If adopted as proposed, the rules will largely expand supervisory resources needed to oversee compliance.
After a two-year silence, the Financial Industry Regulatory Authority (FINRA) has proposed amendments to Rule 3220 (Influencing or Rewarding the Employees of Others) (Gifts Rule) and Rule 3221 (Restrictions on Non-Cash Compensation) (Non-Cash Compensation Rule) and issued a new Proposed Rule 3222 (Business Entertainment) (Business Entertainment Rule) following its 1 rule review on gifts, gratuities, and non-cash compensation.2 The comment period expires on September 23, 2016.
These proposed amendments and new rule codify past guidance and interpretation, reorganize and consolidate existing rules, and include several new concepts that would significantly affect current practice for many FINRA member broker-dealers.3 Of particular note are the new limitations on non-cash compensation and sales contests, the annual limit on gift's increase from $100 to $175 per person, and a lowered threshold for promotional items to $50 per person.
The proposed revisions to the Non-Cash Compensation Rule provisions are significant, especially the expanded applicability of the rule to all securities products sold by a FINRA member. The structure of the Non-Cash Compensation Rule provisions will remain largely the same within Rule 3221 and will address (1) gifts, (2) training or education, and (3) sales contests. Proposed Rule 3222 would separately cover business entertainment. In addition, proposed definitions for terms within the current provisions, particularly with reference to sales targets, inject uncertainly about whether a sales target is or can be "implied" (i.e., whether a sales target may be tacitly in place).
The Non-Cash Compensation Rule maintains the current rule's gift provision structure by allowing the receipt of gifts within the Gifts Rule caps (with an expanded $175 limit) that are not preconditioned on achieving a sales target.
Consistent with current rule provisions and staff guidance,4 amendments to the training and education (T&E) meeting provisions would continue to permit an offeror to reimburse or pay certain expenses of associated persons (e.g., meals, lodging, and transportation) in connection with a T&E meeting. This applies only, however, if the approval, purpose, and location conditions are met and the prohibitions relating to guest expenses and an associated person's attendance preconditioned on achieving a sales target are not violated.
FINRA proposes to impose the general prohibitions on the payment or receipt of non-cash compensation to all securities products (from a more limited applicability to investment company securities, variably insurance contracts, direct participation programs, and public offerings of debt and equity securities). The added compliance burden could be quite significant and would require a dynamic inventory of securities products sold across a firm's architecture.
FINRA also introduces uncertainty by proposing to define existing concepts. Particularly, the phrase "preconditioned on the achievement of a sales target" is proposed to undergo significant revision. Currently, the term does not contemplate the retroactive analysis of whether a sales target may or may not have been unstated, inferred, or tacitly in place. FINRA proposes that the term refer to a non-cash compensation arrangement in which an offeror or broker-dealer communicates in advance (i.e., implicitly or explicitly) that an associated person will receive non-cash compensation only following the achievement of a (1) dollar-denominated goal for selling securities or (2) finishing within a defined number of top sellers of securities. FINRA's proposal therefore would encompass not only explicit goals that are readily evident, but also unspoken selection criteria as a sales target's "implicit" communication. This proposal, if adopted, would require broker-dealers to analyze each communication or series of communications or events to determine whether together such communications or events might comprise an unstated sales target.
The contemplated provisions relating to sales contests leave in place much of the existing scaffolding of the current sales contest provisions in the non-cash compensation rule, but FINRA proposes amendments that would narrow the availability of the rule's current provisions that permit sales contests. Specifically, the proposal prohibits product-specific internal contests.
The current rule and proposed revised rule permit contests based on total production and equal weighting by certain persons (arrangements between a member and its associated persons or a nonmember company and its sales personnel who are an affiliated member's associated persons) that is not preconditioned on achieving a sales target, provided that certain recordkeeping requirements are satisfied.
If the compensation is preconditioned on achieving a sales target, however, the proposed amendments to the rule would state that the contest must be based on the total production of associated persons with respect to all securities distributed by a member and not be based on conditions that would encourage an associated person to recommend particular securities or categories of securities.
The proposal seeks to prohibit product-specific internal sales contests that favor one security or type of security, although FINRA expressed its belief that such contests are not widely used. Proposed Rule 3221 would exclude from the rule's restrictions gifts of a de minimis value or a promotional or commemorative item within the same parameters as the proposed Gift Rule.
The Gift Rule largely maintains its current contours by consolidating guidance from disparate FINRA (and earlier NASD) notices and letters, albeit with a more liberal gift limit. Greater precision on what FINRA will consider a de minimis gift is a new addition to the collected guidance.
FINRA proposes to raise the limit on gifts to allow broker-dealers to be $75 more generous in their gift giving; the proposed rule 3220 amendments would increase the gift cap from $100 to $175 (apparently to capture inflation since the original adoption of the $100 cap). The cap applies to anything of value that a FINRA member or its associated persons give to any person per year "where such payment is in relation to the business of the recipient's employer." The general principle is simple enough, yet the meat of the rule is contained in the supplementary material (SM), which consolidates previous FINRA 6 and adds new interpretations.
The existing guidance found in the proposed SMs includes
- reiterating that there is no express exclusion from the general gift cap for gifts given during the course of business entertainment (SM .01);
- establishing valuation of gifts, as generally the higher of cost or market value, among others (SM .02);
- specifying that gifts must be aggregated yearly by a firm and its associated persons per recipient (SM .03);
- requiring supervision and separate recordkeeping of gifts (SM .07); and
- allowing for the exclusion of bereavement gifts (SM .04), certain personal gifts given for infrequent life events (SM .05), and certain promotional and commemorative items (SM .06).
New interpretations in the proposed amendment provide that gifts of de minimis value or promotional items of nominal value would not be subject to the Gifts Rule's restrictions or its recordkeeping requirements as long as the value of the gift or promotional item is below $50. FINRA cautions that a firm and its associated persons may not engage in patterns of providing gifts or promotional items of less than $50 to circumvent the Gifts Rule's restrictions and recordkeeping requirements. FINRA's previous guidance stated that for a promotional item to be considered of nominal value, its value must be substantially below $100. The proposed rule may not have the intended effect of redirecting compliance resources to more useful endeavors, because some expenditure of supervisory effort will be necessary to supervise that the exemptions are well understood and followed and the $50 exclusion is not circumvented.
Proposed Rule 3222 codifies and expands the current business entertainment guidance from the non-cash compensation rules into a standalone but complementary principles-based rule.
Current FINRA 7 on business entertainment does not prohibit "ordinary and
usual business entertainment" provided that the entertainment "is neither so frequent nor so extensive as to raise any question of propriety and is not preconditioned on the achievement of a sales target." The current standards also require representatives of the member to be in attendance at the business entertainment.
The proposed Business Entertainment Rule seeks to consolidate provisions and guidance that govern business entertainment both provided and accepted by a broker-dealer and its associated persons and would require written supervisory procedures (WSPs) that address such business entertainment. The Business Entertainment Rule would replace the current vague standard that prohibits entertainment that is "so frequent . . . [and] so extensive as to raise any question of propriety" in favor of a standard prohibiting business entertainment that is intended as, or could reasonably be perceived as intended as, an improper quid pro quo. Although the new standard is equally subjective, it may be easier to administer than the current standard. The required WSPs would be designed to
- detect and prevent business entertainment that is intended as, or could reasonably be perceived as intended as, an improper quid pro quo;
- define forms of permissible and impermissible business entertainment based on the location, nature, frequency, and dollar amount of the business entertainment provided, as well as the type and dollar amount of any accommodations or transportation provided in connection with such business entertainment; and
- require appropriate training and education for all personnel who supervise, administer, or are subject to the WSPs.
If the proposal is adopted, a firm's WSPs will have to describe with much greater specificity the permitted and prohibited activities to avoid ordinary and usual business entertainment that may, in hindsight, be reasonably (or not) "perceived" as an improper quid pro quo.
Although in large part an exercise in consolidating and reorganizing existing guidance from rules, letters, and notices, FINRA's rule proposals on gifts, gratuities, and non-cash compensation also contain definitional elements, rule interpretations, and requirements that will largely expand supervisory resources to oversee compliance with the rule, if adopted as proposed.
1. See Retrospective Rule Review Report: Gifts, Gratuities and Non-Cash Compensation (December 2014), https://www.finra.org/sites/default/files/p602010.pdf.
2. See FINRA Regulatory Notice 16-29: Gifts, Gratuities and Non-Cash Compensation Rules (August 2016), http://www.finra.org/sites/default/files/notice_doc_file_ref/Regulatory-Notice-16-29.pdf.
3. Dually registered investment advisers sometimes chose to adopt certain FINRA rules for both their brokerage and advisory businesses, even though they are not subject to FINRA rules for their advisory businesses. This provides consistency in compliance programs, however, firms that have done so will have to consider the implications of maintaining that consistency given the proposed expanded scope of the gifts, gratuities, and business entertainment rules.
4. See NASD Regulatory & Compliance Alert (Summer 2000), http://www.finra.org/sites/default/files/RCA/p002377.pdf. See NASD Interpretive Letter (March 7, 2001), http://www.finra.org/industry/interpretive-letters/march-7-2001-1200am. See Notice to Members 99-55: Questions and Answers Relation to Non-Cash Compensation Rules (July 1999), http://www.complinet.com/file_store/pdf/rulebooks/nasd_9955.pdf.
5. Through a bit of housekeeping, the non-cash compensation provisions in current Rule 2341(l)(5) (old Rule 2830) would be lifted out of the larger investment company securities rule to conform to the new proposed rule 3221.
6. See FINRA Notice to Members 06-69: Gifts and Gratuities (December 2006), http://www.finra.org/sites/default/files/NoticeDocument/p018024.pdf; See letter from Gary L. Goldsholle, Vice President & Associate General Counsel, FINRA, to Amal Aly, Managing Director & Associate General Counsel, SIFMA (December 17, 2007).
7. See Interpretive Letter to Henry H. Hopkins and Sarah McCafferty, T. Rowe Price Investment Services, Inc. (June 10, 1999), http://www.finra.org/industry/interpretive-letters/june-24-1999-1200am.
This article is provided as a general informational service and it should not be construed as imparting legal advice on any specific matter.