FINRA Manual: Contents
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88-88 Amendment to Section 34, of the NASD Rules of Fair Practice Re: Prohibition on Non-Cash Sales Incentives in Public Offerings Effective January 1, 1989
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The Securities and Exchange Commission has approved amendments to Appendix F under Article III, Section 34 of the Rules of Fair Practice ("Appendix F") and the Interpretation of the Board of Governors Review of Corporate Financing, pursuant to Article III, Section 1 of the Rules of Fair Practice (the "Interpretation"). The amendments, which become effective January 1, 1989, prohibit members from accepting non-cash sales incentives in connection with the sale of public direct participation programs, corporate debt and equity offerings, and real estate investment trusts. The text of the amendments are attached.
The amendments to Appendix F and the Interpretation prohibiting non-cash sales incentives in public offerings are the result of the NASD's longstanding concern about the use of incentives as sales compensation. Sales incentives typically are offered to registered representatives of member firms based on their sales of public direct participation programs or real estate investment trusts. Non-cash incentives usually take the form of trips to vacation resorts or the selection of luxury merchandise.
The NASD believes that the ability of members to supervise their registered representatives is severely impacted when an outside entity such as a direct participation program sponsor or real estate investment trust offers and provides non-cash incentives to a member's retail sales force. This is particularly true when direct appeals promoting incentives are made to registered representatives, making it difficult for members to adequately control the participation of their registered representatives in non-cash incentive programs.
Since incentive programs appear to have become more prevalent and more aggressive, the NASD determined that attempts to control sales incentives, short of a prohibition, would not be effective. These amendments, by prohibiting the receipt of non-cash sales incentives and clarifying the procedures for the receipt of cash compensation, strengthen the ability of member firms to supervise their associated persons.
The NASD has determined not to prohibit members from establishing in-house non-cash sales incentive programs where the programs are funded entirely by the member and offered only to registered representatives associated with that member. The NASD believes that it is the influence of outside entities on the member's sales force that has the effect of undermining the member's ability to supervise.With an in-house incentive program, the member has control over the suitability of the particular program, is responsible for the sales methods used to sell an offering, and is in a position to exercise control over its registered representatives.
EXPLANATION OF AMENDMENTS
The amendment to Subsection 5(e) of Appendix F addresses the receipt of non-cash compensation and prohibits any member or person associated with a member from accepting any non-cash compensation or sales incentive (such as travel bonuses, prizes, and awards) offered or provided by any sponsor, affiliate of a sponsor, or direct participation program, including specifically sponsors affiliated with the member.
However, in order to provide for the receipt of small, souvenir-type incentive items by members and associated persons, the amendment permits the acceptance of non-cash incentive items offered directly by a sponsor, affiliate of a sponsor or program where (1) the aggregate value of all such items provided to each associated person during any year does not exceed $50; (2) the value of all such items made available in connection with a public offering is included as underwriting compensation subject to the NASD's underwriting compensation guidelines; and (3) the proposed payment or transfer of all such incentive items is disclosed in the prospectus or similar offering document.
With respect to a member's own in-house incentive program, the amendment to Subsection 5(e) permits a member to provide non-cash compensation or sales incentive items to its associated persons only where no sponsor, affiliate of a sponsor, or direct participation program directly or indirectly participates in or contributes to providing such non-cash compensation.
A sponsor, affiliate of a sponsor, or program would be deemed to be "participating" in an in-house program if it assists in the selection of or arrangements for any trip or merchandise item provided to the associated persons of a member. Similarly, a sponsor, affiliate of a sponsor, or program would be deemed to be "contributing" to an in-house incentive program if it directly or indirectly provides monetary support to such program. Sponsors affiliated with members, as well as independent sponsors, are equally subject to the prohibition on directly or indirectly funding or providing non-cash compensation to associated persons of members.
Subsection 5(f) of Appendix F, as amended, is applicable to the acceptance of cash compensation by members, subject to the limitations on the receipt of direct or indirect non-cash compensation in Subsection 5(e). Under the new amendment, a member may accept cash compensation only if: (1) the compensation is paid directly to the member and any distribution to the member's associated persons is controlled solely by the member; (2) the value of all compensation is included as underwriting compensation subject to the NASD's limits on maximum underwriting compensation; (3) the payment of the compensation is disclosed in the prospectus or similar offering document; (4) the compensation is recorded on the member's books and records as compensation received in connection with a public offering; and (5) the compensation is not directly or indirectly related to any non-cash compensation or sales incentive provided by a member to its associated persons.
These provisions are intended to clarify the fact that a member is permitted to use any cash compensation it may receive to defray the expenses of internal non-cash sales incentive programs, but that affiliated and non-affiliated sponsors may not offer and that affiliated and non-affiliated members may not accept participation in or contribution to such internal non-cash incentive programs. In other words, in-house incentive programs are permitted only when funded entirely by the member's own funds, the receipt of which was not directly or indirectly linked to an in-house incentive program.
The amendment to the Interpretation is applicable to corporate debt and equity offerings, including real estate investment trusts. The amendment imposes the same prohibition as the amendment to Appendix F on members or persons associated with members from accepting, directly or indirectly, any non-cash sales compensation orsales incentive item (including, but not limited to, travel bonuses, prizes, and awards) valued in excess of $50 per person per issuer annually. As in the case of a direct participation program, a member is permitted to provide non-cash sales incentive items to its associated persons provided that no issuer, affiliate of an issuer, including an affiliate of the member, directly or indirectly participates in or contributes to providing such non-cash sales incentives.
The amendments to Appendix F and the Interpretation will become effective January 1, 1989. Most currently operating non-cash sales incentive programs have qualifying periods that coincide with the calendar year; therefore, the last day that sales may be applied to a current incentive program will be December 31, 1988. However, during calendar year 1989, members and their associated persons will be permitted to receive non-cash incentives earned prior to January 1, 1989, provided that the incentive program has been approved by the NASD's Corporate Financing Department and is in compliance with the current requirements of Subsection 5(f) of Appendix F.
Questions regarding this notice can be directed to either Richard J. Fortwengler, Assistant Director, or Ms. AllynM. O'Connor, Supervisor, NASD Corporate Financing Department, at (202) 728-8258.
AMENDMENT TO APPENDIX F UNDER ARTICLE III, SECTION 34 OF THE RULES OF FAIR PRACTICE
(Note: New language is underlined; deleted language is in brackets.)
Organization and Offering Expenses
AMENDMENT TO THE INTERPRETATION OF THE BOARD OF GOVERNORS-REVIEW OF CORPORATE FINANCING, ARTICLE III, SECTION 1 OF THE RULES OF FAIR PRACTICE
(Note: New language is underlined and follows paragraph on "Overallotment Options" under "Arrangement Factors" section of Corporate Financing Interpretation on page 2033 of the NASD Manual.)
When proposed in connection with the distribution of a public offering of securities, it shall be an unfair and unreasonable arrangement 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 affiliate of an issuer in excess of $50 per person per issuer annually. Notwithstanding the foregoing, a member may provide non-cash sales incentive items to its associated persons provided that no is suer, affiliate of the issuer, including specifically an affiliate of the member, directly or indirectly participates in or contributes to providing such non-cash sales incentive.