[Federal Register Volume 63, Number 141 (Thursday, July 23, 1998)]
[Notices]
[Pages 39614-39619]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-19567]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40214; File No. SR-NASD-97-35]


Self-Regulatory Organizations; Order Granting Approval of 
Proposed Rule Change Filed by the National Association of Securities 
Dealers, Inc. Relating to the Regulation of Non-Cash Compensation in 
Connection With the Sale of Investment Company Securities and Variable 
Contracts

July 15, 1998.

I. Introduction and Background

    On May 7, 1997,\1\ the National Association of Securities Dealers, 
Inc. (``NASD'') filed with the Securities and Exchange Commission 
(``Commission'') a proposed rule change pursuant to Section 19(b)(1) of 
the Securities Exchange Act of 1934 (``Act'') \2\ and Rule 19b-4 
thereunder \3\ to amend NASD Conduct Rules relating to the regulation 
of non-cash compensation in connection with the sale of investment 
company securities and variable contracts.
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    \1\ On July 15, 1997, the NASD filed Amendment No. 1 to the 
proposed rule change. On July 23, 1997, the NASD filed Amendment No. 
2 to the proposed rule change. On August 28, 1997, the NASD filed 
Amendment No. 3 to the proposed rule change. A final amendment, 
Amendment No. 4, was filed on December 2, 1997. Amendment No. 1 made 
several changes to the proposed rule language and the rule filing. 
See letter from John Ramsay, Deputy General Counsel, NASD 
Regulation, Inc. (``NASD Regulation'') to Katherine A. England, 
Assistant Director, Commission, dated July 11, 1997. The changes 
made by Amendment No. 1 were incorporated into and published in the 
Federal Register notice of the proposed rule change. See Securities 
Exchange Act Release No. 38993 (August 29, 1997), 62 FR 47080 
(September 5, 1997). Amendment No. 2 made technical changes to 
Amendment No. 1. See letter from John Ramsay, NASD Regulation to 
Katherine A. England, Assistant Director, Commission, dated July 22, 
1997. Amendment No. 3 states that the NASD Board of Governors has 
reviewed the proposed rule change and that no other action by the 
NASD is necessary for Commission consideration of the rule proposal. 
See letter from John Ramsay, NASD Regulation to Katherine A. 
England, Commission, dated August 27, 1997. These two technical 
amendments do not need to be published for comment. Amendment No. 4 
was filed on December 2, 1997. See letter from John Ramsay, NASD 
Regulation to Katherine A. England, Assistant Director, Commission 
Amendment No. 4 responds to comment letters received by the 
Commission in response to its notice of the filing and solicitation 
of comment. It is a technical amendment and therefore not subject to 
notice and comment. NASD Regulation's response is discussed in 
detail in Section III of this approval order.
    \2\ 15 U.S.C. 78s(b)(1).
    \3\ 17 CFR 240.19b-4.
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    Over the past years, the SEC, the investing public and the 
securities industry have raised concerns about actual and potential 
conflicts of interest in the retail brokerage business. Responding to 
these concerns, in May

[[Page 39615]]

1994, an industry committee chaired by Merrill Lynch Chairman Daniel P. 
Tully (``Tully Committee'') was formed at the request of SEC Chairman 
Levitt to address concerns regarding conflicts of interest in the 
brokerage industry. The Tully Committee reviewed industry compensation 
in connection with the sale of all forms of securities for associated 
persons of members, identified conflicts of interest inherent in such 
practices, and identified ``best practices'' used in the industry to 
eliminate or reduce such conflicts of interest. A report was 
subsequently issued by the Tully Committee in April 1995 (the ``Tully 
Report'').\4\ NASD Regulation, a wholly owned subsidiary of the NASD, 
believes this proposed rule change is consistent with the 
characteristics of ``best practices'' identified in the Tully Report to 
the extent that the proposal helps to better align the interests of 
associated persons, broker-dealers and investors with respect to 
investment company securities and variable contracts.
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    \4\ See Report of the Tully Committee on Compensation Practices, 
April 10, 1995.
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    The proposal is the latest in a series of NASD proposals designed 
to control the use of non-cash compensation in connection with a public 
offering of securities. Previous rule changes established restrictions 
on non-cash compensation in connection with transactions in direct 
participation program securities, real estate investment trusts, and 
corporate debt and equity offerings.\5\ in December 1995, the NASD 
filed with the Commission proposed rule change SR-NASD-95-61, which 
proposed substantive prohibitions regarding non-cash compensation and 
incentive-based cash compensation, in connection with investment 
company and variable contract sales. SR-NASD-95-61 was published by the 
Commission for comment on July 8, 1996,\6\ SR-NASD-95-61 raised 
significant issues among comments regarding the nature and treatment of 
certain incentive-based cash compensation arrangements, in particular 
those cash compensation arrangements of insurance-affiliated member 
firms. Most of the commenters opposed the proposed provisions to 
regulate incentive-based cash compensation, stating among other things, 
that the provisions pertaining to cash compensation were over-broad in 
their scope. In response to the commenters, NASD Regulation chose to 
delete those provisions proposing to impose substantive prohibitions 
regarding incentive-based cash compensation. The NASD therefore 
withdrew SR-NASD-95-61 and replaced it with the filing approved herein, 
SR-NASD-95-35, which does not contain provisions imposing substantive 
regulations on the receipt of cash compensation arrangements.\7\
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    \5\ See e.g., order approving proposed rule change relating to 
the offering on non-cash sales incentives as inducement to sell 
interests in direct participation programs. Securities Exchange Act 
Release No. 26185 (October 14, 1988), 53 FR 41262 (October 20, 
1998). See also order approving proposed rule change to prohibit 
NASD members and associated persons from accepting non-cash 
compensation in connection with the sale of real estate investment 
trust, and debt or equity corporate offerings. Securities Exchange 
Act Release No. 26186 (October 14, 1988), 53 FR 41265 (October 20, 
1988).
    \6\ See Securities Exchange Act Release No. 37374 (June 26, 
1996), 61 FR 35822 (July 8, 1996).
    \7\ See Securities Exchange Act Release No. 37374 (June 26, 
1996), 61 FR 35822 (July 8, 1996). Notwithstanding its decision to 
bifurcate the regulation of cash and non-cash compensation in the 
instant filing, NASD Regulation has informed the Commission that it 
is aware of a broad range of cash compensation practices by which 
investment company and variable contract issuers or their affiliates 
provide various incentives and rewards to individual broker-dealers 
and their registered representatives for selling the issuers' 
products. NASD Regulation staff continues to believe that various 
cash incentive compensation practices, which create an incentive to 
favor one product over another, also may compromise the ability of 
securities salespersons to render advice and services that are in 
the best interest of customers.
    As a result of its continuing concerns regarding the appropriate 
regulatory response to cash compensation arrangements, in August 
1997, NASD Regulation issued Notice to Members 97-50, which 
solicited comments pertaining to conflicts of interest arising from 
the payment of cash incentives. Among other things, Notice to 
Members 97-50 solicited comment as to whether cash compensation 
should be subject to disclosure versus substantive prohibitions.
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II. Summary Description of the Proposed Rule Change

    In general, the terms of the rule change would 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. Limited exceptions to this general 
prohibition allow an associated person to receive payment from persons 
other than his or her NASD member firm where the compensation is 
approved by the member, or compensation received by the associated 
person is treated as compensation received by the member for purposes 
of NASD rules.
    New record keeping provisions of the proposed rule change would 
require that members maintain records of any compensation, cash or non-
cash, received by the member or its associated person from offerors. 
NASD Investment Company Rule 2830, as amended, would prohibit receipt 
by a member of cash compensation from the offeror unless such 
arrangement is described in the current prospectus. NASD Investment 
Company Rule 2830 prohibitions against a member receiving compensation 
in the form of securities would be retained. The amendments would 
prohibit, moreover, with certain exceptions, members and persons 
associated with members from directly or indirectly accepting or paying 
any non-cash compensation in connection with the sale of investment 
company and variable contract securities.
    The exceptions from the non-cash compensation prohibitions would 
permit: (1) gifts of up to $100 per associated person annually; (2) an 
occasional meal, ticket to a sporting event or theater, or comparable 
entertainment; (3) payment of reimbursement for training and 
educational meetings held by a broker-dealer or mutual fund or 
insurance company for the purpose of educating associated persons of 
broker-dealers, as long as certain conditions are met; (4) in-house 
sales incentive programs of broker-dealers for their own associated 
persons; (5) sales incentive programs of mutual fund 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 proposed rule amendments would define the terms ``affiliated 
member,'' ``compensation,'' ``cash compensation,'' ``non-cash 
compensation,'' and ``offeror.'' NASD Regulation is proposing to adopt 
a definition of the term ``affiliated member'' for both the Investment 
Company Rule, Rule 2830, and the Variable Contract Rule, Rule 2820, to 
include a member that, 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 and variable 
contracts industries, whereby a non-member owns or controls one or more 
subsidiary broker-dealer member firms for underwriting and/or wholesale 
and retail distribution services.
    For ease of reference in appropriate paragraphs of the proposed 
rules, NASD Regulation is also proposing to include in the Variable 
Contracts Rule and the Investment Company Rule a new definition of 
``compensation'' to mean ``cash compensation and non-cash 
compensation,'' and to amend the

[[Page 39616]]

appropriate paragraphs in the proposed rule language accordingly.
    ``Cash compensation,'' as proposed to be defined in the Investment 
Company and Variable Contract Rules, would include any discount, 
concession, fee, service fee, commission, asset-based sales charge, 
loan, override or cash employee benefit received in connection with the 
sale and distribution of investment company securities or variable 
contracts. This term would encompass compensation arrangements 
currently covered under the Investment Company Rule in subparagraph 
(l)(1), to Conduct Rule 2830, as well as asset-based sales charges and 
service fees as currently defined in subparagraphs (b) (8) and (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 proposed new term also 
includes cash employee benefits to make clear that certain payments of 
ordinary employee benefits as part of an overall compensation package 
are not included in the definition of non-cash compensation.
    The ``non-cash compensation'' definition is proposed to be 
identical in applicability to both the Investment Company and Variable 
Contract Rules and would encompass any form of compensation received by 
a member in connection with the sale and distribution of investment 
company and variable contract securities that is not cash compensation, 
including, but not limited to, merchandise, gifts and prizes, travel 
expenses, meals and lodging. Thus, the definition of ``non-cash 
compensation'' encompasses reimbursement for costs incurred by a member 
or person associated with a member in connection with travel, meals and 
lodging.
    Finally, NASD Regulation 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. The term 
``offeror,'' as defined in the Variable Contracts Rule, would include 
an insurance company, a separate account of an insurance company, an 
investment company that funds a separate account, any advisor to a 
separate account of an insurance company or an investment company that 
funds a separate account, 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. The definition of the term 
``associated person of an underwriter'' in the Investment Company Rule, 
which is proposed to be deleted, encompasses the issuer, the 
underwriter, the investment advisor to the issuer, and any affiliated 
person of such entities. The term ``affiliated person'' in the proposed 
definition of ``offeror'' is defined in accordance with Section 2(a)(3) 
of the 1940 Act.\8\ The term ``underwriter'' is defined in Section 
2(a)(40) of the 1940 Act.\9\ It is intended to reference the principal 
underwriter through which the investment and insurance company 
distributes securities to participating dealers for sale to the 
investor.
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    \8\ 15 U.S.C. 80a-2(a)(3).
    \9\ 15 U.S.C. 80a-2(a)(40).
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III. Amendment No. 4 and NASD Regulation's Response to Comments 
Received on the Proposal

    The Commission received letters from eight commenters regarding the 
proposed rule change.\10\ Two of the commenters generally supported the 
proposal with modifications. Four of the commenters opposed the 
proposal, and two of the commenters requested clarification regarding 
certain aspects of the proposal, but did not assert an opinion as to 
their general support of opposition to the proposal. NASD Regulation 
responded to the issues raised by the commenters in a letter dated 
December 2, 1998.\11\ This response letter is discussed below in 
addition to a description of the amendments to the proposal that were 
made as a result of comments received from the Commission's notice of 
the proposal and solicitation of public comment.
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    \10\ See letters to Jonathan Katz, Secretary, SEC from Banc One 
Corporation (``Banc One''), dated September 29, 1997; Investment 
Company Institute (``ICI''), dated September 26, 1997; M Financial 
Group (``M Financial''), dated September 30, 1997; Drinker Biddle & 
Reath (``Drinker Biddle''), dated, September 29, 1997; Merrill Lynch 
Pierce, Fenner & Smith Incorporated (``Merrill Lynch''), dated 
October 1, 1997; Bruce Avedon, dated October 16, 1997; First 
Investors Corporation (``First Investors''), dated October 16, 1997; 
and the Securities Industry Association (``SIA''), dated October 16, 
1997.
    \11\ See Letter from John Ramsay, Deputy General Counsel, NASD 
Regulation Inc., to Katherine England, Assistant Director, Division 
of Market Regulation, SEC, dated December 2, 1998.
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A. The Bifurcation of the Regulation of Non-Cash and Cash Compensation

    M Financial, Banc One, Merrill Lynch, and the SIA expressed the 
opinion that it would be imprudent and potentially confusing to 
introduce substantive regulations regarding non-cash compensation prior 
to fully evaluating the answers to the questions regarding cash 
compensation raised by NASD Regulation in Notice to Members 97-50. In 
responding to these commenters, NASD Regulation notes that since the 
late 1980s, the NASD, with the support of its Investment Company and 
Insurance Affiliated Committees, has focused on crafting a rule to 
address non-cash compensation practices that create particularly strong 
point-of-sale incentives and supervisory problems for member firms. 
NASD Regulation believes the proposed rule change, which has the 
general support of the industry, is appropriate to address these issues 
and need not be linked to cash compensation issues, which raise much 
broader and more complicated concerns.
    The ICI urged NASD Regulation to reinstate the cash incentive 
provision in the earlier proposal SR-NASD-95-61 to prevent cash 
payments directly to individuals, because such payments create the 
potential to undermine an NASD member's supervisory control over its 
associated persons. In response, NASD Regulation explains that the 
intended purpose of the now deleted cash incentive provision was to 
prevent the monetizing of non-cash compensation. NASD Regulation 
determined to delete the cash incentive provision in response to 
comments, primarily from insurance affiliated members, that the 
provision was over-broad, and to solicit comments in Notice to Members 
97-50 on cash compensation issues. The potential of payments to 
individuals to undermine an NASD member's supervisory control over its 
associated person has always been a major concern that the proposed 
rule change has attempted to address. Thus, paragraph (h)(1) and (l)(1) 
of the proposed rule change, which were also contained in predecessor 
versions, with limited exceptions prohibit individual associated 
persons from accepting any compensation, cash or non-cash, from anyone 
other than the member with which the person is associated.
     The ICI noted that in connection with the discussion of the 
implementation period of the proposed rule change, NASD Regulation 
states that the requirement that ``[w]ith respect to the non-cash and 
cash sales incentive provisions, no new sales incentive programs may be 
commenced after the effective date'' is incongruent with the removal of 
the cash sales incentive provision and needs to be clarified. NASD 
Regulation agrees with this

[[Page 39617]]

observation and has thus made a technical amendment to the proposed 
rule change to delete the words ``and cash'' from the above cited 
statement.

B. Effective Date of Proposal

    M Financial maintained that the proposed implementation plan 
interferes with the completion on ongoing commitments, and NASD 
Regulation should extend the ``grace period'' for completing on-going 
incentive programs. The proposal, M Financial argues, does not allow 
adequate time for insurers and broker-dealers to honor their 
commitments for programs that have already begun. Having taken this 
argument under advisement, NASD Regulation believes the proposed 
``grace period'' is fair and will not unduly burden the completion of 
ongoing commitments, particularly since industry participants have been 
aware for some time of the proposed rule and the proposed grace period 
and, in many cases, have already begun to adjust accordingly.

C. In-house Compensation Plans

    Merrill Lynch and the ICI urged that the proposed rule change be 
revised to permit in-house incentive programs where the compensation is 
based on sales of investment company securities within a designated 
broad investment objective or category, rather than all investment 
company securities sold by the member. NASD Regulation is of the 
opinion that it would be inappropriate to permit in-house incentive 
programs based on broad objectives or categories. Some members, NASD 
Regulation notes, may carry limited numbers of funds, or only one fund, 
for a given objective or category which, under the commenters' 
suggestion could result in sales incentive contests tied to one or a 
few funds, which would vitiate the purpose of the proposed rule.

D. Contributions of NASD Members to Non-NASD Member Compensation 
Arrangements

    Drinker Biddle and the ICI maintained that, although the proposed 
rule change would permit a non-NASD member or other NASD member to 
contribute to a member's permissible in-house non-cash compensation 
arrangement, as currently drafted, it could be read to prohibit 
contributions by NASD members to non-cash compensation arrangements of 
non-NASD members, for example, banks. The commenters stated, moreover, 
that this is probably an unintended consequence of a revision to the 
prior proposal that not only prohibits an NASD member or person 
associated with a member from accepting any non-cash compensation 
(subject to certain specified exceptions), but also prohibits members 
and associated persons from making payments or offers of payment of 
such compensation. Thus, the commenters recommended that the NASD 
clarify that an NASD member also could contribute to the non-cash 
compensation arrangements of a non-NASD member, such as a bank, 
provided that the arrangement complies with the requirements of the 
proposed rule change.
    NASD Regulation agrees that members should not be prohibited from 
contributing to non-cash compensation arrangements of a non-member, 
provided that the arrangement complies with the conditions of the 
proposed rule. Thus, paragraph (h)(4)(E) of Rule 2820 is amended as 
follows: New language has been underlined.
    ``Contributions by a non-member company or other member to a non-
cash compensation arrangement between a member and its associated 
persons, or contributions by a member to a non-cash compensation 
arrangement of a non-member,  provided that the arrangement meets the 
criteria in subparagraph (h)(4)(D).''
    In addition, paragraph (1)(5)(E) of the proposed Rule 2830 is 
amended as follows:
    ``Contributions by a non-member company or other member to a non-
cash compensation arrangement between a member and its associated 
persons, or contributions by a member to a non-cash compensation 
arrangement of a non-member, provided that the arrangement meets the 
criteria in subparagraph (1)(5)(D).''

E. Proposed Prospectus Disclosure

    Three commenters objected to the prospectus disclosure requirements 
regarding certain compensation arrangements. Specifically, Banc One 
stated that the proposal to require additional detailed disclosure in a 
current prospectus regarding special cash compensation arrangements, 
including the names of individual members engaged in such arrangements, 
is unnecessary. Merrill Lynch and the SIA noted that the current rule 
provides that ``[n]o underwriter or associated person of an underwriter 
shall * * * pay * * * any * * * concession * * *'' which is not 
disclosed in the prospectus, whereas the proposed rule would be revised 
to state ``[n]o member shall accept any cash compensation from an 
offeror unless such compensation is described in a current 
prospectus.'' These commenters expressed the opinion that the proposed 
rule would inappropriately shift the burden of ensuring that such 
disclosure appears in the prospectus from underwriters to NASD member 
dealers, who are unable to write or control the disclosure contained in 
an investment company's prospectus. The SIA maintained, moreover, that 
the disclosure requirement would be inconsistent with the SEC's 
proposal on prospectus disclosure and confusing for members, if the 
NASD mandated additional disclosure at a time when the SEC is trying to 
streamline prospectus disclosure.
    In responding to the comments objecting to the proposed prospectus 
disclosure, NASD Regulation notes that the prospectus disclosure 
requirement in the proposed rule change is similar to the current 
prospectus disclosure requirement, but the proposed rule change applies 
only to cash compensation. Rule 2830 currently requires disclosure of 
all compensation, including non-cash compensation, paid or offered to 
be paid by an underwriter or its associated person in connection with 
the sale of investment company securities. By contrast, the proposed 
rule change governs the conduct of NASD members who accept payments in 
connection with investment company securities. Specifically, the 
proposed rule change prohibits NASD members from accepting any cash 
compensation from an offeror that is not described in the current 
prospectus of the investment company.
    As to the concern that the proposed rule change inappropriately 
shifts the burden for disclosure from offerors of funds to NASD member 
dealers, NASD Regulation points out that the proposed rule changes does 
not impose a specific prospectus disclosure requirement on the dealer-
member; rather, the rule prohibits the ``acceptance'' by a member of 
cash and special cash compensation unless disclosed in the prospectus. 
Finally, NASD Regulation has stated in the proposed rule change that it 
will reevaluate prospectus disclosure in light of the SEC's recent 
initiatives for a simplified prospectus.

F. Proposed Definitions

    The SIA suggested modifications to several of the proposal's 
definitions. Specifically, it maintained the ``affiliated member'' 
definition is too narrow and should be modified to include arrangements 
where member firms and fund groups are affiliated through ownership, 
but are not under common control. NASD Regulation believes expanding 
the definition of affiliated member would expand the universe of non-
members that could

[[Page 39618]]

sponsor a non-cash arrangement under sub-paragraphs (h)4)(D) of rule 
2820 and (1)(5)(D) of Rule 2830 to non-members that have only a 
business or investment interest, rather than a control interest, in a 
member. Subparagraphs (h)(4)(D) and (1)(5)(D), as explained in 
Amendment No. 4, were intended in part to give member firms and their 
parent insurance company or mutual fund control over the sponsorship 
and organization of a non-cash arrangement, and to limit that control 
to such relationships.
    The SIA also suggested modifications to the definition of service 
fee. It stated that service fees are payments for continuing investor 
services and, as such, should be excluded from the definition of ``cash 
compensation.'' NASD Regulation, in response, asserts that it 
understands that ``service fees'' may serve myriad purposes and has 
intentionally drafted a broad definition of ``cash compensation'' to 
address the various forms and ways in which such compensation may be 
paid.
    Noting that the definition of ``offeror'' would pick up any party 
that has a five percent ownership arrangement with an investment 
company, including an investor owning more than five percent of a fund, 
the SIA stated that the definition is overly broad and the term should 
be more narrowly defined. As explained by NASD Regulation, the 
definition of offeror was broadly drafted to address those entities 
that may function as offerors of cash or non-cash compensation in 
connection with the sale and distribution of investment company and 
variable contract securities. NASD Regulation believes that it is very 
unlikely that an investor could or would act in such capacity.
    Finally, one commenter, Bruce Avedon, requested that NASD 
Regulation expressly clarify its position that the definition of ``cash 
compensation,'' as amended in Rule 2820, does not include fees and 
reimbursement for reasonable travel expenses paid to directors of life 
insurance companies for attending board of directors' meetings. In 
response to this request for clarification, NASD Regulation notes that 
directors' fees are not paid pursuant to the sale and distribution of 
securities, and it therefore considers such fees to be outside the 
purview of the new rule.

G. Training and Education Exceptions

    The SIA requested specific clarification that an issuer that is an 
affiliate of a member firm could provide compensation for training and 
education programs under the provisions of (l)(5)(C) of Rule 2830, as 
well as under the provisions of (l)(5)(D). Proposed paragraph 
(l)(5)(C), as interpreted by NASD Regulation, would permit an issuer 
that is an affiliate of a member firm to provide payment or 
reimbursement for a training and education meeting held by the member, 
as long as the five conditions under (l)(5)(C) are satisfied. Proposed 
paragraph (l)(5)(D), as interpreted by NASD Regulation, does not 
address training and education meetings.
    Finally, the SIA requested clarification that condition (v) of 
provision (l)(5)(C), which specifies that payment or reimbursement by 
an offeror for a permissible training and education program cannot be 
preconditioned by the offeror on the achievement of a sales target, 
does not preclude payment by an offeror to a training or education 
program aimed at the member's top producers during a given time period, 
or payment by a fund to a training or education program aimed at the 
member's top producers.
    As explained in Amendment No. 4 to the proposal, condition (ii) of 
subparagraph (h)(4)(C) of Rule 2820 and (l)(5)(C) of Rule 2830 states 
that attendance by the member's associated persons at a training and 
education meeting must, among other things, not be preconditioned on 
the achievement of a sales target. In connection with this condition, 
NASD Regulation stated in the proposed rule and reiterated in response 
to comment letters, that the condition is not, however, intended to 
prevent a member from designating persons to attend a meeting 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, through the sales incentive program of a 
member's non-member affiliate, or through the achievement of a sales 
target.
    Consistent with this reasoning, as explained by NASD Regulation, 
condition (v) of Paragraph (l)(5)(C) would not prevent payment of 
reimbursement by an offeror for a training or education program aimed 
at the member's top producers during a given time period, or payment by 
a fund to a training or education program aimed at the member's top 
producers, so long as payment is not earned through a member's in-house 
sales incentive program, through the sales incentive program of a 
member's non-member affiliate, or preconditioned on achieving a sales 
target.

IV. Conclusion

    After carefully considering all comments received and the NASD's 
response to comments, the Commission has determined that the proposed 
rule change should be approved. The Commission believes that the 
amendment is responsive to commenters' concerns. Indeed, in its 
consideration of the views and opinions expressed by commenters and the 
NASD's response, the Commission is of the opinion that the NASD 
proposal, as amended, complies with the requirements of the statute. 
Although further steps could be taken, and the NASD is considering 
future action regarding cash compensation arrangements, the Commission 
believes that the measured steps taken in the proposal are consistent 
with the Act.
    While some commenters urged that NASD Regulation defer action on 
the proposal until it addresses the issue of cash compensation, the 
NASD has taken considerable steps over the past decade to address 
concerns raised by non-cash compensation arrangements, and, 
accordingly, the Commission believes it is appropriate for the NASD to 
address non-cash compensation arrangements at this time, while 
continuing to consider the most appropriate regulatory approach to cash 
compensation arrangements made in connection with mutual fund and 
variable contract sales.
    The Commission expects that future proposals by NASD Regulation to 
address the issue of cash compensation will be consistent with the 
prospectus disclosure principles that the Commission set forth in 
amended Form N-1A. These principles include a focus on information 
central to investment decisions and avoidance of detailed highly 
technical disclosure that discourages investors from reading the 
prospectus or obscures essential information about an investment in a 
fund.\12\ In the release adopting amendments to Form N-1A, the 
commission noted its believe that if its fund disclosure initiative are 
to have their intended effect, all parties involved in the disclosure 
process--funds, their legal counsels and other advisors, the Commission 
and its staff, and other regulators and their staff--should act 
consistently with the basic disclosure principles that serve as the 
cornerstone of the initiative.
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    \12\ See Investment Company Act Release No. 23064 (March 13, 
1998), 63 FR 13916 (March 23, 1998).
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    The Commission believes the proposed rule change is consistent with 
the provisions of Section 15A(b)(6) of the Act,\13\ which require in 
pertinent part that the Association adopt and amend its rules to 
promote just and

[[Page 39619]]

equitable principles of trade, prevent fraudulent and manipulative acts 
and practices, and generally provide for the protection of investors 
and the public interest. Specifically, the proposed rule change is 
designed to reduce point-of-sale impact of non-cash sales incentives 
that may compromise the duty of registered representatives to match the 
investment needs of customers with the most appropriate investment 
product. The Commission believes the proposal appropriately recognizes 
that the interest of those giving investment advice and those seeking 
investment advice can diverge where non-cash compensation exists as an 
incentive to sell specific investment products.
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    \13\ 15 U.S.C. 78o-3.
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    Accordingly, the proposed rule change is designed to limit 
compensation arrangements that may threaten the mutuality and harmony 
of interest between firms, their representatives, and the investing 
public. To that end, the proposal addresses direct and perceived 
conflicts of interest stemming from non-cash compensation arrangements, 
such as contests offering lavish trips and expensive prizes and gifts 
for the sale of investment company and variable contract securities. 
Investor confidence in the operation of the securities markets is in 
turn bolstered as a consequence of the removal of such conflicts of 
interest.
    The proposal facilitates, moreover, the ability of NASD members to 
execute compliance and supervisory responsibilities by restricting the 
potential for third-party non-cash incentives to undermine the 
supervisory control of an NASD member with respect to its associated 
persons. An NASD member is thus assisted in its efforts to create 
unbiased compensation plans that are arranged with the approval of, and 
administered and recorded by, the member firm. The Commission believes 
greater supervisory and compliance control of compensation structures 
of associated persons will enhance the ability of NASD members to 
implement policies and procedures to ensure that registered 
representative compensation structures align the interests of the firm, 
the registered representative, and the investor.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that File No. SR-NASD-97-35 be, and hereby is, approved.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 98-19567 Filed 7-22-98; 8:45 am]
BILLING CODE 8010-01-M