At the same time it was wrapping up a two-year review of the gift and entertainment practices of its member firms, NASD, along with the Securities Exchange Commission, fined a New York securities firm $9.7 million for illegally lavishing gifts and entertainment on Fidelity Investments equity traders.
As part of the joint investigation with the SEC, NASD fined Jefferies & Co. Inc. $5.5 million for providing Fidelity traders with more than $1.6 million in gifts, entertainment, and trips between 2002 and 2004. SEC fined Jefferies $4.2 million
“The value of improper gifts and entertainment in this case is unprecedented,” said James S. Norris, NASD executive vice president and head of enforcement, in a press release announcing the enforcement action. “NASD’s gift and gratuity rules were designed to prevent just the sort of conduct at issue here, which threatens the integrity of the relationship between a brokerage firm and the institutional customer.”
Jefferies hired Kevin Quinn in 2002 as an institutional sales trader in its equity division and, according to investigators, provided him with an annual travel and entertainment budget of $1.5 million. This, the investigation determined, was used by Quinn to entertain Fidelity traders and increase Jefferies’ brokerage business with the Boston-based firm.
And it seems to have worked. According to the SEC, in the six months preceding Quinn’s hiring in 2002, Jefferies received $1.7 million in commissions from Fidelity. But, in the first nine months of 2004, Fidelity paid out $24.5 million to Jefferies.
According to NASD, “Jefferies routinely and repeatedly reimbursed Quinn for gifts prohibited by NASD rules, which Quinn provided to Fidelity traders.” (NASD rules currently limit the value of gifts that firms and associated persons may give to customers of the firm to $100 per recipient, per year.)
For example, in the three years beginning in 2002, Jefferies—through Quinn—provided one Fidelity trader with private chartered flights to Bermuda, Los Angeles, Florida, and Puerto Rico, at a cost of more than $140,000. In 2002, Quinn provided another Fidelity trader with tickets to the Wimbledon tennis championships in London at a cost of $19,000, along with eight bottles of wine worth $5,900. Another Fidelity trader received a $47,000 private chartered flight to the Turks and Caicos Islands.
NASD found that Quinn provided entertainment to Fidelity traders at an excessively lavish level as well. Between 2002 and 2004, Jefferies reimbursed Quinn more than $1 million for entertainment expenses, including $225,000 for four-day golf outings to such locations as Las Vegas and Cabo San Lucas, Mexico. In 2003, Quinn paid more than $75,000 for limousine service and private round-trip chartered flights between Boston and Miami for several Fidelity traders.
As part of the enforcement action, NASD permanently barred Quinn from “associating with any NASD-registered firm in any capacity.” It also fined Scott Jones, Quinn’s supervisor at Jefferies, and suspended him for three months from associating with any NASD-registered firm in a supervisory capacity. Jefferies was also ordered to hire an independent consultant to review its gift and entertainment policies. According to The Wall Street Journal, the SEC is continuing to investigate Fidelity.
Gift Rules Crackdown
The enforcement action against Jefferies capped a two-year investigation by NASD into the gift and entertainment practices of more than 40 of its member firms.
In a report released December 4, the same day as the Jefferies enforcement action was announced, NASD reported that it found evidence that members had not complied with Conduct Rule 3060, the NASD “gift rule.” Many firms apparently failed to implement the procedures necessary to comply with the $100 limit on gifts.
Investigators also found that firms focused their supervision of gifts and entertainment on cost control, rather than compliance, without adequately identifying who is receiving these gifts and determining if they create conflict of interest or other violations of company policies and procedures.
As a result of the investigation, NASD sent member firms added guidance on how to comply with Conduct Rule 3060. NASD also reminded members of the changes it, along with the New York Stock Exchange, have proposed to gift rules. The guiding principle behind the proposed changes is that, according to NASD, “a member should not do or give anything of value to an employee of a customer that is intended or designed to cause, or otherwise 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.”
The proposed rule doesn’t impose specific dollar limits for business entertainment, but it requires firms to set them, or to set guidelines for advance supervisory approval of these expenses.
“Ordinarily when the NASD files a rule proposal or IM [interpretive material], as in this case, the usual presumption is that it doesn’t take effect until it is formally approved by the SEC,” says Susan Krawczyk, a partner with the Washington, D.C., law firm Sutherland, Asbill & Brennan. This time, Krawczyk says, the NASD could be encouraging its member firms to re-examine its gift and entertainment rules based on the new proposals, before they’re finally approved.
Krawczyk, who specializes in the state and federal regulation of the sale and marketing of financial products, points out that in its gifts and entertainment review, NASD says that member firms should reevaluate their gift-giving procedures and should look to the new rule proposals as “valuable resources.”
NASD and NYSE are also in the process of merging their regulatory operations, which leads Krawczyk to wonder whether the SEC has put a hold on rule filings until after the merger takes effect in the second quarter of 2007. “The SEC hasn’t invited comment [on the proposed gift and entertainment rule], which is the next step,” Krawczyk says. “So one of the questions I have is, as a practical matter, will they [the rule proposals] just sit there until after the merger, or will they continue to move forward.”