Planners who work for one of the 5,000 companies that fall under the regulatory arm of NASD, may soon be dealing with new guidelines on gift-giving and entertainment. Concerned that excessive entertaining and gift-giving compromise the ability of brokers to work in the best interests of their clients, NASD and the New York Stock Exchange have recently proposed new rules that would force companies to come up with specific policies and procedures — a change from the vaguely worded entertainment guidelines found in the current rules. Final approval from the Securities and Exchange Commission is pending.
The new rules were developed as NASD was wrapping up a two-year investigation into the gift and entertainment practices of more than 40 member companies. In early December, NASD, along with the Securities and Exchange Commission, fined New York securities firm Jefferies & Co. $9.7 million for illegally lavishing gifts and entertainment on Fidelity Investments equity traders.
Over the Top
As part of the joint investigation with the SEC, NASD fined Jefferies $5.5 million for providing Fidelity traders with more than $1.6 million in gifts, entertainment, and trips between 2002 and 2004. The 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.
In 2002, Jefferies' equity division hired institutional sales trader Kevin Quinn 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.
Did the strategy work? According to the SEC, in the six months preceding Quinn's hiring in 2002, Jefferies received $1.7 million in commissions from Fidelity. In the first nine months of 2004, Jefferies received $24.5 million from Fidelity.
According to NASD, “Jefferies routinely and repeatedly reimbursed Quinn for gifts prohibited by NASD rules, which Quinn provided to Fidelity traders.” (Current NASD rules limit the value of gifts that companies and associated persons may give to customers to $100 per recipient, per year.)
Among the examples of exorbitant gift-giving: Jefferies (through Quinn) lavished 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 gave another Fidelity trader $19,000 worth of tickets to the Wimbledon tennis championships in London, along with eight bottles of wine valued at $5,900. Yet another Fidelity trader was given a $47,000 private chartered flight to the Turks and Caicos Islands.
In addition, 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.
In a report released December 4, the same day as the Jefferies enforcement action was announced, NASD said that it found evidence 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 NYSE, have proposed, the guiding principle of which is that the member firms should not be acting in a “manner that is inconsistent with the best interests of the customer.”
The proposed rule maintains the $100 limit on gifts, but makes changes in the guidelines for business entertainment. Rather than imposing specific dollar limits for entertainment, it requires firms to set the limits and to implement guidelines for advance supervisory approval of these expenses (see sidebar).
“Ordinarily when the NASD files a rule proposal or IM [interpretive material], as in this case… 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, NASD could be encouraging its member firms to re-examine their gift and entertainment policies based on the new proposals, even before final SEC approval.
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,” she says. “So one of the questions I have is, as a practical matter, will [the rule proposals] just sit there until after the merger, or will they continue to move forward?”
New Rule Puts the Onus on Companies
Currently, NASD Rule 3060 and New York Stock Exchange Rule 350 prohibit companies or their associates from giving gifts or gratuities totaling more than $100 annually, per recipient. They also allow for “ordinary and usual business entertainment neither so frequent nor so extensive as to raise any question of propriety.”
A joint rule now being considered by the Securities and Exchange Commission amends the entertainment guidelines so that NASD and NYSE member companies must:
- Define the forms of business entertainment that are appropriate and inappropriate;
- Determine the dollar amount thresholds for entertainment that requires advance supervisory approval;
- Effectively supervise compliance with the company's written gift and entertainment policies;
- Maintain detailed records of the nature and dollar amount of entertainment.
The rule also clarifies business entertainment to mean events attended by both a company employee and a client; otherwise, it would be considered a gift and be subject to the $100 cap.