Publications

Overview

On January 23, 2005 the NASD proposed interpretive material to NASD Conduct Rule 3060 to more explicitly outline the policies and procedures a member must adopt in connection with its business entertainment practices with respect to a customer’s employees.¹ The proposed interpretive material, if approved, would expand on and supersede prior NASD staff guidance. Comments on the proposed interpretive material are due by February 23, 2006.

Rule 3060

Rule 3060 (Influencing or Rewarding Employees of Others) prohibits any member or person associated with a member from directly or indirectly giving anything of value, including gratuities, in excess of $100 per individual per year to any person where such payment or gratuity is in relation to the business of the recipient’s employer. A gift of any kind is considered a gratuity. In 1999, the NASD staff issued a letter stating that Rule 3060 does not prohibit “ordinary and usual business entertainment” such as an occasional meal, sporting event, theater production or comparable entertainment event, provided that such entertainment is “neither so frequent nor so extensive as to raise any question of propriety.”²

In light of recent well-publicized abuses and because the 1999 letter did not provide sufficient guidance, the NASD is now proposing IM-3060 (Entertainment of the Employees of Persons who are Customers of a Member) (“Proposed IM-3060”) to more explicitly outline the policies and procedures that a member must adopt in connection with its business entertainment practices.³ Citing Rule 2110 (Standards of Commercial Honor and Principles of Trade), the NASD states that the overriding principal of Proposed IM-3060 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 reasonably likely to cause, the employee to act in a manner inconsistent with the best interests of the customer.⁴

Proposed IM-3060

Definitions of “Customer” and “Business Entertainment”

Proposed IM-3060 would define the terms “customer” and “business entertainment”. For purposes of Proposed IM-3060, the term “customer” means:

A person that maintains, or whose employee receives business entertainment for the purpose of having such person prospectively maintain, an account with a member or is otherwise a customer of the member for the purposes of investment banking or securities business, and has an employee, agent or representative act on behalf of the account in some capacity in respect of such account or customer relationship with the member.

The term “employee(s)” as used in Proposed IM-3060 means all persons who are employees, officers, directors, agents or representatives of a customer. In Notice to Members 06-06 (“NTM 06-06”) the NASD points out that the def inition recognizes the distinction between business entertainment provided directly to a natural person customer, which is not covered by Rule 3060 and business entertainment provided to employees, agents or representatives of a customer, which is covered by Rule 3060. NTM 06-06 also states that members cannot circumvent Proposed IM-3060 by providing business entertainment to a natural person customer who is also an employee, agent or representative of a customer by claiming that the such business entertainment applies only to the “natural person” relationship.

Proposed IM-3060 would define the term “business entertainment” to mean:

Providing entertainment to an employee in the form of a 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. Any thing of value given to an employee that is not defined as entertainment is a gift under Rule 3060.

If the member does not accompany the person associated with the customer or other otherwise participate in the event, the event, meal or activity is not considered “business entertainment.” Rather, the event would be treated as a gift subject to the limitations on gratuities in Rule 3060. In addition, the definition of “business entertainment” would expressly include transportation and lodging expenses provided by the member.

Written Policies and Procedures

Proposed IM-3060 provides that members must have written policies and procedures covering their business entertainment practices. The policies and procedures must address the following areas:

• The Form of Business Entertainment. A member must determine and define the forms of business entertainment that are appropriate and inappropriate, including the appropriate venues, nature, frequency, types and class of accommodations and transportation, and either the dollar amounts of business entertainment or specified dollar thresholds requiring advance written supervisory approval.

  Proposed IM-3060 does not impose hard dollar limits and permits each member to adopt its own policies and procedures. In addition, members may adopt policies that do not treat all recipients of business entertainment in the same manner. However, policies and procedures “that set standards that are so unbounded or vague that no reasonable determination of propriety can be discerned” would be deemed by the NASD to be a violation of Proposed IM-3060 and Rule 2110. Finally, Proposed IM-3060 expressly allows members to set different standards for business entertainment in connection with educational, charitable or philanthropic events, provided the differentiation is explicitly address in the written policies and procedures with specifically tailored standards.

• Promotion of Conduct Consistent with Rule 2110.A member’s policies and procedures must be designed to promote conduct consistent with Rule 2110 and should not undermine the performance of an employee’s duty to a customer. Consequently, Proposed IM-3060 provides that members should avoid any business entertainment that is so lavish or extensive that an employee would feel compelled to act in a manner inconsistent with the interests of his or her employer.

• Supervision and Compliance. The written policies and procedures must be designed to effectively supervise compliance with a member’s written policies and procedures concerning business entertainment. Members are free to define the approach and method of their written policies and procedures, provided they are reasonably designed to comport with the principals stated in Proposed IM-3060. However, it must be clear from the supervisory policies and procedures what factors determine the appropriate level of business entertainment and how those determinations are executed, monitored and enforced. In addition, the supervisory procedures should provide a method for evidencing both the breadth of supervisory activities as well as the information upon which supervision is conducted. As an example, Proposed IM-3060 states that a member’s policies must evidence the basis upon which a supervisor will determine that business entertainment does not violate a member’s standards as to the nature, frequency and dollar amounts of entertainment. Finally, a member must periodically review the policies and procedures to determine if they are practical and fulf ill their purpose.

• Recordkeeping. A member must maintain detailed records of the nature and expense of business entertainment and make such information available to a customer with respect to its employee upon request. This will allow a customer to review the types of business entertainment received by its employees.

• Qualification of Supervisors. A member must establish standards to ensure that persons designated to supervise, approve and document business entertainment expenses are suff iciently qualified and that periodic monitoring for compliance with the written policies and procedures is conducted. Proposed IM-3060 recommends, but does not require, periodic monitoring of business entertainment by an independent reviewer.

• Training and Education. Members must require training and education of all applicable personnel concerning the member’s business entertainment policies and procedures. A member must be able to demonstrate that it trains its associated persons who supervise and who are subject to the written policies and procedures relating to business entertainment.

Acceptable Forms of Business Entertainment

Proposed IM-3060 provides that a member’s written policies and procedures must be reasonably designed to avoid any business entertainment of an employee that is intended or designed to cause, or would be “reasonably judged to have the likely effect of causing” an employee to act in manner that is not in the best interest of a customer. While bound by Rule 2110, a member may determine that certain activities, while legal, are nevertheless inappropriate for business entertainment. Similarly, members may determine that certain modes of private transport, luxurious accommodations or destinations are not appropriate either as a matter or course or unless certain circumstances are present and senior management has approved the business entertainment.

Footnotes

1. Notice to Members 06-06 (January 2006). The New York Stock Exchange has announced that it is submitting a rule f iling with the Securities and Exchange Commission that is substantially similar to the NASD proposal.
2. Letter dated June 10, 1999 from R. Clark Hooper, NASD to Henry Hopkins and Sarah McCaffrey, T. Rowe Price Investment Services, Inc.
3. Notice to Members 06-06 (January 2006).
4. Rule 2110 precludes the offering any thing of value, including but not limited to business entertainment, which comprises conduct that is either illegal under applicable law or would expose a member, customer or recipient of the member’s entertainment to any civil liability to any governmental authority or agency.

For More Information

Please contact Richard S. Heller, James P. Jalil, Donald S. Mendelsohn, JoAnn M. Strasser, or Michael V. Wible or any member of our Corporate Transactions & Securities practice group for more information.

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