[Federal Register Volume 68, Number 79 (Thursday, April 24, 2003)]
[Notices]
[Pages 20191-20195]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-10099]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47697; File No. SR-NASD-2003-68]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change by the National Association of 
Securities Dealers, Inc. To Amend Its Restrictions on Non-Cash 
Compensation in Connection With Corporate Financing and Direct 
Participation Programs

April 18, 2003.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'')\1\ and rule 19b-4 thereunder,\2\ notice is hereby given that 
on April 7, 2003, the National Association of Securities Dealers, Inc. 
(``NASD''), filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in items I, II, 
and III below, which items have been prepared by the NASD. The NASD has 
designated the proposed rule change as one that constitutes a stated 
policy, practice, or interpretation with respect to the meaning, 
administration, or enforcement of an existing rule pursuant to rule 
19b-4(f)(1) under the Act,\3\ which renders it effective upon receipt 
of the filing by the Commission. The Commission is publishing this 
notice to solicit comments on the proposed rule change from interested 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ 17 CFR 240.19b-4(f)(1).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The NASD is proposing a proposed rule change to codify in NASD 
rules 2710 (Corporate Financing rule) and 2810 (Direct Participation 
Programs or ``DPP'' rule) its stated policies, practices, and 
interpretations regarding members' receipt of non-cash compensation in 
connection with the sale and distribution of securities. The express 
prohibitions on the receipt of non-cash compensation currently in the 
Corporate Financing rule and the DPP rule generally limit the receipt 
of such items to $100 per person annually and do not include certain 
detailed exceptions under NASD rules 2820 (Variable Contracts rule) and 
2830 (Investment Company rule) for members selling mutual fund shares 
and variable annuities. The proposed rule change would codify 
exceptions in the Variable Contracts and Investment Company rules for 
members selling debt, equity,

[[Page 20192]]

DPP, and real estate investment trust (``REIT'') securities--while 
maintaining the current non-cash compensation prohibitions on the 
receipt of gifts with more than a de minimus value, payments and 
reimbursements preconditioned on the achievement of a sales target, and 
payments and reimbursements for travel and meetings that are not bona 
fide due diligence meetings or training and education meetings. In 
addition, the proposed rule change will codify the NASD's policy and 
practice of applying Interpretive Material issued by NASD staff 
relating to the non-cash compensation provisions uniformly and 
consistently to the Corporate Financing rule, the DPP rule, the 
Investment Company rule, and the Variable Contracts rule. Below is the 
text of the proposed rule change. Proposed new language is in italics; 
proposed deletions are in brackets.
* * * * *
    2710.Corporate Financing Rule--Underwriting Terms and Arrangements
    (a)-(b) No Change
    (c) Underwriting Compensation and Arrangements
    (1)-(5) No Change
    (6) Unreasonable Terms and Arrangements
    (A) No Change
    (B) Without limiting the foregoing, the following terms and 
arrangements, when proposed in connection with the distribution of a 
public offering of securities, shall be unfair and unreasonable:
    (i)-(xii) No Change
    (xiii) [for a member or person associated with a member to accept, 
directly or indirectly, any non-cash sales incentive item including, 
but not limited to, travel bonuses, prizes and awards, from an issuer 
or an affiliate thereof in excess of $100 per person per issuer 
annually. Notwithstanding the foregoing, a member may provide non-cash 
sales incentive items to its associated persons provided that no 
issuer, or an affiliate thereof, including specifically an affiliate of 
the member, directly or indirectly participates in or contributes to 
providing such non-cash sales incentive; or].
    (xiv)-(xv) Renumbered (xiii)-(xiv).
    (7)-(8) No Change
    (d) Non-Cash Compensation
    (1) Definitions
    The terms ``compensation,'' ``non-cash compensation'' and 
``offeror'' as used in this Section (d) of this Rule shall have the 
following meanings:
    (A) ``Compensation'' shall mean cash compensation and non-cash 
compensation.
    (B) ``Non-cash compensation'' shall mean any form of compensation 
received in connection with the sale and distribution of securities 
that is not cash compensation, including but not limited to 
merchandise, gifts and prizes, travel expenses, meals and lodging.
    (C) ``Offeror'' shall mean an issuer, an adviser to an issuer, an 
underwriter and any affiliated person of such entities.
    (2) Restrictions on Non-Cash Compensation
    In connection with the sale and distribution of a public offering 
of securities, no member or person associated with a member shall 
directly or indirectly accept or make payments or offers of payments of 
any non-cash compensation, except as provided in this provision. Non-
cash compensation arrangements are limited to the following:
    (A) Gifts that do not exceed an annual amount per person fixed 
periodically by the Board of Governors \1\ and are not preconditioned 
on achievement of a sales target.
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    \1\ The current annual amount fixed by the Board of Governors is 
$100.
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    (B) An occasional meal, a ticket to a sporting event or the 
theater, or comparable entertainment 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) associated persons obtain the member's prior approval to attend 
the meeting and attendance by a member's associated persons is not 
conditioned by the member on the achievement of a sales target or any 
other incentives pursuant to a non-cash compensation arrangement 
permitted by subparagraph (d)(2)(D);
    (ii) the location is appropriate to the purpose of the meeting, 
which shall mean an office of the issuer or affiliate thereof, the 
office of the member, or a facility located in the vicinity of such 
office, or a regional location with respect to regional meetings;
    (iii) the payment or reimbursement is not applied to the expenses 
of guests of the associated person; and
    (iv) the payment or reimbursement by the issuer or affiliate of the 
issuer is not conditioned by the issuer or an affiliate of the issuer 
on the achievement of a sales target or any other non-cash compensation 
arrangement permitted by subparagraph (d)(2)(D).
    (D) Non-cash compensation arrangements between a member and its 
associated persons or a company that controls a member company and the 
member's associated persons, provided that 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
    (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 
subparagraph (d)(2)(D).
    A member shall maintain records of all non-cash compensation 
received by the member or its associated persons in arrangements 
permitted by subparagraphs (d)(2)(C)-(E). The records shall include: 
The names of the offerors, non-members or other members making the non-
cash compensation contributions; the names of the associated persons 
participating in the arrangements; the nature and value of non-cash 
compensation received; the location of training and education meetings; 
and any other information that proves compliance by the member and its 
associated persons with subparagraph (d)(2)(C)-(E).
    (d) Renumbered as (e).
* * * * *
    2810. Direct Participation Programs
    (a) No Change
    (b) Requirements
    (1)-(3) No Change
    (4) Organization and Offering Expenses
    (A)-(D) No Change
    (E) [No member or person associated with a member shall directly or 
indirectly accept any non-cash compensation or sales incentive item 
including, but not limited to, travel bonuses, prizes, and awards 
offered or provided to such member or its associated persons by any 
sponsor, affiliate of a sponsor or program. Notwithstanding the 
foregoing, a member may provide non-cash compensation or sales 
incentive items to its associated persons provided that no sponsor, 
affiliate of a sponsor or program, including specifically an affiliate 
of the member, directly or indirectly participates in or contributes to 
providing such non-cash compensation. Further, this subparagraph shall 
not prohibit a person associated with a member from accepting any non-
cash sales incentive item offered directly to that person by a sponsor, 
affiliate of a sponsor or program where:
    (i) the aggregate value of all such items paid by any sponsor or 
affiliate of

[[Page 20193]]

a sponsor to each associated person during any year does not exceed 
$100.00;
    (ii) the value of all such items to be made available in connection 
with an offering is included as compensation to be received in 
connection with the offering for purposes of subparagraph (B); and
    (iii) the proposed payment or transfer of all such items is 
disclosed in the prospectus or similar offering document,]
    (F) Renumbered to (E).
    (5)-(6) No Change
    (c) Non-Cash Compensation
    (1) Definitions
    The terms ``compensation,'' ``non-cash compensation'' and 
``offeror'' as used in this section (c) of this rule shall have the 
following meanings:
    (A) ``Compensation'' shall mean cash compensation and non-cash 
compensation.
    (B) ``Non-cash compensation'' shall mean any form of compensation 
received in connection with the sale and distribution of direct 
participation securities that is not cash compensation, including but 
not limited to merchandise, gifts and prizes, travel expenses, meals 
and lodging.
    (C) ``Offeror'' shall mean an issuer, sponsor, an adviser to an 
issuer or sponsor, an underwriter and any affiliated person of such 
entities.
    (2) Restriction on Non-Cash Compensation
    In connection with the sale and distribution of direct 
participation securities, no member or person associated with a member 
shall directly or indirectly accept or make payments or offers of 
payments of any non-cash compensation, except as provided in this 
provision. Non-cash compensation arrangements are limited to the 
following:
    (A) Gifts that do not exceed an annual amount per person fixed 
periodically by the Board of Governors \1\ and are not conditioned on 
achievement of a sales target.
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    \1\ The current annual amount fixed by the Board of Governors is 
$100.
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    (B) An occasional meal, a ticket to a sporting event or the 
theater, or comparable entertainment 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) associated persons obtain the member's prior approval to attend 
the meeting and attendance by a member's associated persons is not 
conditioned by the member on the achievement of a sales target or any 
other incentives pursuant to a non-cash compensation arrangement 
permitted by subparagraph (c)(2)(D);
    (ii) 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;
    (iii) the payment or reimbursement is not applied to the expenses 
of guests of the associated person; and
    (iv) the payment or reimbursement by the offeror is not conditioned 
by the offeror on the achievement of a sales target or any other non-
cash compensation arrangement permitted by subparagraph (c)(2)(D).
    (D) Non-cash compensation arrangements between a member and its 
associated persons or a company that controls a member company and the 
member's associated persons, provided that 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
    (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 
subparagraph (c)(2)(D).
    A member shall maintain records of all non-cash compensation 
received by the member or its associated persons in arrangements 
permitted by subparagraphs (c)(2)(C)-(E). The records shall include: 
the names of the offerors, non-members or other members making the non-
cash compensation contributions; the names of the associated persons 
participating in the arrangements; the nature and value of non-cash 
compensation received; the location of training and education meetings; 
and any other information that proves compliance by the member and its 
associated persons with subparagraph (c)(2)(C)-(E).
    (c) Renumbered as (d).
* * * * *

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

1. Purpose
    The NASD is proposing to codify a stated policy, practice, and 
interpretation that the more detailed non-cash compensation provisions 
in the Variable Contracts rule and Investment Company rule apply to the 
sale and distribution of public offerings of securities and direct 
participation securities as governed by the Corporate Financing rule 
and DPP rule, respectively. The NASD is proposing to conform the 
language in the Corporate Financing rule and the DPP rule to be 
consistent with the more detailed language contained in the Variable 
Contracts rule and the Investment Company rule. NASD staff has 
consistently applied the more detailed provisions in Variable Contracts 
rule and the Investment Company rule to the sale and distribution of 
public offerings of securities and DPP securities.
    Since 1994, the Commission, the NASD, and the securities industry 
have raised concerns about actual and potential conflicts of interest 
in the retail brokerage business created by a broad range of 
compensation practices whereby program sponsors or issuers provide 
incentives or rewards to individual broker-dealers and their registered 
representatives for selling the issuer's products. NASD staff believes 
that the use of non-cash compensation can create significant point-of-
sale incentives that may compromise suitability determinations and 
heighten the potential for loss of supervisory control over sales 
practices. In addition, NASD staff believes that the use of non-cash 
compensation incentives may result in the loss of investor confidence 
by increasing the perception of inappropriate practices.
    Responding to these concerns, the NASD in January 1999 amended the 
Variable Contracts rule and the Investment Company rule to establish 
comprehensive restrictions on the use of non-cash compensation in 
connection with the sale and distribution of investment company 
securities and

[[Page 20194]]

variable contracts.\4\ These amendments generally limited the manner in 
which members can pay for or accept non-cash compensation and detail 
the types of non-cash compensation that are permissible. The amendments 
also provided limited exceptions to the non-cash compensation 
restrictions for payments or reimbursements that are in connection with 
training and education meetings. The 1999 amendments also defined 
certain key terms, such as ``compensation'' and ``non-cash 
compensation.''
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    \4\ See Securities Exchange Act Release No. 40214 (July 15, 
1998), 63 FR 39614 (July 23, 1998) (SR-NASD-97-35).
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    Current provisions of the Corporate Financing rule and the DPP rule 
limit the receipt of non-cash compensation by member firms and 
associated persons in connection with the sale and distribution of DPP 
securities, REIT programs, and corporate debt and equity offerings. 
These types of non-cash compensation, adopted in 1988, are not as 
comprehensive as the restrictions that were later adopted in the 
Variable Contracts rule and the Investment Company rule in 1999.
    Generally, consistent with the current non-cash compensation 
requirements in NASD rules 2820 and 2830, the proposed rule change will 
conform the text of NASD rules 2710 and 2810 to rules 2820 and 2830: 
(1) Adopt definitions of the terms ``compensation,'' ``non-cash 
compensation,'' and ``offeror;'' (2) provide express exceptions from 
the non-cash compensation limitations for bona fide training and 
education meetings; and (3) prohibit, with certain exceptions, members 
or persons associated with members from directly or indirectly 
accepting or paying any non-cash compensation in connection with public 
offerings of debt or equity securities or transactions in direct 
participation programs.
    Consistent with NASD rules 2820 and 2830, the proposed rule change 
will provide express exceptions from the non-cash compensation 
provisions that 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 or reimbursement for 
training and education meetings held by broker-dealers or issuers/
sponsors for the purpose of educating associated persons of broker-
dealers, so long as certain conditions are met; (4) in-house sales 
incentive programs of broker-dealers for their own associated persons; 
and (5) contributions by any non-member company or other member to a 
broker-dealer's permissible in-house sales incentive program, provided 
there is compliance with certain criteria.
    NASD staff has consistently been concerned about the use of sales 
incentives in connection with the sale of any type of securities to a 
member's customers, including transactions in DPP securities, REIT 
programs, and corporate debt and equity offerings. For example, these 
incentive programs may offer registered representatives exotic trips or 
expensive merchandise if they sell a specific dealer's product. The 
NASD believes that the potential conflicts of interest that arise from 
the receipt of non-cash compensation in connection with the sale of 
variable products and mutual fund securities also exist in connection 
with the sale of these types of securities.
    Since January 1999, through interpretive advice, responses to 
exemptive requests, and in the course of the filing review process 
under the DPP and Corporate Financing rules, NASD staff has 
consistently applied the non-cash compensation prohibitions in NASD 
rules 2820 and 2830 to sales of variable annuities, mutual funds, DPP 
securities, REIT programs, and corporate debt and equity offerings. 
Accordingly, although training and education meetings are not 
specifically permitted under the DPP and Corporate Financing rule, the 
NASD has recognized that bona fide training and education meetings that 
meet the strict requirements set out in the Variable Contracts rule and 
Investment Company rule can be held consistent with the non-cash 
compensation prohibitions.
    DPP Rule. Paragraph (b)(4)(E) of the DPP rule currently prohibits a 
member or associated person from accepting, directly or indirectly, 
non-cash compensation or sales incentive items from any sponsor or 
affiliate of a sponsor, unless the following requirements are 
satisfied: (1) The aggregate value of all such items received annually 
does not exceed $100; (2) the value of all such items is included as 
compensation received in connection with the offering; and (3) the 
proposed payment of such items is disclosed in the prospectus.
    The DPP rule currently does not contain an exception for training 
and education meetings. Through interpretive advice, the NASD has 
approved members' receipt of non-cash compensation in connection with 
bona fide training and education meetings. The NASD considers such a 
meeting to be one that educates registered representatives and assists 
them in making a suitability determination regarding a DPP product for 
their customers and that is otherwise in compliance with the training 
and education provisions of NASD rules 2820 and 2830. In Notice to 
Members 85-29 (April 1985), the NASD announced that reimbursement for 
training and education meetings is permitted under the DPP rule if the 
expenses are recognized as underwriting compensation, disclosed in the 
prospectus, and come within the 10% limit on underwriting compensation 
permitted under the rule. NASD staff has consistently applied the 10% 
compensation limit and training and education policies in the DPP rule 
set forth in Notice to Members 85-29 to REIT offerings that are filed 
with the Corporate Financing Department under the Corporate Financing 
rule.
    Corporate Financing Rule. Although the rule language of the non-
cash compensation provision in the Corporate Financing rule is 
different from the language of the non-cash compensation provision in 
the DPP rule, paragraph (c)(6)(B)(xiii) of the Corporate Financing rule 
currently contains a provision that prohibits a member or associated 
person from accepting, directly or indirectly, non-cash compensation or 
sales incentive items in excess of $100 per person per issuer annually 
from any issuer or affiliate thereof. The rule does not contain an 
exception for training and education meetings.
    Training and Education Meetings. Currently, both the Variable 
Contracts rule and the Investment Company rule contain an express 
exception to the non-cash compensation provisions for training and 
education meetings that the industry believes are necessary to educate 
representatives about their products. The rules, however, contain 
conditions that must be satisfied before the exception can be used. 
Specifically, they require prior approval of attendance by the 
associated person from his or her member firm, satisfaction of the 
recordkeeping requirements, that attendance at the meeting not be 
preconditioned on the achievement of a sales target, that the location 
of the meeting be an office of the offeror or facility in the vicinity 
of the office, and that no reimbursement be provided for expenses of a 
guest.
    Since the adoption of these provisions, the NASD has issued strict 
guidelines on the appropriate use of the training and education 
exception through Regulatory & Compliance Alerts, interpretive letters, 
and other correspondence with members. This guidance has stated that a 
sponsor is not permitted to pay for certain expenses in

[[Page 20195]]

connection with a training and education meeting, including, but not 
limited to, golf outings, cruises, tours, and other entertainment. The 
NASD believes that amending the non-cash compensation provisions of the 
DPP and Corporate Financing rules will codify stated policy, practice, 
and interpretive advice and make these rules generally consistent with 
those governing variable annuities and mutual funds. The NASD believes, 
in addition, that these amendments will allow this body of interpretive 
guidance to be applied consistently with respect to training and 
education meetings relating to any of the relevant products.
2. Statutory Basis
    The NASD believes that the proposed rule change is consistent with 
the provisions of section 15A(b)(6) of the Act,\5\ which requires, 
among other things, that the NASD's rules must be designed to prevent 
fraudulent and manipulative acts and practices; to promote just and 
equitable principles of trade; and, in general, to protect investors 
and the public interest. The NASD believes the proposed rule change 
will make the non-cash compensation provisions of the Corporate 
Financing rule and the DPP rule comparable to the more detailed non-
cash compensation provisions that are currently in the Variable 
Contracts rule and the Investment Company rule. The proposed rule 
change also will provide expressly that NASD Interpretive Materials 
will apply to all four rules.
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    \5\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    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.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    The NASD has represented that the proposed rule change is effective 
upon filing pursuant to section 19(b)(3)(A)(ii) of the Act \6\ and rule 
19b-4(f)(1) thereunder,\7\ in that it constitutes a stated policy, 
practice, or interpretation with respect to the meaning, 
administration, or enforcement of an existing rule.
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    \6\ 15 U.S.C. S78s(b)(3)(A)(ii).
    \7\ 17 CFR S240.19b-4(f)(1).
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    At any time within 60 days of this filing, the Commission may 
summarily abrogate this proposal 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, including whether the proposed rule 
change is consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. 
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 File No. SR-NASD-2003-68 and 
should be submitted by May 15, 2003.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\8\
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    \8\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-10099 Filed 4-23-03; 8:45 am]
BILLING CODE 8010-01-P