On May 22, 2007, the Securities and Exchange Commission (the “SEC”) published a notice (“Release”) in the Federal Register requesting comment on rule filings by the National Association of Securities Dealers (“NASD”)1 and the New York Stock Exchange (“NYSE”)2 relating to business entertainment by member firms and their associated persons of employees of customers. The NASD rule filing proposes to add interpretive material, IM-3060 ( “IM-3060”), under NASD Rule 3060. IM-3060 would codify the principle that a member or its associated persons should not do or give anything of value to an employee – or any other agent – of a customer that is intended or designed to cause, or would be reasonably judged to have the likely effect of causing, such customer representative to act in a manner that is inconsistent with the best interest of the customer. The NYSE rule filing proposed to add a new rule, Rule 350A, governing gifts and entertainment practices (“Rule 350A”). Rule 350A, as proposed, is similar to IM-3060. Comments on IM-3060 are due by June 12, 2007.
IM-3060 began with Notice to Members 06-06, published by the NASD in January 2006, to solicit comment on a proposal to add interpretive material under Rule 3060 addressing business entertainment practices.3 (Rule 3060 prohibits any member or associated person of the member, directly or indirectly, from giving, or permitting to be given, anything of value (including gratuities) in excess of $100 per year to any person where the payment is in relation to the business of the recipient’s employer.) NYSE also had under consideration its own approach to regulating business entertainment and on February 15, 2006, filed its rulemaking petition for Rule 350A with the SEC. On April 11, 2006, NASD filed its rulemaking petition for IM-3060 with the SEC. On April 17, 2006, NASD filed an amendment to its original petition, primarily to revise the original version of IM-3060 to conform more closely to Rule 350A.
Overview of IM-3060
IM-3060 prohibits a member from providing business entertainment to customer representatives that would discourage the customer representative from acting in the best interest of the customer. IM-3060 provides guidance on written policies and procedures that members can adopt to comply with the objective of the rule.
A. Key Definitions
The requirements of IM-3060 are triggered by three new definitions: “customer,” “customer representative,” and “business entertainment.” IM-3060 would define “customer” as:
A person that maintains a business relationship with a member via the maintenance of an account, through the conduct of investment banking, or pursuant to other securities-related activity; or a person whose customer representative receives business entertainment for the purpose of encouraging such person to establish a business relationship with a member by opening an account with the member or by conducting investment banking or other securities-related activity with the member.
IM-3060 would define “customer representative” as:
A person who is an employee, officer, director, or agent of a customer, unless such person is a family member of the customer.
The Release explains that the term “customer representative” replaces the term “employee” used in prior versions of IM-3060, to clarify that the rule applies to persons other than employees and conforms to the terminology of Rule 350A. The definition also excludes family members from the definition to address situations where a family member has power-of-attorney or similar authority over another family member’s account (e.g., an adult child with authority over his or her elderly parent’s account).
IM-3060 would define “business entertainment” as:
Any social event, hospitality event, sporting event, entertainment event, meal, leisure activity, or event of like nature or purpose, including entertainment offered in connection with a charitable event, educational event or business conference, as well as any transportation or lodging related to such activity or event, in which an associated person of a member accompanies a customer representative.
This definition codifies NASD’s position that an associated person of a member must accompany or participate in an event for it to be deemed business entertainment. However, IM-3060 would recognize an exception where there is an exigent circumstance. The Release elaborates on what is considered an exigent circumstance, providing examples such as where a member has a sick child, experiences an accident or confronts some other sudden, overriding circumstance. The Release explains further that for the exception to apply, any such “exigent circumstance” must be “well documented” and is subject to prior approval. However, in “very limited circumstances where such prior approval cannot be reasonably obtained,” the Release indicates that it would be allowable for “a prompt post-event review to be conducted” that is “documented” by a supervisory person.
B. Written Policies and Procedures for Business Entertainment
M-3060 would require that written policies and procedures for business entertainment address the following:
1. Members must define the forms of business entertainment that are appropriate or inappropriate business entertainment, including standards addressing the nature and frequency of entertainment, types and class of accommodation and transportation, and either firm dollar limits or thresholds requiring advance written approval. No hard limits are imposed by IM-3060, nor does it mandate uniform treatment for all recipients or events. IM-3060 permits a firm to establish tailored standards for events deemed to be primarily educational, charitable or philanthropic in nature.
2. Members should design their policies and procedures to detect and prevent business entertainment that is intended as, or could reasonably be perceived to be intended as, an improper quid pro quo. The Release notes that policies and procedures should “preclude providing business entertainment that is lavish or extensive in nature that a customer representative would likely feel compelled” to act in a manner inconsistent with the interests of his or her employer (e.g., directing order flow without due regard to best execution).
3. Members’ policies and procedures must establish qualification standards for supervisors who administer the policies and procedures. In addition, the Release explains that members’ policies and procedures must evidence the basis upon which a supervisor will determine that business entertainment does not violate a member’s standards.
4. Members’ policies and procedures must provide for appropriate training and education of all applicable personnel. Specifically, IM-3060 requires a member to train persons associated with it who supervise, administer and are subject to such written business entertainment policies and procedures in all applicable requirements.
The Release notes that as long as the policies and procedures are “reasonably designed” to comport with the principles of IM-3060, members are free to define the approach and method of their written policies and procedures.
IM-3060 would require a member firm to track business entertainment expenses. IM-3060 would provide an exception for recording expenses where the business expense and associated expenses are under $50 or where an additional expense, in addition to a recorded business expense, is less than $50. The Release provides an example, stating that where a member purchases hot dogs for a customer representative at a hockey game that is already recorded as a business expense, the member would not have to record the purchase of the hot dog. IM-3060 explains further that members cannot segregate events to circumvent the $50 limit. The Release provides an example of this prohibited segregation as a dinner expense of $40 followed by a sporting event with a ticket price of $40. IM-3060 also grants customers the authority to request information from members regarding the business entertainment expenses provided to the customer representatives of the customer. The Release explains that a member can set reasonable guidelines for such information but cannot impede a customer’s attempt to obtain records.
D. Exemption for Members with Business Entertainment Expenses Below $7, 500
IM-3060 would provide a partial exemption for a member with annual business expenses below $7,500. The $7,500 limit is to be measured on a fiscal year basis, and a member relying on the exemption must maintain evidence demonstrating that its business entertainment expenses were below the threshold.
E. NYSE’s New Proposed Rule 350A
The Rule 350A, similar to IM-3060, focuses on addressing conflict-of-interest issues that arise in connection with the provision of business entertainment by members to customer representatives of customers or prospective customers. As the Release observes, the text of IM-3060 as noticed by the SEC is very similar to the text of NYSE’s new proposed Rule 350A. Notably, however, Rule 350A, unlike IM-3060, would require an NYSE member to provide notice to customers who utilize customer representatives that, upon a customer’s written request, the NYSE member will promptly provide detailed information regarding the manner and expense of any business entertainment provided to its customer representative by such member organization. (IM-3060 simply requires a member to provide such information to a customer upon request.) Also, the NYSE indicated that, in conjunction with the implementation of its final rule, it will issue an informational memo discussing factors to be considered when establishing criteria used to evaluate the propriety of business entertainment with respect to entertainment, clients and business purpose.
The SEC is requesting comments on both the NASD and NYSE rule filings. In particular, the SEC is soliciting comment on the difference between the NASD and NYSE proposed rules and whether NASD should have a similar notification provision for customers utilizing customer representatives. The comment period closes June 12, 2007.