United States: NASD NTM 06-06: Gifts and Business Entertainment

NASD issued a Notice to Members¹ ("NTM 06-06") proposing new interpretive material ("Proposed IM") to NASD Conduct Rule 3060 (Influencing or Rewarding Employees of Others) that outlines the policies and procedures that members must adopt in connection with their business entertainment practices. The Proposed IM would expand on and supersede prior NASD staff guidance with regard to business entertainment practices. The Proposed IM’s overriding principle 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 would be reasonably judged to have the likely effect of causing, such employee to act in a manner that is inconsistent with the best interests of the customer (i.e., the employee’s employer). The New York Stock Exchange announced that it would seek approval from the Securities and Exchange Commission to amend its gifts and entertainment rule. Comments on the Proposed IM are due by February 23, 2006.

NASD Conduct 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. The rule protects against improprieties that could arise when members or their associated persons give gifts or gratuities to employees of a customer. NASD staff issued an interpretive letter in 1999 stating that NASD Conduct Rule 3060 does not prohibit "ordinary and usual business entertainment" (such as an occasional meal, sporting event, theater production or comparable entertainment) provided the entertainment is "neither so frequent nor so extensive as to raise any question of propriety."² The Proposed IM provides extensive guidance on such "business entertainment" by identifying the required policies, procedures and supervision that is required with respect to such business entertainment.

The requirements set forth under the Proposed IM are triggered by two new definitions: customer and business entertainment. The Proposed IM would define "customer" for purposes of the Proposed IM as:

This definition would distinguish between business entertainment provided to natural person customers and business entertainment provided to employees, agents or representatives of a customer that is a business entity; the former is not covered by Conduct Rule 3060, while the latter is covered by Conduct Rule 3060.³

This definition codifies NASD’s position that a member must accompany or participate in an event for it to be deemed business entertainment. Accordingly, if a member gives tickets to a sporting event but does not accompany the recipient to the event, the tickets are deemed to be a gift rather than business entertainment.

The Proposed IM provides the following guidance regarding the written policies and procedures that members would be required to adopt:

1. Members must determine and define the forms of business entertainment that are appropriate and inappropriate, including appropriate venues, nature, frequency, types and class of accommodation and transportation, and either firm dollar limits or thresholds requiring advance written approval. No hard limits are imposed by the Proposed IM. In addition, there is no requirement that members adopt the same limits or treat all recipients equally. In this respect, the Proposed IM explicitly notes that members could establish different standards for business entertainment that pertains to educational, charitable or philanthropic events if such differentiation is explicitly addressed in their written policies and procedures. However, the Proposed IM cautions that members must not adopt procedures that "set standards that are so unbounded or vague that no reasonable determination of propriety can be discerned."
2. Members’ written policies and procedures must promote conduct consistent with Rule 2110 (Standards of Commercial Honor and Principles of Trade) and must not undermine an employee’s duty to the customer (i.e., such employee’s employer). Accordingly, the policies and procedures "should preclude providing business entertainment that is so lavish or extensive in nature that an employee 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’ written policies and procedures must provide for effective supervision and compliance with their business entertainment policies. As long as the policies and procedures are "reasonably designed" to comport with the principles in the Proposed IM, members are free to define the approach and method of their written policies and procedures. The factors that determine appropriate levels of business entertainment and how those determinations are executed, monitored and enforced must be set forth in the written supervisory procedures. In addition, 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 must maintain detailed records of business entertainment expenses and make such records available to the customer with respect to its employees upon written request.
5. Members must establish standards to ensure that persons designated to supervise, approve and document business entertainment expenses are sufficiently qualified and that periodic monitoring for compliance with the written policies and procedures is conducted. While the Proposed IM does not require an independent review, firms should, where practicable, establish procedures to have periodic monitoring of business entertainment by an "independent reviewer."⁴
6. Members should oversee the training and education of all personnel concerning their business entertainment policies and procedures.

Finally, the Proposed IM expressly states that members may not offer anything of value, including, but not limited to, business entertainment, which is illegal under any applicable law or would expose the member, customer or recipient to any civil liability to any governmental authority or agency.

© 2006 Sutherland Asbill & Brennan LLP. All Rights Reserved.

This article is for informational purposes and is not intended to constitute legal advice.