Article by Kevin Keogh, Gregory P. Gnall and Claudette Robertson Druehl

The White & Case Broker-Dealer Update provides a brief overview of some of the latest legislative, regulatory and judicial actions, policy statements and decisions that affect broker-dealers.

Originally published February 2006

In reaction to perceived abuses concerning excessive entertainment expenses by brokerage firms, NASD recently issued a request for comment on its proposed Interpretive Material ("proposed IM") to Rule 3060 (Influencing or Rewarding Employees of Others). The purpose of the proposed IM is to provide greater clarity and consistency regarding the obligations of securities firms and individual brokers in providing business entertainment to the employees of customers. The New York Stock Exchange, which worked closely with NASD on the issue, plans to propose similar revisions to its Rule 350.

I. NASD Rule 3060

NASD Rule 3060 currently prohibits any firm or person associated with a firm from giving anything of value in excess of $100 per year to any person when such payment is related to the business of the recipient’s employer. The Rule, however, does not prohibit "ordinary and usual business entertainment."1 The Rule seeks both to avoid improprieties that may arise when members give gifts to employees of a customer and to preserve an employee’s duty to that customer. The proposed interpretation does not change the current $100 limit on gifts.

II. Proposed IM to Rule 3060

A. Definitions of "Customer" and "Business Entertainment"

The proposed IM begins by defining the term "customer." A customer is 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." Additionally, "employees" are "all persons who are employees, officers, directors, agents or representatives of a customer." These definitions highlight the distinction between business entertainment provided to a natural person who is a customer (not covered by Rule 3060) and business entertainment provided to employees, agents or representatives of a customer (covered by Rule 3060).

The proposed IM also defines the term "business entertainment" as "providing entertainment to an employee in the form of any 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." This definition highlights the NASD’s position that a member must accompany or participate in an event in order for it to be considered business entertainment (rather than a gift). Further, business entertainment now expressly includes transportation and lodging expenses.

B. Guidance Regarding Written Policies and Procedures by a Member

In order to advance the NASD’s intent of avoiding situations where entertainment may cause an employee of a customer to act inconsistent with its best interests, the proposed IM provides the following guidance as to written policies and procedures that a member must adopt with regard to business entertainment practices:

(1) Defining Appropriate Forms of Business Entertainment: A member must have written policies and procedures that determine and define forms of business entertainment that are appropriate and inappropriate, including the appropriate venues, nature, frequency, types and class of accommodation and transportation in connection with business entertainment, and either the dollar amounts of business entertainment or specified dollar thresholds requiring advance written supervisory approval.

Members may distinguish, and set specifically tailored standards for business entertainment in connection with events that are educational, charitable or philanthropic in nature (but any differentiations must be explicitly addressed in the written policies and procedures with specifically tailored standards);

(2) Consistency with Rule 2110: A member must have written policies and procedures that are designed to promote conduct of the member and its associated persons that is consistent with their obligations under Rule 2110 (Standards of Commercial Honor and Principles of Trade) and does not undermine the performance of an employee’s duty to a customer;

(3) Supervision: A member must have written policies and procedures that are designed to effectively supervise compliance with a member’s written compliance policies and procedures concerning business entertainment;

(4) Records of Expenses: A member must have written policies and procedures that maintain detailed records of the nature and expense of business entertainment and make such information available upon written request to a customer in respect of its employees;

(5) Qualifications of Supervisors: A member must have written policies and procedures that 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 (by an independent reviewer, when practicable); and

(6) Training: A member must have written policies and procedures that require appropriate training and education to all applicable personnel. Note also that a member must be able to demonstrate that it trains its associated persons who supervise.

The proposed IM does not impose rigid limits on the policies and procedures that a member must adopt. Members are not required to impose similar procedures as one another nor are they required to impose the same procedures for all customers. However, the proposed IM stresses that policies and procedures must not be unreasonably vague and business entertainment should not be so lavish as to interfere with an employee’s duty to a customer. Members should instead compete for business on the basis of providing high quality professional services.

The comment period for the proposed interpretation expires on February 23, 2006.

Notice to Members 06-06 can be found at:

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1. Letter to Henry H. Hopkins and Sarah McCafferty, T. Rowe Price Investment Services, Inc., from R. Clark Hooper, NASD, dated June 10, 1999 (1999 Letter).

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