Publications

Overview

The NASD has issued for comment a proposal to expand the prohibitions on non-cash compensation to include the sale and distribution of any security or type of security. Currently, the prohibitions on non-cash compen-sation apply only to publicly offered securities, direct participation programs (“DPPs”), variable insurance contracts and investment company securities. The NASD also proposes prohibiting all product-specific cash and non-cash sales contests. Currently, internal product-specific non-cash sales contests are permitted provided they meet certain criteria.

The Existing Rules

NASD members and their associated persons generally are prohibited from directly or indirectly accepting or making payments or offers of non-cash compensation in connection with the sale of DPPs, variable insurance products, investment company securities, and the public offering of other securities, including REITS.¹  The prohibitions contain a number of exceptions.²  One exception permits a NASD member to hold an internal non-cash sales contest with respect to the sale of investment company securities or variable insurance products provided that the contest is based on total production and the credit for each type of security sold is equally weighted.³

Proposed Rule 2311

Expansion of the Non-Cash Compensation Rule

The NASD now believes that the general prohibitions on the payment and receipt of non-cash compensationshould apply to all types of securities, as the conflicts of interest that underlie the prohibitions exist with respect to all securities. The NASD proposal would eliminate the current non-cash compensation provisions in Rules 2710(i), 2810(c), 2820(g)(4) and 2830(l)(5) and replace them with proposed Rule 2311. Proposed Rule 2311 would apply to the payment or receipt of non-cash compensation with respect to the sale of stocks, bonds, variable insurance products, investment company securities, DPPs, REITS and any other type of security. Proposed Rule 2311 would retain the current exceptions for (i) gifts, (ii) the occasional meal, ticket to a sporting event or the theater, or comparable entertainment and (iii) training and educational meetings.⁴  However, some changes would be added to the exceptions to define certain terms, and to add clarity and understanding to the rules.

Prohibition of Product-Specific Sales Contests

The NASD also believes that product-specific sales contests, including those that conform to the total production and equal weighting requirements, create an incentive to engage in conduct that is not in the best interests of customers. Therefore, proposed Rule 2311 eliminates the current exceptions for product-specific sales contests.⁵

The prohibition would apply to “stock of the day” and similar promotions, as well as increased bonuses or “President's Club” memberships awarded for the sale of specific securities or types of securities within a defined period.

Under the proposed rule, a member would be able to hold a sales contest among its associated persons that is based on total production on the sale of all securities. Members also would be permitted to award bonuses to registered representatives based on production across all securities. In both situations, a member would be required to maintain records of the contests, including the criteria for awarding prizes and the names of the associated persons who participated in the contest.

Finally, the proposal would eliminate an existing provision that permits non-member companies or other members to contribute to a non-cash compensation arrangement between a member and its associated persons, or contributions by a member to a non-cash compensation arrangement of a non-member.

The proposal does not cover different sales load structures or differential cash payouts among various products. The NASD notes that the treatment of so-called “differential compensation” arrangements currently is the subject of Securities and Exchange Commission rulemaking.

Request For Comments

In addition to general comments on the proposal, the NASD specifically requests comment on whether the proposed definition of “sales contest” adequately addresses those compensation arrangements that create inappropriate incentives, without prohibiting legitimate forms of compensation. The NASD also requests comment on whether there is a need to retain in some form the provision on member and non-member contributions to non-cash compensation arrangements of other members or non-members. The comment period closes on August 5, 2005.

For More Information

Please contact 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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