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94-67 NASD Solicits Member Comment On Cash And Non-Cash Compensation For Selling Investment Company And Variable Contract Securities;

Comment Period Expires October 3, 1994

SUGGESTED ROUTING

Senior Management
Corporate Finance
Institutional
Legal & Compliance
Mutual Fund

Executive Summary

The NASD requests member comment on proposed amendments to Article III, Sections 26 and 29 of the Rules of Fair Practice that would revise existing rules applicable to the sale of investment company securities and establish new rules applicable to the sale of variable contract securities. In connection with the sale of investment company and variable contract securities, the proposed amendments would: (1) prohibit, with certain exceptions, members and associated persons from accepting any non-cash compensation from an investment or insurance company or another member; (2) prohibit associated persons from receiving any compensation from anyone other than the member with which the person is associated, unless permitted by the rule; (3) prohibit receipt by a member of cash compensation from the offerer unless such arrangement is described in the current prospectus; and (4) require that members maintain records of compensation received from offerers. The amendments also would retain the prohibition, in connection with the sale of investment company securities, against a member receiving compensation in the form of securities from an offerer.

The exceptions from the non-cash compensation prohibition would permit: (1) in-house sales incentive programs for a broker/dealer's associated persons; (2) sales incentive programs of mutual funds and insurance companies for the associated persons of a broker/dealer subsidiary; (3) payment or reimbursement for training and education meetings held by a broker/dealer or a mutual fund or insurance company for associated persons of broker/dealers; (4) gifts of up to $ 100 per associated person annually; and (5) an occasional meal, ticket to a sporting event or theater, or entertainment for associated persons and their guests. The text of the proposed amendments and an addendum containing background information on the proposals follows this Notice.

Background

The NASD is requesting comment on proposed amendments to Article III, Sections 26 and 29 of the Rules of Fair Practice that would, among other things, prohibit the receipt of non-cash items of compensation (with certain exceptions) in connection with the sale of investment company and variable contract securities. The current requirements of Subsection 26(1) regulate the disclosure and form of dealer concessions between underwriters and retail dealers of investment company securities (Investment Company Rule). These provisions prohibit dealer concessions in the form of securities, and the payment of concessions directly to associated persons of a member. The provisions also set forth requirements regarding the disclosure of compensation arrangements between underwriters and dealers in the investment company's prospectus.1 In comparison, Article III, Section 29 currently does not contain similar regulations for sales of variable contract securities (Variable Contracts Rule). Thus, the proposed amendments to the Investment Company Rule would modify current requirements and the amendments to the Variable Contracts Rule would establish new requirements that address compensation arrangements between an investment or insurance company and any member participating in the distribution of the company's securities.

The Investment Companies and Insurance Affiliated Member Committees of the NASD have each considered the current environment in which investment company and variable contract securities are sold. The Committees did not find that the manner in which non-cash compensation is offered and paid to members and their associated persons indicates a level of supervisory and compliance problems similar to those present in the sale of direct participation program securities (DPPs) which led the NASD to prohibit non-cash compensation in the sale of such securities in 1988.2 The Committees believe, however, that the increased use of non-cash compensation for the sale of investment company securities heightens the potential for loss of supervisory control over sales practices and increases the possibility for the perception of impropriety, which may result in a loss of investor confidence. The Committees determined, therefore, that limiting non-cash compensation for the sale of investment company securities is appropriate at this time.

Description Of Proposed Amendments

DEFINITIONS

Associated Person of an Underwriter—The definition of the term "associated person of an underwriter" is proposed to be deleted from Subsection (b)(7) to the Investment Company Rule and is incorporated in the proposed new term "offeror," as discussed more fully below. The term encompasses the issuer, the underwriter, the investment adviser to the issuer, and any affiliated person of such entities.

Offeror—The NASD is proposing to define the term "offeror" in the Investment Company Rule to include an investment company, an adviser to an investment company, an underwriter, and any affiliated person of such entities. The term would be defined in the Variable Contracts Rule to include a separate account of an insurance company, an adviser to a separate account of an insurance company, an underwriter, and any affiliated person of such entities. The enumerated entities included in the definition of "offeror" were previously included in the definition of "associated person of an underwriter." The term "affiliated person" is defined in accordance with Section 2(a)(3) of the Investment Company Act of 1940 (1940 Act). The term "underwriter" is defined in Section 2(a)(40) of the 1940 Act and is intended to reference the principal underwriter through which the investment company and insurance company distribute securities to participating dealers for sale to the investor.

Cash Compensation—This term encompasses cash compensation arrangements covered under the current provisions of the Investment Company Rule. The proposed amendments to the Investment Company Rule are intended to be applicable only to those compensation arrangements for the sale of investment company securities that are covered under the current provisions of the Investment Company Rule. The Variable Contracts Rule amendments are proposed to have a similar scope for the sale of variable contract securities.

Non-Cash Compensation—This term encompasses any form of non-cash compensation received by a member or persons associated with a member in connection with the sale and distribution of investment company and variable contract securities, including, but not limited to, merchandise, gifts and prizes, and payment of travel expenses, meals, and lodging. Thus, the definition of "non-cash compensation" encompasses payments of cash to reimburse costs for travel, meals, and lodging incurred by a member or an associated person.

REGULATING CASH AND NON-CASH COMPENSATION

The NASD is proposing to adopt as Section (1) of the Investment Company Rule and Section (h) of the Variable Contracts Rule new provisions governing the receipt of cash and non-cash compensation by members and associated persons. The proposed amendments would apply to both variable annuity and variable life products under the Variable Contracts Rule. As to the Investment Company Rule, the proposed amendments would apply to securities sales of an investment company registered under the 1940 Act. Thus, the proposed rules would apply to securities sales by a face-amount certificate company, a unit investment trust, and open- and closed-end management companies. Closed-end management companies are also regulated under Article III, Section 44 of the Rules of Fair Practice, and the receipt of non-cash compensation is prohibited under Subsection (c)(6)(ix) of that rule.3

The preamble to the new provisions provides that such compensation must be received "in connection with the sale and distribution" of investment company or variable contract securities, as applicable. The NASD is aware that members and their associated persons receive compensation for the sale of non-securities products from insurance companies and receive other forms of payments from investment and insurance companies that are not for sales and distribution activities. The preamble is intended to clarify that the provisions only relate to cash and non-cash compensation received in connection with the sale and distribution of the security covered by the rule.

Limitation on Receipt of Compensation by Associated Persons—The NASD is proposing in new Subsection (1)(1) of the Investment Company Rule and new Subsection (h)(1) of the Variable Contracts Rule to prohibit an associated person from accepting any compensation from any person other than the member with which the person is associated, except as permitted elsewhere in the proposed rule.

Ministerial Exception to Limitation on Receipt of Compensation by Associated Persons—The second proposed sentence of new Subsection (1)(1) of the Investment Company Rule and new Subsection (h)(1) of the Variable Contracts Rule clarifies that the prohibition on receipt of compensation by an associated person from any person other than the member with which the person is associated does not prohibit arrangements, agreed to by a member, where an investment or insurance company maintains a commission account as a ministerial service for a member and pays commission checks from the account directly to the member's associated persons. This exception is intended to recognize current practice in the insurance industry, and reflects the view of the Securities and Exchange Commission (SEC) in Securities Exchange Act Rel. No. 34-8389 (August 29, 1968) (Release 8389) that under certain circumstances such commission payments to associated persons may be made by a life insurance company acting for a subsidiary broker/dealer.4 The NASD is proposing that the same exception recognize other SEC no-action letters that permit an insurance company to establish a commission account as a ministerial service to make payments of commission overrides for sales of insurance and investment company securities products.5

NASD staff also recognizes that the SEC has issued a number of no-action letters permitting, inter alia, associated persons to receive compensation for the sale of variable contract products from a licensed corporate insurance agent acting for one or more insurance companies.6 The NASD believes it would be appropriate to permit reliance on the NASD's ministerial exception, so long as there is a legitimate state law impediment that prevents an insurance company or its licensed corporate insurance agent from making payments of compensation for the sale of variable contract products directly to the broker/dealer entity and the arrangement otherwise complies with the terms of an appropriate SEC no-action letter.7 To the extent that an arrangement proposed by a member to rely on the ministerial exception does not appear to come within the parameters of Release 8389 or an applicable no-action letter previously issued by the SEC, the NASD recommends that members request a no-action position from the staff of the Division of Market Regulation of the SEC.

The NASD requests comment on whether (1) there are other situations, not discussed above, where the SEC has issued interpretive or no-action positions on payments of commissions directly to associated persons, and (2) the language of the ministerial exception appropriately encompasses the situations discussed above and any other situations where commissions may be paid directly to associated persons pursuant to SEC interpretive or non-action positions.

Securities As Compensation—The NASD will retain the provision currently in Subsection (1)(1)(A) that prohibits members and their associated persons from receiving compensation in the form of securities of any kind. The NASD proposes that this provision be renumbered as new Subsection (1) (2) of the Investment Company Rule.

Recordkeeping Requirement—The NASD is proposing to adopt as new Subsection (1)(3) of the Investment Company Rule and Subsection (h)(2) of the Variable Contracts Rule the general requirement that members must maintain records of all compensation, cash and non-cash, received from offerers. The records are required to include the names of the offerers, the names of the associated persons, and the amount of cash and/or the nature of non-cash compensation received. Two exceptions are provided to the recordkeeping requirement, as described in Subsection (1)(5)(a) and (b) of the Investment Company Rule and Subsection (h)(5)(a) and (b) of the Variable Contracts Rule. These arrangements are discussed below as they are also exceptions to the prohibition on non-cash compensation.

Prospectus Disclosure of Cash Compensation—Newly numbered Subsection (1)(4) in the Investment Company Rule preserves the requirement currently in Subsection (1)(1)(C) prohibiting acceptance of compensation by a member from an offerer unless such compensation is disclosed in the prospectus. In the case where special cash compensation arrangements are made available by an offerer to a member, but are not available on the same terms to all members to distribute the securities, the disclosure shall include the name of the recipient member and the details of the special arrangements. The provision has been modified to reference only "cash compensation" because non-cash compensation is proposed to be prohibited in a manner that would not require disclosure of any such non-cash compensation.

Exceptions From Prospectus Disclosure Requirement—The NASD is proposing an additional exception from the prospectus disclosure requirement in proposed Subsection (1)(4) in the Investment Company Rule and proposed Subsection (h)(3) in the Variable Contracts Rule. The first two exceptions in paragraphs (a) and (b) incorporate current Subsections (1)(4)(A) and (B) of the Investment Company Rule, with minor language changes for clarification. These two provisions provide an exception from disclosure for compensation arrangements between: (1) principal underwriters of the same security; and (2) the principal underwriter of a security and the sponsor of a unit investment trust that utilizes such security as its underlying investment. By their terms, these provisions describe arrangements that would not trigger the proposed recordkeeping requirements.

The additional exception being proposed is contained in paragraph (c), and excepts from the prospectus disclosure requirement compensation arrangements between a non-member company and its sales personnel who are registered representatives of an NASD member that directly or indirectly controls, is controlled by, or is under common control with, the non-member company. The purpose of this exception is to permit an investment or insurance company to provide cash compensation to the employees of an NASD member firm with which it has a control relationship without the need to disclose such arrangements. Regardless of the exception, however, the member is required to comply with the record-keeping requirements of the proposed rule for compensation received from a non-member company. As the prospectus disclosure provision is only related to compensation received by a member from an offeror, it is not necessary to provide an exception for the in-house compensation paid by a member to its own associated persons.

Prohibition on Non-Cash Compensation—The NASD is proposing to adopt as new Subsection (1)(5) to the Investment Company Rule and Subsection (h)(4) to the Variable Contracts Rule a prohibition on non-cash compensation. The new provision prohibits a member or an associated person from directly or indirectly accepting any non-cash compensation offered or provided to such member or its associated persons unless such non-cash compensation is permitted under another provision.

Exceptions From Non-Cash Compensation, Recordkeeping, and Direct Payment Prohibitions for Gifts and Entertainment—Proposed Subsection (1)(5) to the Investment Company Rule and Subsection (h)(4) to the Variable Contracts Rule include two exceptions for gifts and entertainment, which may be paid directly to an associated person and, as non-cash items, do not have to be disclosed in the prospectus. Additionally, these two forms of non-cash compensation are specifically excepted from the recordkeeping requirement of the proposed rule.

Proposed Subsections (1)(5)(a) and (b) to the Investment Company Rule and Subsections (h)(4)(a) and (b) of the Variable Contracts Rule provide that, so long as such compensation is not provided as a precondition or an incentive to sell, the following items are excepted from the prospectus disclosure requirement and an associated person may accept them from a person other than the member-employer: (1) gifts that do not exceed an annual amount per person fixed periodically by the Board of Governors, which is currently $100 per person; and (2) an occasional meal, a ticket to a sporting event or the theater, or comparable entertainment for persons associated with a member and, if appropriate, their guests, which is neither so frequent nor so extensive as to raise any question of impropriety. The latter exception has been revised from the current language to reflect that entertainment for associated persons will usually include a spouse or guest of the person and that payment for a guest is permissible.

The current requirement that such entertainment "not be conditioned on sales of shares of investment companies" and that gifts of up to $ 100 be "unconditional" was replaced by the requirement that the entertainment or gift "not be provided or offered as an incentive to sell." The revised language is intended to clarify that such gifts and entertainment are permitted to be provided as rewards, for example, for past sales, but shall not be part of an incentive program or plan which requires that the recipient reach a specific sales goal to receive the entertainment or gift. It is believed that the revised language permits the continuation of normal business practices, while preventing an investment or insurance company from providing the gift or entertainment as part of a non-cash sales incentive program.

Exception From Non-Cash Compensation Prohibition For Training And Education Meetings— The NASD is proposing an exception for training and education meetings to the prohibition on non-cash compensation as Subsection (1)(5)(c) of the Investment Company Rule and Subsection (h)(4)(c) of the Variable Contracts Rule. The proposed exception would, under certain circumstances, permit payment or reimbursement by offerers for meetings held by the offeror or by a member for the purpose of training or educating associated persons. This provision is intended to continue to permit members and offerers to hold training and education meetings for associated persons. In the case of a meeting held by a member, it is not unusual for offerers to reimburse certain of the member's expenses related to the meeting in exchange for the opportunity to discuss with the member's associated persons a particular training or education topic. In the case of a meeting held by an offeror, the offeror provides an opportunity for associated persons of many members to attend a training and education meeting, so long as attendance is determined by the member firm.

Since the proposed prospectus disclosure provision only requires disclosure of cash compensation, the proposed exception would not trigger the disclosure requirements as payment or reimbursement of expenses by an offeror for a member's training and education meeting is considered to be non-cash compensation. The proposed exception would, however, be subject to the prohibition on an associated person accepting any compensation from anyone other than his or her member-employer.

The limitations imposed on the exception are intended to ensure that the meeting is for the purpose of training and education and is not, in fact, a prohibited non-cash sales incentive trip or entertainment. The payment or reimbursement by offer-ors for such meetings would be subject to the recordkeeping requirement in order that information on such payments and reimbursements is in the records of the member and, therefore, subject to examination by the NASD. To avoid supervisory problems, associated persons would also be required to obtain the member's prior approval to attend the meeting.

Such prior approval would satisfy the prohibition on associated persons accepting any compensation from anyone other than their member-employer. Members should establish a procedure so that their records reflect that appropriate approval has been provided to associated persons in connection with such meetings for review by the NASD.

The location of the meeting must be appropriate to its purpose. A showing of appropriate purpose is demonstrated where the location is the office of the offeror or the member, or a facility located in the vicinity of such office. To address meetings where the attendees are from a number of offices in a region of the country, the meeting location may be in a regional location. The NASD will periodically review the proposed meeting location and agenda to determine whether the meeting is for the purpose of training or education.

The payment or reimbursement by an offeror may also only be applied to the expenses of the member and its associated persons in attending the meeting and shall not be used to defray the expenses of guests of the associated person. Thus, either the member-employer of the associated person or the associated person must pay the expenses of a guest of an associated person attending a training or education meeting. The non-cash sales incentive prohibitions in connection with DPPs in Article III, Section 34 and in connection with REITs and corporate equity and debt in Article III, Section 44 of the Rules of Fair Practice do not include rule language providing a similar exception for training and education meetings. However, the NASD has interpreted those rules to provide a similar exception.8

Finally, the exception permitting training and education meetings is only available if the payment or reimbursement by the offeror is not conditioned on sales or the promise of sales by the member or its associated persons. This requirement is intended to ensure that the offeror making the payment or reimbursement does not participate in any manner in a member's decision as to which associated persons will attend a member's or offerer's meeting. The provision is not, however, intended to prevent a member from designating persons to attend a meeting held by the member or by an offeror based on sales or any other criteria as deemed appropriate by the member-employer, so long as attendance at the meeting is not earned through a member's in-house sales incentive program. The requirement prohibiting offerers from conditioning payment on sales or the promise of sales should be compared to that applicable to gifts and entertainment which prohibits the offeror from requiring that the recipient meet a specific sales goal.

Exception From Non-Cash Compensation and Direct Payment Prohibitions for In-House Arrangements—The NASD is proposing to adopt as Subsection (1)(6) to the Investment Company Rule and Subsection (h)(5) of the Variable Contracts Rule an exception from the prohibitions on non-cash compensation and direct payments to associated persons for non-cash compensation arrangements between a member and its associated persons and between an investment or insurance company and the sales personnel of a member with which it has a control relationship. This provision is not subject to the proposed disclosure requirements.

In-house payment arrangements, however, are subject to three conditions. They must conform to the recordkeeping requirement, must be multi-product type oriented, and may not involve, directly or indirectly, an unaffiliated investment or insurance company or other member participating in or contributing to such non-cash compensation arrangements.

The phrase "multi-product type" is intended to ensure that in-house non-cash compensation arrangements are not based on the sale of a specifically designated mutual fund or variable contract. That is, for multi-product type firms (e.g., firms selling mutual funds, equity securities, DPPs, variable contracts, corporate bonds, etc.), the non-cash arrangement must be based on the sales of more than one product type. For single-product type firms (e.g., a firm selling only mutual funds or only variable contracts), the rule permits one product type to be the basis for the sales incentive. However, the incentive must be based on the associated person's gross production of all securities within that product type, not on the sales of a specifically designated mutual fund or variable contract.

The prohibition against the involvement of unaffiliated investment or insurance companies or other members is intended to ensure that, except in the narrow areas where non-cash compensation arrangements are permitted, investment and insurance companies and other members do not, by payments of cash to a member or by some other means, participate in or contribute to a permitted non-cash compensation arrangement.

Both the Investment Companies and Insurance Affiliated Members Committees believe that the exception for non-cash compensation arrangements between a member and its associated persons should be equally available in the context of non-cash compensation arrangements between a non-member company and the associated persons of the company's affiliated NASD member firm. This practice, which is codified in Subsection (1)(4)(C) of the Investment Company Rule, has long been permitted in the sale of investment company and variable contract securities products. In both cases, the non-cash compensation arrangement is internal to the employer-employee relationship and, therefore, should not raise the supervisory concerns that are present in the compensation arrangements between a non-member and the unaffiliated broker/dealers selling its product. Moreover, the Committees note that it has generally not been the practice for the NASD to regulate the internal compensation arrangements between a member and its associated persons.

Operation Of Proposed New Rules

To facilitate understanding of the proposed new rules, the NASD is providing examples of different compensation arrangements with an analysis of the applicability of the different provisions of the proposed new rules. References to the provisions of the proposed rules will only be to the amendments proposed to the Investment Company Rule to simplify the discussion.

Examples

Example 1: An offeror holds an overnight educational meeting for associated persons of broker/dealer firms at a location that requires transportation by airplane and includes meals.

Analysis: This arrangement would be permitted if it complies with the requirements of proposed Section (1)(5)(c) of the Investment Company Rule that permits training and education meetings, so long as the member controls the determination of which associated persons will attend the meeting, the associated persons obtain the member's prior approval to attend the meeting, the location is appropriate to the purpose of the meeting, the payments by the offerer are only for expenses of the associated persons, and the member satisfies the recordkeeping requirements set forth in Subsection (1)(3) of the Investment Company Rule and Subsection (h)(2) of the Variable Contracts Rule.
Example 2: An offeror holds a training or educational meeting for associated persons not affiliated with the offeror. The meeting is more social than business; for example, it is comprised of two to three hours per day of training/educational sessions and the remainder of the day consists of social activities.

Analysis: This arrangement would be prohibited by proposed Section 5 of the Investment Company Rule as non-cash compensation. For an offeror or a member (for persons associated with other members) to provide a training and educational meeting, the arrangements must comply with the exception in proposed Section (1)(5)(c). An offeror is, however, allowed to entertain associated persons of a member, so long as the arrangement complies with proposed Section (1)(5)(b) that assumes there is a meal or entertainment that is not a "meeting," and does not raise any question of impropriety.
Example 3: A broker/dealer holds its annual meeting for its associated persons and their guests, paying all expenses without reimbursement from any offeror not affiliated with the broker/dealer.

Analysis: This arrangement would be permitted by proposed Section (1)(6) of the Investment Company Rule and can be at any location which the member-employer deems appropriate. If attendance at the event is conditioned on the achievement of specified sales goals under an incentive program, the incentive program must meet the requirements of Section (1)(6)(a) that the program must be multi-product type oriented or, if the member is a single-product type firm, must be based on the gross production of associated persons.
Example 4: Same arrangement as Example 3, except that one or more non-member companies not affiliated with the broker/dealer pays for certain of the meeting arrangements or reimburses certain of the broker/dealer's expenses.

Analysis: This arrangement would be permitted under proposed Section (1)(5)(c) of the Investment Company Rule only if the member controls the determination of which associated persons will attend the meeting, the associated persons obtain the member's approval to attend the meeting, the location is appropriate to the purpose of the meeting, the payments by the offeror are only for expenses of the associated persons, and the member satisfies the recordkeeping requirements. While it is the decision of the member to choose who attends the meeting, it may not use an incentive program to determine who attends.
Example 5: Same arrangement as Example 3, except that an affiliated non-member company pays for or reimburses the member's expenses.

Analysis: This arrangement would be permitted under proposed Section (1)(6) of the Investment Company Rule, under the same conditions as set forth in Example 3.
Example 6: An investment or insurance company establishes a program for the payment of a special cash incentive bonus for broker/dealers that meet certain specific sales targets.

Analysis: This arrangement would be permitted because the incentive is in the form of cash, subject to the requirements of proposed Sections (1)(1), (3), and (4) of the Investment Company Rule which prohibit payment of the incentive directly to an associated person, require that the member maintain a record of the cash bonus, and require that the special compensation arrangement be described in the current prospectus.
Example 7: An investment or insurance company pays a percentage commission to a broker/dealer for the sale of its securities products. The broker/dealer uses the commission to pay for the expenses of a training or educational meeting for its associated persons.

Analysis: This arrangement would be permitted, subject to compliance with proposed Sections (1)(1), (3), and (4) of the Investment Company Rule. The meeting is not specifically subject to the requirements of proposed Subsection (1)(5)(c) of the Investment Company Rule because (absent a more direct relationship between the payment and the meeting) the commission payment would not be viewed as intended as a payment or reimbursement for the member's in-house educational meeting.

Proposed Implementation Of New Rules

The NASD is proposing that the amendments to the Investment Company and Variable Contracts Rules be implemented to prohibit the initiation of a new non-cash incentive program after the approval of the amendments by the SEC. Thus, if the proposed amendments were approved, for example, on July 1, 1995, no new program could begin from that effective date forward. However, sales that occurred after the July 1 approval date could be applied to a non-cash incentive program that was already in progress. Therefore, after the July 1, 1995, effective date, members and their associated persons would be permitted to receive non-cash sales incentives earned before that effective date.

The NASD requests comment on the proposed structure of implementation to assist it in developing an appropriate transition methodology that takes into account the structure of non-cash sales incentive programs that are used in the sale of investment company and variable contract securities products.

Request For Comment

The NASD encourages all members and other interested parties to comment on the proposed amendments to Article III, Sections 26 and 29 of the Rules of Fair Practice. Comments should be forwarded to:

Joan C. Conley
Office of the Secretary
NASD
1735 K Street, N.W.
Washington, D.C. 20006-1506

Comments should be received by October 3, 1994.

Questions concerning this Notice should be directed to Clark Hooper, Vice President, Advertising/ Investment Companies Regulation Department, at (202) 728-8325; Suzanne E. Rothwell, Associate General Counsel, Office of General Counsel, at (202) 728-8247; and Robert J. Smith, Attorney, Office of General Counsel, at (202) 728-8176.


1 In Notice to Members 94-14 (March 1994), the NASD clarified the obligations of members in complying with the compensation disclosure requirements for mutual funds in Subsection 26(1)(1)(C) to Article III of the Rules of Fair Practice. See, also, Notice to Members 94-41 (May 1994).

2 For a detailed discussion of the background of the proposed amendments, please call Carolyn Thrower, Advertising/Investment Companies Regulation, at (202) 728-6977.

3 See, Sections 3, 4, and 5 of the 1940 Act. Section (b)(8)(C) to Article III, Section 44 of the Rules of Fair Practice provides an exemption from compliance with Section 44 for securities of investment companies registered under the Investment Company Act of 1940, except for securities of a closed-end management company as defined in Section 5(a)(2)of the 1940 Act.

4 Release 8389 states that the SEC would not recommend enforcement action where the insurance company makes payments directly to its life insurance agents who are also persons associated with the insurance company's subsidiary broker/dealer, so long as: (1) such payments are made as a purely ministerial service and are properly reflected on the books and records of the broker/dealer; (2) a binding agreement exists between the insurance company and the broker/dealer that all books and records are maintained by the insurance company as agent for the broker/dealer and are preserved in conformity with the requirements of Rules 17a-3 and l7a-4 under the Securities Exchange Act of 1934; (4) all such books and records are subject to inspection by the SEC in accordance with Section 17(a) of the Exchange Act; and (5) the subsidiary broker/dealer has assumed full responsibility for the securities activities of all persons engaged directly or indirectly in the variable annuity operation.

5 See, e.g., SEC No-Action Letter to The Mutual Benefit Life Insurance Company (publicly available January 21, 1985) and other SEC no-action letters cited therein.

6 See, Traditional Equinet, publicly available January 8, 1992; and Mariner Financial Services, publicly available December 16, 1988, which include references to other SEC no-action letters in the incoming letters requesting the SEC no-action position.

7 Thus, to rely on an SEC no-action letter, there must be state law impediments that satisfy either category (1) or (2) and also satisfy category (3). Regardless of whether a state law impediment exists, an insurance company may rely on Release 8389 to establish a ministerial account where an insurance company makes commission payments directly to associated persons of its subsidiary broker/dealer makes commission payments.

8 See, Securities Exchange Act Rel. No. 26185 (October 14, 1988); 53 FR 41262 (October 20, 1988), footnote 4, at 41263.


Proposed Amendments To Sections 26 And 29 To Article III Of The Rules Of Fair Practice

(Note: New text is underlined; deleted text is in brackets.)

Investment Companies

Section 26

Application

(a) (Unchanged)

Definitions

(b)
(1)–(6) (Unchanged.)
(7) ["Associated person of an underwriter" as used in subsection (1) of this section, shall include an issuer for which an underwriter is the sponsor or a principal underwriter, any investment adviser to such issuer, or any affiliated person (as defined in Section 2(a)(3) of the 1940 Act) of such underwriter, issuer or investment advisor.] The terms "offerer," "cash compensation" and "non-cash compensation" as used in Subsection (1) shall have the following meanings:

"Offerer" shall mean an investment company, an adviser to an investment company, an underwriter and any affiliated person (as defined in Section 2(aV3) of the Investment Company Act of 1940) of such entities.

"Cash compensation" shall mean any discount, concession, fee, commission, asset-based sales charge, loan, or override received in connection with the sale and distribution of investment company securities.

"Non-cash compensation" shall mean any non-cash form of compensation received in connection with the sale and distribution of investment company securities, including but not limited to merchandise, gifts and prizes, and payment of travel expenses, meals and lodging.
(c) – (k) (Unchanged.) [Dealer concessions]
[(1)(1) No underwriter or associated person of an underwriter shall offer, pay, or arrange for the offer or payment to any other member, in connection with retail sales or distribution of investment company securities, any discount, concession, fee or commission (hereinafter referred to as "concession") which:]
[(A) is in the form of securities of any kind, including stock, warrants or options;]
[(B) is in a form other than cash (e.g., merchandise or trips), unless the member earning the concession may elect to receive cash at the equivalent of no less than the underwriter's cost of providing the non-cash concession; or]
[(C) is not disclosed in the prospectus of the investment company. If the concessions are not uniformly paid to all dealers purchasing the same dollar amounts of securities from the underwriter, the disclosure shall include a description of the circumstances of any general variations from the standard schedule of concessions. If special compensation arrangements have been made with individual dealers, which arrangements are not generally available to all dealers, the details of the arrangements, and the identities of the dealers, shall also be disclosed.]
[(2) No underwriter or associated person of an underwriter shall offer or pay any concession to an associated person of another member, but shall make such payment only to the member.]
[(3)
(A) In connection with retail sales or distribution of investment company shares, no underwriter or associated person of an underwriter shall offer or pay to any member or associated person, anything of material value, and no member or associated person shall solicit or accept anything of material value, in addition to the concessions disclosed in the prospectus.]
[(B) For purposes of this paragraph (1)(3), items of material value shall include but not be limited to:]
[(i) gifts amounting in value to more than $50 per person per year.]
[(ii) gifts or payments of any kind which are conditioned on the sale of investment company securities.]
[(iii) loans made or guaranteed to a non-controlled member or person associated with a member.]
[(iv) wholesale overrides (commissions) granted to a member on its own retail sales unless the arrangement, as well as the identify of the member, is set forth in the prospectus of the investment company.]
[(v) payment or reimbursement of travel expenses, including overnight lodging, in excess of $50 per person per year unless such payment or reimbursement is in connection with a business meeting, conference or seminar held by an underwriter for informational purposes relative to the fund or funds of its sponsorship and is not conditioned on sales of shares of an investment company. A meeting, conference or seminar shall not be deemed to be of a business nature unless: the person to whom payment or reimbursement is made is personally present at, or is en route to or from, such meeting in each of the days for which payment or reimbursement is made; the person on whose behalf payment or reimbursement is made is engaged in the securities business; and the location and facilities provided are appropriate to the purpose, which would ordinarily mean the sponsor's office.]
[(C) For purposes of this paragraph (1)(3), items of material value shall not include:]
[(i) an occasional dinner, a ticket to a sporting event or the theater, or comparable entertainment of one or more registered representatives which is not conditioned on sales of shares of an investment company and is neither so frequent nor so extensive as to raise any question of propriety.]
[(ii) a breakfast, luncheon, dinner, reception or cocktail party given for a group of registered representatives in conjunction with a bona fide business or sales meeting, whether at the headquarters of a fund or its underwriter or in some other city.]
[(iii) an unconditional gift of a typical item of reminder advertising such as a ballpoint pen with the name of the advertiser inscribed, a calendar pad, or other gifts amounting in value to not more than $50 per person per year.]
[(4) The provisions of this subsection (1) shall not apply to:]
[(A) Contracts between principal underwriters of the same security.]
[(B) Contracts between principal underwriter of a security and the sponsor of a unit investment trust which utilizes such security as its underlying investment.]
[(C) Compensation arrangements of an underwriter or sponsor with its own sales personnel.]

Member Compensation

(l) In connection with the sale and distribution of investment company
(1) Except as described below, no associated person of a member shall accept any compensation, cash or non-cash, from anyone other than the member with which the person is associated. This requirement will not prohibit arrangements, agreed to by a member, where an insurance company maintains a commission account as a ministerial service for a member and, on behalf of the member, pays commission checks from such an account directly to associated persons of the member.
(2) No member or person associated with a member shall accept any compensation from an offeror which is in the form of securities of any kind.
(3) Except for items described in Subsection (1)(5)(a) and (b). a member shall maintain records of all compensation, cash and non-cash, received from offerers. The records shall include the names of the offerors, the names of the associated persons and the amount of cash and/or the nature of non-cash compensation received.
(4) No member shall accept any cash compensation from an offeror unless such compensation is described in the current prospectus of the investment company. When special cash compensation arrangements are made available by an offeror to a member, which arrangements are not made available on the same terms to all members who distribute the investment company securities of the offeror. a member shall not enter into such arrangements unless the name of the member and the details of the arrangements are disclosed in the prospectus. Prospectus disclosure requirements shall not apply to cash compensation arrangements between:
(a) principal underwriters of the same
(b) the principal underwriter of a security and the sponsor of a unit investment trust which utilizes such security as its underlying investment: and
(c) a non-member company and its sales personnel who are associated persons of an NASD member which, directly or indirectly controls, is controlled by. or is under common control with that non-member company provided that the recordkeeping requirement in Subsection (1)(3) is
(5) No member or person associated with a member shall directly or indirectly accept any non-cash compensation offered or provided to such member or its associated persons. Notwithstanding the foregoing prohibition and the provisions of Subsection (1)(1), the following items of non-cash compensation may be accepted:
(a) Gifts to associated persons of members that do not exceed an annual amount per person fixed periodically by the Board of Governors1 and are not preconditioned on achievement of a specified sales target.
(b) An occasional meal, a ticket to a sporting event or the theater, or comparable entertainment for persons associated with a member and, if appropriate, their guests, which is neither so frequent nor so extensive as to raise any question of propriety and is not preconditioned on achievement of a specified sales target.
(c) Payment or reimbursement by offerers in connection with meetings held by an offeror or by a member for the purpose of training or education of associated persons of a member, provided that:
(i) the recordkeeping requirement in Subsection (1)(3) is satisfied:
(ii) associated persons obtain the member's prior approval to attend the meeting: (iii) the location is appropriate to the purpose of the meeting, which shall mean an office of the offeror or the member, or a facility located in the vicinity of such office. or a regional location with respect to regional meetings:
(iv) the payment or reimbursement is only applied to the expenses of the member and persons associated with the member in attending the meeting, which shall not include guests of the associated person; and
(v) the payment or reimbursement by the offeror is not conditioned on sales or the promise of sales by the member or persons associated with the member.
(6) Notwithstanding the prohibition in Section (5). non-cash compensation arrangements are permissible between a member and its associated persons or a non-member company and its sales personnel who are associated persons of a member which, directly or indirectly controls, is controlled by. or is under common control with that non-member company, provided that:
(a) the member's or non-member's non-cash compensation arrangement is multi-product type oriented, or. for single-product type firms, based on the gross production of the associated person:
(b) no unaffiliated non-member company or other member directly or indirectly participates in or contributes to such non-cash compensation arrangements: and
(c) the recordkeeping requirement in Subsection (1)(3) is satisfied.
* * * Variable Contracts Of An Insurance Company Section 29
(a) (Unchanged.)

Definitions

(b)
(1)–(2) (Unchanged.)
(3) The terms "offeror." "cash compensation" and "non-cash compensation" as used in Subsection (h) shall have the following meanings:

"Offeror" shall mean a separate account of an insurance company, an adviser to a separate account of an insurance company, an underwriter and any affiliated person (as defined in Section 2(a)(3) of the Investment Company Act of 1940) of such entities.

"Cash compensation" shall mean any discount, concession, fee, commission, asset-based sales charge, loan or override received in connection with the sale and distribution of variable contracts.

"Non-cash compensation" shall mean any form of non-cash compensation received in connection with the sale and distribution of variable contracts, including but not limited to merchandise, gifts and prizes, and payment of travel expenses, meals and lodging.
(c) – (g) (Unchanged.)

Member Compensation

(h) In connection with the sale and distribution of variable contracts:
(1) Except as described below, no associated person of a member shall accept any compensation, cash or non-cash, from anyone other than the member with which the person is associated. This requirement will not prohibit arrangements, agreed to by a member, where an insurance company maintains a commission account as a ministerial service for a member and, on behalf of the member, pays commission checks from such an account directly to associated persons of the member.
(2) Except for items as described in Subsection (h)(4)(a) and (b). a member shall maintain records of all compensation, cash and non-cash, received from offerers. The records shall include the names of the offerors, the names of the associated persons and the amount of cash and/or the nature of non-cash compensation received.
(3) No member shall accept any cash compensation from an offeror unless such compensation is described in the current prospectus of the investment company. When special cash compensation arrangements are made available by an offeror to a member, which arrangements are not made available on the same terms to all members who distribute the investment company securities of the offeror. a member shall not enter into such arrangements unless the name of the member and the details of the arrangements are disclosed in the prospectus. Prospectus disclosure requirements shall not apply to cash compensation arrangements between:
(a) principal underwriters of the same security;
(b) the principal underwriter of a security and the sponsor of a unit investment trust which utilizes such security as its underlying investment: and
(c) a non-member company and its sales personnel who are associated persons of an NASD member which. directly or indirectly controls, is controlled by. or is under common control with that non-member company provided that the recordkeeping requirement in Subsection (h)(3) is
(4) No member or person associated with a member shall directly or indirectly accept any non-cash compensation offered or provided to such member or its associated persons. Notwithstanding the foregoing prohibition and the provisions of Subsection (h)(1), the following items of non-cash compensation may be accepted:
(a) Gifts to associated persons of members that do not exceed an annual amount per person fixed periodically by the Board of Governors2 and are not preconditioned on achievement of a specified sales target.
(b) An occasional meal, a ticket to a sporting event or the theater, or comparable entertainment for persons associated with a member and, if appropriate, their guests, which is neither so frequent nor so extensive as to raise any question of propriety and is not preconditioned on achievement of a specified sales target.
(c) Payment or reimbursement by offerers in connection with meetings held by an offeror or by a member for the purpose of training or education of associated persons of a member, provided that:
(i) the recordkeeping requirement in Subsection (h)(2) is satisfied:
(ii) associated persons obtain the member's prior approval to attend the meeting:
(iii) the location is appropriate to the purpose of the meeting, which shall mean an office of the offeror or the member, or a facility located in the vicinity of such office, or a regional location with respect to regional meetings:
(iv) the payment or reimbursement is only applied to the expenses of the member and persons associated with the member in attending the meeting, which shall not include guests of the associated person: and
(v) the payment or reimbursement by the offeror is not conditioned on sales or the promise of sales by the member or persons associated with the
(5) Notwithstanding the prohibition in Section (4), non-cash compensation arrangements are permissible between a member and its associated persons or a non-member company and its sales personnel who are associated persons of a member which, directly or indirectly controls, is controlled by. or is under common control with that non-member company, provided that:
(a) the member's or non-member's non-cash compensation arrangement is multi-product type oriented, or, for single-product type firms, based on the gross production of the associated person:
(b) no unaffiliated non-member company or other member directly or indirectly participates in or contributes to such non-cash compensation arrangements; and
(c) the recordkeeping requirement in Subsection (h)(2) is satisfied.

1 The current annual amount fixed by the Board of Governors is $100.

2 The current annual amount fixed by the Board of Governors is $100.


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