Wednesday, January 25, 2006
The NASD has put forward new "interpretive material" (here) (called IM, but not to be confused with what my teenage daughter does ad nauseam) to its Rule 3060, entitled "Influencing or Rewarding Employees of Others." The new approach comes in response to revelations that brokerage firms have been lavishing benefits on traders at mutual funds, including Fidelity, in the form of "business entertainment" to win their firms' business and avoid the rules restricting gifts. In one particularly wholesome example, brokers paid for the bachelor party of a Fidelity trader in Miami that included hiring a dwarf for tossing purposes (see earlier post here) that is the subject of an SEC and U.S. Attorney's Office investigation. The IM first gives a definition of "business entertainment" to distinguish it from the more restrictive rules on gifts, which cannot exceed $100 in value:
[A]ny social event, hospitality event, charitable event, sporting event, entertainment event, meal, leisure activity or event of like nature or purpose, as well as any transportation and/or lodging accompanying or related to such activity or event, including such business entertainment offered in connection with an educational event or business conference, in which a person associated with a member accompanies and participates with such employee irrespective of whether any business is conducted during, or is considered attendant to, such event." This definition codifies NASD’s longstanding position that a member must accompany or participate in an event for it to be deemed business entertainment. Thus, for example, if a member gives tickets to a sporting event but does not accompany the recipient to the event, the tickets are deemed to be a gift rather than business entertainment. In addition, the definition of "business entertainment" expressly includes transportation and lodging expenses provided by a member.
The idea of defining "business entertainment" is to tighten up on what is permissible and not just a gift in disguise. From there, though, the NASD then puts the burden on the brokers to come up with their own policies about what is and is not acceptable. The IM adopts a general approach that business entertainment should not go, in effect, too far, but does little to create any kind of bright line. According to the proposed IM:
The overriding principle of the proposed IM is that a member or its associated persons should not do or give anything of value to an employee of a customer that is intended or designed to cause, or otherwise would be reasonably judged to have the likely effect of causing, such employee to act in a manner that is inconsistent with the best interests of the customer. The proposed IM provides guidance concerning the written policies and procedures that members must adopt surrounding their business entertainment practices. First, the member must determine and define the forms of business entertainment that are appropriate and inappropriate, including appropriate venues, nature, frequency, types and class of accommodation and transportation, and either firm dollar limits or thresholds requiring advance written approval. Notably, the proposed IM does not impose hard limits, nor does it require that all members adopt the same limits or even treat all recipients equally. At the same time, however, a member’s policies and procedures must not be so unbounded or vague that no reasonable determination of propriety can be discerned. In addition, the proposed IM expressly would allow members to set different standards for business entertainment in connection with events that are educational, charitable or philanthropic in nature.
Different standards means that each firm will be accountable -- or not -- for what it is willing to permit in this area. Will some firms write standards that leave enough wiggle room to avoid ever being in violation of the rule except in the most egregious cases? Policing the brokers may not be the best approach if mutual funds can hide the true costs of their trading through minimal, and untimely, disclosure. The better approach may be to enhance the disclosure of trading costs, and the firms that are used to execute transactions (including the amount paid to each), so that all can see how much is being paid. Would the industry accept that level of transparency? Perhaps not, but adopting a "standard" that allows firms to set different standards may not do much to curb excessive business entertainment. (ph)