[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