in the caption above and should

be submitted by July 29, 1996.

For the Commission, by the Division of

Market Regulation, pursuant to delegated

authority, 17 CFR 200.30–3(a)(12).

Jonathan G. Katz,

Secretary.

[FR Doc. 96–17250 Filed 7–5–96; 8:45 am]

BILLING CODE 8010–01–P

SOCIAL SECURITY ADMINISTRATION

Statement of Organization, Functions

and Delegations of Authority

Notice is being given that two new

chapters are being issued, Chapter TC,

Office of the Chief Actuary and Chapter

TE, Office of the Deputy Commissioner,

Communications and that Chapter TA,

Office of the Deputy Commissioner,

Programs, Policy, Evaluation and

Communications (TA) is being reissued.

Within the Deputy Commissioner,

Programs, Policy, Evaluation and

Communications notice is given that the

Office of the Actuary (TAC); the Office

of Communications (TAL); the

Resources Management Staff (TAA–1);

the Office Automation Support Staff

(TAA–2); the Office of Program

Coordination and Planning (TAB); the

Office of Policy Analysis and Evaluation

(TAQ); the Office of Policy (TAK); and

the Office of Disclosure Policy (TAG)

are abolished. Notice is also given of the

establishment of the Office of Policy and

Planning (TAR) and the Office of

Program Support (TAS) and the retitling

of the Office of Research and Statistics

(TAN) as the Office of Research,

Evaluation and Statistics.

Finally, notice is given that in the

Office of Disability (TAE) the Office of

Medical Evaluation (TAEA) is being

abolished. The functions are being

redistributed among the Office of the

Associate Commissioner for Disability,

the Division of Medical and Vocational

Policy (TAEC) and the Federal

Disability Determination Services

(TAEB).

The new and reissued Chapters read

as follows:

ADD new chapter

Chapter TC—Office of the Chief Actuary

TC.00 Mission

TC.10 Organization

TC.20 Functions

Section TC.00 The Office of the

Chief Actuary—(Mission): The Office of

the Chief Actuary (OCACT) plans and

directs a program of actuarial estimates

and analyses pertaining to the SSAadministered retirement, survivors and

disability insurance programs and

supplemental security income program

and to projected changes in these

programs. Evaluates operations of the