Self-Regulatory Organizations; National Association of Securities Dealers, Inc.; Notice of Filing of Proposed Rule Change and Amendment Nos. 1 and 2 Thereto Relating to Interpretive Material to NASD Rule 3060 To Require Members To Adopt Policies and Procedures Addressing Business Entertainment, 28743-28752 [E7-9742]

Download as PDF Federal Register / Vol. 72, No. 98 / Tuesday, May 22, 2007 / Notices sunset one year after the Pilot Stocks Phase Date, currently scheduled to occur on July 9, 2007. NASD has filed the proposed rule change for immediate effectiveness.12 The proposed rule change will become operative upon filing with the Commission. 2. Statutory Basis NASD believes that the proposed rule change is consistent with the provisions of Section 15A(b)(6) of the Act,13 which requires, among other things, that NASD rules be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, and, in general, to protect investors and the public interest. NASD believes that the proposed exemptive authority is appropriate because it will allow NASD to address certain implementation issues as they arise. B. Self-Regulatory Organization’s Statement on Burden on Competition NASD does not believe that the proposed rule change will result in any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act. jlentini on PROD1PC65 with NOTICES C. Self-Regulatory Organization’s Statement on Comments on the Proposed Rule Change Received From Members, Participants or Others While NASD did not solicit comments on the proposed rule change, as discussed above, NASD did receive a comment letter in connection with SR– NASD–2007–002.14 NASD is filing the proposed rule change specifically to address this comment letter and the concerns raised by the commenter about the burdens associated with implementation of the new Regulation NMS-related trade report modifiers. As noted above, NASD has determined that the Regulation NMS-related modifiers required under the NASD trade reporting rules are crucial to its regulatory program and does not agree with the commenter that the self-help modifier should be optional. NASD believes that the proposed exemptive authority strikes a fair balance between the needs of NASD’s regulatory program and member concerns regarding the timing and burdens of the necessary systems changes. The proposed rule change should alleviate such burdens by affording members additional time, if needed, to make the necessary systems 12 NASD is filing this proposed rule change for immediate effectiveness to allow NASD to address exemptive requests immediately without regard to when the changes to the underlying trade reporting rules are operational. 13 15 U.S.C. 78o–3(b)(6). 14 See FIF Letter, supra note 11. VerDate Aug<31>2005 18:21 May 21, 2007 Jkt 211001 changes relating to the self-help modifier, the qualified contingent trade modifier, the sub-penny modifier, and the modifier used to distinguish inbound and outbound intermarket sweep orders. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action The foregoing proposed rule change has become effective pursuant to Section 19(b)(3)(A)(i) of the Act 15 and subparagraph (f)(1) of Rule 19b–4 thereunder,16 because it constitutes a stated policy, practice, or interpretation with respect to the meaning, administration, or enforcement of an existing rule. At any time within 60 days of the filing of the proposed rule change, the Commission may summarily abrogate such rule change if it appears to the Commission that such action is necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Act. IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods: Electronic Comments • Use the Commission’s Internet comment form (http://www.sec.gov/ rules/sro.shtml); or • Send an e-mail to rulecomments@sec.gov. Please include File Number SR–NASD–2007–032 on the subject line. Paper Comments • Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549–1090. All submissions should refer to File Number SR–NASD–2007–032. This file number should be included on the subject line if e-mail is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s Internet Web site (http://www.sec.gov/ rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the 15 15 16 17 PO 00000 U.S.C. 78s(b)(3)(A)(i). CFR 240.19b–4(f)(1). Frm 00078 Fmt 4703 Sfmt 4703 28743 Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission’s Public Reference Room. Copies of the filing also will be available for inspection and copying at the principal office of NASD. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR–NASD–2007–032 and should be submitted on or before June 12, 2007. For the Commission, by the Division of Market Regulation, pursuant to delegated authority.17 Jill M. Peterson, Assistant Secretary. [FR Doc. E7–9741 Filed 5–21–07; 8:45 am] BILLING CODE 8010–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–55765; File No. SR–NASD– 2006–044] Self-Regulatory Organizations; National Association of Securities Dealers, Inc.; Notice of Filing of Proposed Rule Change and Amendment Nos. 1 and 2 Thereto Relating to Interpretive Material to NASD Rule 3060 To Require Members To Adopt Policies and Procedures Addressing Business Entertainment May 15, 2007. Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’) 1 and Rule 19b–4 thereunder,2 notice is hereby given that on April 11, 2006, the National Association of Securities Dealers, Inc. (‘‘NASD’’) filed with the Securities and Exchange Commission (‘‘SEC’’ or ‘‘Commission’’) the proposed rule change as described in Items I, II, and III below, which Items have been prepared by NASD. On April 17, 2007, NASD filed Amendment No. 1 to the proposed rule change.3 On May 1, 2007, NASD filed Partial Amendment 17 17 CFR 200.30–3(a)(12). U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 3 Amendment No. 1 replaced and superseded the original rule filing in its entirety. 1 15 E:\FR\FM\22MYN1.SGM 22MYN1 28744 Federal Register / Vol. 72, No. 98 / Tuesday, May 22, 2007 / Notices No. 2 to the proposed rule change.4 The Commission is publishing this notice to solicit comments on the proposed rule change, as amended, from interested persons.5 I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change NASD is proposing to adopt Interpretive Material (‘‘IM’’) to NASD Rule 3060 to require members to adopt policies and procedures addressing business entertainment. Below is the text of the proposed rule change. Proposed new language is in italics. * * * * * IM–3060. Business Entertainment The NASD Board of Governors is issuing this interpretation concerning the obligations of a member in connection with any business entertainment of a customer representative. This interpretation does not apply to any non-cash compensation that falls within Rule 2820(g) or Rule 2830(l) (i.e., entertainment provided by offerors to associated persons of a member in connection with the sale and distribution of variable contracts or investment company securities). This interpretation does not apply to any member that does not engage in business entertainment. For any member that engages in business entertainment, this interpretation applies only with respect to business entertainment provided to customer representatives. This interpretation supersedes any prior interpretive letters or statements of NASD staff regarding business entertainment under Rule 3060. jlentini on PROD1PC65 with NOTICES (a) General Requirements No member or person associated with a member shall, directly or indirectly, provide any business entertainment to a customer representative pursuant to the establishment of, or during the course of, a business relationship with any customer that is intended or designed to cause, or would be reasonably judged to have the likely effect of causing, such 4 Partial Amendment No. 2 attached Exhibit 4 of Amendment No. 1, which shows changes of the proposed rule text from the immediately preceding filing. 5 The Commission also is separately publishing a notice by the New York Stock Exchange LLC (‘‘NYSE’’) to propose new NYSE Rule 350A on business entertainment, which is substantially similar to NASD’s proposed rule text. See Securities Exchange Act Release No. 55766 (May 15, 2007) (SR–NYSE–2006–06). The NYSE proposal and the NASD proposal primarily differ in that the NYSE proposal contains a ‘‘Notice to Customers’’ provision. See discussion infra Part IV, Solicitation of Comments section. VerDate Aug<31>2005 18:21 May 21, 2007 Jkt 211001 customer representative to act in a manner that is inconsistent with: (1) The best interests of the customer; or (2) The best interests of any person to whom the customer owes a fiduciary duty. (b) Definitions For purposes of this interpretation, the following definitions shall apply: (1) The term ‘‘customer’’ means: (A) A person that maintains a business relationship with a member via the maintenance of an account, through the conduct of investment banking, or pursuant to other securities-related activity; or (B) A person whose customer representative receives business entertainment for the purpose of encouraging such person to establish a business relationship with the member by opening an account with the member or by conducting investment banking or other securities-related activity with the member. (2) The term ‘‘customer representative’’ means a person who is an employee, officer, director, or agent of a customer, unless such person is a family member of the customer. (3) The term ‘‘family member’’ means a person’s parents, mother-in-law or father-in-law, spouse, brother or sister, brother-in-law or sister-in-law, son-inlaw or daughter-in-law, and children. (4) The term ‘‘business entertainment’’ means any social event, hospitality event, sporting event, entertainment event, meal, leisure activity, or event of like nature or purpose, including business entertainment offered in connection with a charitable event, educational event or business conference, as well as any transportation or lodging related to such activity or event, in which an associated person of a member accompanies a customer representative. (A) If a customer representative is not accompanied by an appropriate associated person of the member, any expenses associated with the business entertainment will be considered a gift under Rule 3060 unless exigent circumstances make it impractical for an associated person of the member to attend. All instances where such exigent circumstances are invoked must be clearly and thoroughly documented and be subject to the prior written approval of a designated supervisory person or, in very limited circumstances where such prior approval cannot reasonably be obtained, to a prompt post-event review to be conducted and documented by such supervisory person. PO 00000 Frm 00079 Fmt 4703 Sfmt 4703 (B) Anything of value given or provided to a customer representative that does not fall within the definition of ‘‘business entertainment’’ is a gift under Rule 3060. (C) In valuing business entertainment expenses pursuant to this interpretation, a member’s written policies and procedures must specify the methodology to be used by the member to calculate the value of business entertainment. In general, business entertainment expenses should be valued at the higher of face value or cost to the member. (c) Written Policies and Procedures (1) Each member must have written policies and supervisory procedures that: (A) Define forms of business entertainment that are appropriate and inappropriate using quantitative and/or qualitative standards that address the nature and frequency of the entertainment provided, as well as the type and class of any accommodations or transportation provided in connection with such business entertainment; and (B) Make clear that anything of value given or otherwise provided to a customer representative that does not fall within the definition of ‘‘business entertainment’’ is a gift under Rule 3060; and (C) Impose either specific dollar limits on business entertainment or require advance written supervisory approval beyond specified dollar thresholds; and (D) Are designed to detect and prevent business entertainment that is intended as, or could reasonably be perceived to be intended as, an improper quid pro quo or that could otherwise give rise to a potential conflict of interest or undermine the performance of a customer representative’s duty to a customer or any person to whom the customer owes a fiduciary duty; and (E) Establish standards to ensure that persons designated to supervise and administer the written policies and procedures are sufficiently qualified; and (F) Require appropriate training and education for all personnel who supervise, administer, or are subject to the written policies and procedures. (2) A member’s written policies and procedures may distinguish, and set specifically tailored standards for, business entertainment in connection with events that are deemed to be primarily educational, charitable, or philanthropic in nature, provided that such standards comply with the requirements of this interpretation and E:\FR\FM\22MYN1.SGM 22MYN1 Federal Register / Vol. 72, No. 98 / Tuesday, May 22, 2007 / Notices are explicitly addressed in the written policies and procedures. (d) Recordkeeping (1) Each member’s written policies and procedures must require the maintenance of detailed records of business entertainment expenses provided to any customer representative. The member is not required to maintain records of: (A) Business entertainment when the total value of the business entertainment, including all expenses associated with the business entertainment, does not exceed $50 per day; or (B) Additional expenses incurred in connection with otherwise recorded business entertainment that do not, in the aggregate, exceed $50 per day. (2) Each member’s written policies and procedures must include provisions reasonably designed to prevent associated persons of the member from circumventing the recordkeeping requirements in contravention of the spirit and purpose of this interpretation (e.g., a pattern of providing a customer representative with business entertainment valued at $48). (3) Each member’s written policies and procedures must require that, upon a customer’s written request, the member will promptly make available to the customer any business entertainment records regarding business entertainment provided to customer representatives of that customer. jlentini on PROD1PC65 with NOTICES (e) Exemption for Members With Business Entertainment Expenses Below $7,500 A member whose business entertainment expenses in the course of its fiscal year are below $7,500 shall be subject only to paragraphs (a), (b), and (c)(1)(D) and (E) of this interpretation, and shall be exempt from paragraphs (c) (other than (c)(1)(D) and (E) as noted above) and (d). Each member that relies on this exemption must evidence that its business entertainment expenses are below the $7,500 threshold. * * * * * II. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, NASD included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. NASD has prepared VerDate Aug<31>2005 18:21 May 21, 2007 Jkt 211001 summaries, set forth in sections A, B, and C below, of the most significant aspects of such statements. A. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change 1. Purpose (A) Background: NASD Rule 3060 prohibits any member or person associated with a member, directly or indirectly, from giving anything of value in excess of $100 per year to any person where such payment is in relation to the business of the recipient’s employer. In 1999, NASD staff issued an interpretive letter stating that Rule 3060 does not prohibit ‘‘ordinary and usual business entertainment’’ (such as an occasional meal, sporting event, theater production, or comparable entertainment event) provided that the entertainment ‘‘is neither so frequent nor so extensive as to raise any question of propriety.’’ 6 The 1999 Letter noted that the interpretation was based, in part, on NASD’s rules governing noncash compensation in connection with the offer and sale of investment company shares and variable annuities. Recently, NASD members have requested more guidance on the rules concerning gifts and business entertainment in the wake of press reports of enforcement actions regarding gifts and gratuities.7 In response to these requests, NASD is proposing interpretive material to NASD Rule 3060 to outline the policies and procedures that a member must adopt in connection with its business entertainment practices.8 The proposed rule change would supersede any prior guidance of NASD staff regarding business entertainment under Rule 3060, including the 1999 Letter. The proposed rule change would not supersede any guidance provided under other NASD 6 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’’), available at http:// www.nasd.com/web/idcplg?IdcService= SS_GET_PAGE&ssDocName=NASDW_002715. 7 See, e.g., Jenny Anderson, Fidelity Disciplines 16 Traders Over Gifts From Brokers, N.Y. Times, Dec. 17, 2004, at C5; Andrew Caffrey & Jeffrey Krasner, Probe of Gifts Said to Focus on Fidelity, Boston Globe, Dec. 7, 2004, at A1; Probe on Gifts to Fund Officials Is Said to Include Jefferies, Los Angeles Times, Dec. 3, 2004, at C4; Jenny Anderson, On Wall Street, A Closer Look At Giving Gifts, N.Y. Times, Nov. 24, 2004, at C1; Greg Farrell, Brokerages’ gifts to mutual fund managers scrutinized, USA Today, Nov. 24, 2004, at B2. 8 In addition, NASD also recently published guidance concerning gifts and gratuities under Rule 3060. See Notice to Members 06–69 (December 2006). PO 00000 Frm 00080 Fmt 4703 Sfmt 4703 28745 rules.9 NASD has also clarified that any non-cash compensation falling under Rule 2820(g) or Rule 2830(l) would be subject to the standards imposed by those rules.10 Rule 3060 is intended to prevent improprieties that may arise when a member or an associated person of a member gives gifts or gratuities to employees of a customer. To guard against these improprieties, Rule 3060 imposes a $100 annual limit on gifts and gratuities that a member or person associated with a member can give to an employee of a customer in relation to the employer firm’s business. However, ordinary and usual business entertainment is not considered a gift or gratuity and is permitted ‘‘so long as it is neither so frequent nor so extensive as to raise any question of propriety.’’ 11 The proposed rule change is intended to replace this statement regarding business entertainment with an approach that permits each member to adopt specific policies and procedures tailored to its business needs. The proposed rule change also seeks to provide members with general guidance concerning the types of issues that a firm’s policies and procedures must address and mandates that each member maintain appropriate records to ensure that persons associated with the member are complying with the written policies and procedures. In general, NASD, working closely with the New York Stock Exchange (the ‘‘NYSE’’), concluded that, in clarifying a member’s obligation under Rule 3060, a specific standard was unworkable and impractical.12 As NASD noted in the Notice to Members seeking comment on the proposed rule change, ‘‘the proposed IM does not impose hard limits, nor does it require that all members adopt the same limits or even treat all recipients equally.’’ 13 Rather, the proposed rule change requires that each member assess its use of business entertainment, determine what limitations are appropriate and meet the general guidelines set forth in the proposed rule change, and adopt written 9 For example, the proposed rule change would not supersede the guidance given by NASD staff in Notice to Members 99–55 (July 1999) concerning NASD Rules 2820 and 2830. 10 NASD published a Notice to Members requesting comment on a proposed rule change to replace Rules 2820(g) and 2830(l), among others, with a new Rule 2311. See Notice to Members 05– 40 (June 2005). If such a rule change is proposed and approved, NASD will amend the language of proposed IM–3060 to reflect the change. 11 See 1999 Letter. 12 The NYSE also has filed a proposed rule change with the Commission addressing business entertainment. See supra note 5. 13 See Notice to Members 06–06 (January 2006). E:\FR\FM\22MYN1.SGM 22MYN1 28746 Federal Register / Vol. 72, No. 98 / Tuesday, May 22, 2007 / Notices jlentini on PROD1PC65 with NOTICES policies and procedures to ensure that persons associated with the member are following those limitations. The introductory paragraph in the proposed interpretation also makes clear that the interpretation does not apply to any member that does not engage in business entertainment. While, as discussed below, some commenters criticized a general, principles-based approach as lacking clarity and uniform standards, NASD and the NYSE both concluded that such an approach was more appropriate. The proposed rule change expands upon the existing principles-based approach to business entertainment established in the 1999 Letter but specifically addresses the content of a member’s written policies and procedures. (B) General Requirements: The observance of ‘‘high standards of commercial honor and just and equitable principles of trade’’ required of a member in the conduct of its business under NASD Rule 2110 includes the obligation of a member not to act in a manner contrary to the best interests of a customer in the conduct of business with or for such customer. Consequently, when a member interacts with an employee—or any other agent— of a customer, the member should not give that person anything of value that is intended or designed to cause, or otherwise would be reasonably judged to have the likely effect of causing, such person to act in a manner that is inconsistent with the best interests of the customer or any person to whom the customer owes a fiduciary duty.14 Paragraph (a) of the proposed rule change codifies this concept by explicitly setting forth the general purpose behind proposed IM–3060. NASD believes that the guiding principle in navigating the concern of placing a customer representative in conflict with his duty to a customer is that members should compete for business on the basis of providing the best professional services. While it is not inappropriate for business entertainment to foster an environment for the member to promote or educate the customer representative with respect to such professional services, it is inconsistent with the terms of proposed IM–3060 to use business entertainment to provide incentives to customer 14 NASD Rule 2110 precludes the offering of any thing of value, including but not limited to business entertainment, that comprises conduct that, to any degree, is either illegal under any applicable law or would expose the member, customer, or recipient of the member’s business entertainment to any civil liability. For example, any business entertainment that violated the Foreign Corrupt Practices Act or any commercial bribery statutes and laws would, in turn, violate Rule 2110. VerDate Aug<31>2005 18:21 May 21, 2007 Jkt 211001 representatives to conduct customer business with and/or through the member without due consideration as to whether the nature and terms of such professional services meet the objectives and are in the best interests of the account. (C) Definitions: There are three defined terms that are integral to an understanding of the proposed rule change.15 First, ‘‘customer’’ is defined as (1) ‘‘a person that maintains a business relationship with a member via the maintenance of an account, through the conduct of investment banking, or pursuant to other securities-related activity’’ or (2) ‘‘a person whose customer representative receives business entertainment for the purpose of encouraging such person to establish a business relationship with the member by opening an account with the member or by conducting investment banking or other securities-related activity with the member.’’ 16 The definition of ‘‘customer’’ has been amended from the previous rule filing; however, the changes do not affect those persons considered ‘‘customers’’ for the purpose of the proposed rule change. Second, for purposes of the proposed rule change, a ‘‘customer representative’’ means ‘‘a person who is an employee, officer, director, or agent of a customer, unless such person is a family member of the customer.’’ The term ‘‘customer representative’’ replaces the term ‘‘employee’’ in the previous rule filing to clarify that the term includes persons other than employees. The term also now conforms to the terminology in the NYSE’s proposed rule change. Moreover, the definition has been amended to exclude certain family members from the definition of customer representative.17 This exclusion has been added to the definition to address situations where a close family member has power-ofattorney or similar authority over another family member’s account (e.g., an adult child with authority over his or her elderly parent’s account). NASD believes that these situations are unlikely to result in the types of conflicts of interest the proposed rule change seeks to address. This definition, when coupled with the general requirements set forth in 15 Terms used in the interpretation have the same meaning as those defined in NASD’s By-Laws and rules unless otherwise specified. 16 NASD Rule 0120(n) defines the term ‘‘person’’ to ‘‘include any natural person, partnership, corporation, association, or other legal entity.’’ 17 The term ‘‘family member’’ means a person’s parents, mother-in-law or father-in-law, spouse, brother or sister, brother-in-law or sister-in-law, son-in-law or daughter-in-law, and children. PO 00000 Frm 00081 Fmt 4703 Sfmt 4703 paragraph (a) of the proposed rule change, limit the proposed rule change to business entertainment provided to a customer representative. This point is explicitly addressed in the preamble to the interpretation, which states: ‘‘This interpretation does not apply to any member that does not engage in business entertainment. For any member that engages in business entertainment, this interpretation applies only with respect to business entertainment provided to customer representatives.’’ Thus, the proposed rule change does not address business entertainment provided to a natural person customer.18 It addresses only business entertainment provided to a customer representative of the customer (although such customer may be a natural or non-natural person). Third, ‘‘business entertainment’’ is defined as ‘‘any social event, hospitality event, sporting event, entertainment event, meal, leisure activity, or event of like nature or purpose, including entertainment offered in connection with a charitable event, educational event or business conference, as well as any transportation or lodging related to such activity or event, in which an associated person of a member accompanies a customer representative.’’ This definition codifies NASD’s long-standing position that an associated person of a member must accompany or participate in an event for it to be deemed ‘‘business entertainment’’ rather than a ‘‘gift.’’ In addition, NASD has deleted the portion of the definition that stated that it is not necessary for business to be conducted for an event to be ‘‘business entertainment.’’ The definition of business entertainment encompasses all the events enumerated provided that the customer representative is accompanied by an associated person of the member; because the clause did not further define business entertainment, it has been deleted. As noted above, the definition of ‘‘business entertainment’’ generally prescribes that if a customer representative is not accompanied by an appropriate associated person of a member, any expenses associated with the business entertainment will be 18 As discussed in footnote 5 of Notice to Members 06–06, and as noted below, natural persons who are both natural person customers and customer representatives should be treated as customer representatives. That is, associated persons of a member cannot avoid the application of the firm’s business entertainment policies by claiming that business entertainment provided to a person who is both a natural person customer and a customer representative was provided to that individual solely in his or her ‘‘personal,’’ rather than business, capacity. E:\FR\FM\22MYN1.SGM 22MYN1 jlentini on PROD1PC65 with NOTICES Federal Register / Vol. 72, No. 98 / Tuesday, May 22, 2007 / Notices considered a gift under Rule 3060. An exception to this requirement is proposed to address instances when exigent circumstances make it impractical for an associated person of a member to attend a business entertainment event. All instances where such exigent circumstances are invoked must be clearly and thoroughly documented and be subject to the prior written approval of a designated supervisory person or, in very limited circumstances where such prior approval cannot reasonably be obtained, to a prompt post-event review to be conducted and documented by such supervisory person. NASD believes that the ‘‘exigent circumstances’’ exception provides necessary flexibility in light of realworld, last minute emergency situations that could arise that would make it difficult, if not impossible, for an appropriate associated person of a member to attend a business entertainment event with a customer representative. Examples of exigent circumstances would be a sick child, an accident, or some other sudden, overriding circumstance. NASD does not believe this provision would lead to circumvention of the spirit or substance of the proposed rule change since all such occurrences are subject to detailed documentation such that any patterns of abuse would become quickly apparent to supervisory personnel. Paragraph (b)(4)(C) of the proposed rule change provides guidance to members on the valuation of business entertainment. The proposed rule change requires that a member’s written policies and procedures specify how the firm will calculate the value of business entertainment. In general, business entertainment items should be valued at the greater of face value or cost to the member. NASD has been asked about the extent to which the proposed rule change reaches business entertainment conducted outside the United States, particularly entertainment provided by persons who are employed in commonly controlled affiliates of a financial services company operating in the United States and/or foreign jurisdictions. As an initial matter, proposed IM–3060 reaches all business entertainment of a member firm and persons associated with a member, even if such entertainment occurs outside of the United States or is provided to foreign individuals. However, NASD does not believe that all persons who are employed in commonly controlled affiliates of a financial services company operating in the United States and/or foreign jurisdictions are necessarily VerDate Aug<31>2005 18:21 May 21, 2007 Jkt 211001 associated persons of the member, even if they report to a person who, in another capacity, is an associated person of a member. An associated person of a member may have management and supervisory responsibilities for non-member affiliates of a financial services company, located within or outside of the United States, without the result that the persons being managed and supervised in the non-member affiliates would necessarily be deemed associated persons of the member. It is the view of NASD that in such instances the following factors establish that an employee of a non-member affiliate is not an associated person of the member: (1) The manager/supervisor of that employee is recognized in the organization as having a scope of responsibilities outside of the member firm; (2) the exercise of the management and supervision over that employee by such manager/supervisor is not controlled by the member, is reviewable for purposes of performance and compensation outside of the member, and is not conducted for the benefit of the member; and (3) the employee of the non-member affiliates is not otherwise employed or engaged in the investment banking or securities business of the member and controlled by the member in respect of such activities. (D) Written Policies and Procedures: A member’s policies and procedures must be designed to promote conduct consistent with NASD Rule 2110 and should not undermine the performance of a customer representative’s duty to a customer. The proposed rule change requires members to adopt written policies and procedures concerning business entertainment that: (1) Define forms of business entertainment that are appropriate and inappropriate using quantitative and/or qualitative standards that address the nature and frequency of the entertainment provided, as well as the type and class of any accommodation or transportation provided in connection with such business entertainment; (2) impose either specific dollar limits on business entertainment or require advance written supervisory approval beyond specified dollar thresholds; (3) are designed to detect and prevent business entertainment that is intended as, or could reasonably be perceived to be intended as, an improper quid pro quo or that could otherwise give rise to a potential conflict of interest or undermine the performance of a customer representative’s duty to a customer; (4) establish standards to ensure that persons designated to supervise and administer the written PO 00000 Frm 00082 Fmt 4703 Sfmt 4703 28747 policies and procedures are sufficiently qualified; and (5) require appropriate training and education for all personnel who supervise, administer, or are subject to the written policies and procedures. (i) Define Forms of Appropriate and Inappropriate Business Entertainment: A member’s written policies and procedures concerning business entertainment must define forms of business entertainment that are appropriate and inappropriate using quantitative and/or qualitative standards that address the nature and frequency of the entertainment provided, as well as the type and class of any accommodations or transportation provided in connection with such business entertainment. A member’s policies and procedures should include provisions regarding appropriate venues, nature, frequency, and types and class of accommodation and transportation. A member may determine that certain activities, though legal, are nevertheless inappropriate for business entertainment. NASD believes that the standards of business entertainment adopted by members must meet the requirements of Rule 2110 that members and persons associated with a member adhere to high standards of commercial honor. Consequently, a member would violate proposed IM–3060 not only if it failed to adopt procedures, but also if the procedures set standards that are so unbounded or vague that no reasonable determination of propriety can be discerned. The proposed rule change also would allow, but not require, members to establish different standards for business entertainment in connection with events that are educational, charitable, or philanthropic in nature. If a member chooses to distinguish between forms of business entertainment in its policies and procedures, it should ensure that these types of business entertainment nonetheless comply with Rule 2110 and the general requirements set forth in paragraph (a) of the proposed rule change. (ii) Impose Either Specific Dollar Limits on Business Entertainment or Require Advance Written Supervisory Approval Beyond Specified Dollar Thresholds: A member’s written policies and procedures must impose either specific dollar limits on business entertainment or require advance written supervisory approval beyond specified dollar thresholds. The proposed rule change does not impose hard dollar limits or require that all E:\FR\FM\22MYN1.SGM 22MYN1 jlentini on PROD1PC65 with NOTICES 28748 Federal Register / Vol. 72, No. 98 / Tuesday, May 22, 2007 / Notices members adopt the same dollar limits or treat all recipients equally. (iii) Designed to Detect and Prevent Business Entertainment That Is Intended As, or Could Reasonably Be Perceived To Be Intended As, an Improper Quid Pro Quo: A member’s written policies and procedures must include procedures designed to detect and prevent business entertainment that is intended as, or could reasonably be perceived to be intended as, an improper quid pro quo. For example, members should develop written policies and procedures reasonably designed to preclude providing business entertainment that is so lavish or extensive in nature that a customer representative would likely feel compelled to place order flow on behalf of the customer without due regard to best execution or other transaction pricing considerations. NASD does not intend that this standard would establish a per se violation of the proposed IM if a customer representative who received business entertainment from the member is later found to have violated his or her obligations to his or her employer; however, such actions by a customer representative may warrant further investigation by the member firm as to whether the member’s policies and procedures are, in fact, reasonably tailored to prevent these types of violations.19 While an NASD member is not ultimately responsible for the conduct of its customers’ employees or agents, the member is responsible for ensuring that persons associated with the member do not engage in activities that are designed to, or reasonably likely to, cause the recipient to engage in improper conduct. Moreover, a member’s compliance with its policies and procedures would not serve to automatically shield the member from all liability under the proposed IM for any misconduct by a customer representative. (iv) Supervision: As is the case with every NASD rule, supervision is a critical component of business entertainment policies and procedures. Members are free to define the approach and method of their written policies and procedures provided they are reasonably designed to comport with the principles stated in the proposed rule filing. Irrespective of the manner in which a member crafts its procedures, it must be clear from the supervisory policies and procedures what factors 19 NASD Rule 3012(a) requires members to test and verify their supervisory procedures and ‘‘create additional or amend supervisory procedures where the need is identified by such testing and verification.’’ VerDate Aug<31>2005 18:21 May 21, 2007 Jkt 211001 determine appropriate levels of business entertainment and how those determinations are executed, monitored, and enforced. This is particularly true if members elect to use qualitative, rather than quantitative, standards. In addition, such supervisory procedures should provide a method for evidencing both the breadth of supervisory activities as well as the information upon which such supervision is conducted. For example, a member’s policies and procedures must evidence the basis upon which a supervisor will determine that business entertainment does not violate a member’s standards as to the nature, frequency, and dollar amounts of entertainment. A member’s policies and procedures must establish standards to ensure that persons designated to supervise and administer the member’s written policies and procedures are sufficiently qualified. The requirement that the persons designated to supervise business entertainment expenses be ‘‘sufficiently qualified’’ is not intended to impose a registration requirement or similar obligation on these individuals; rather, the requirement is intended to ensure that the member’s designation is of persons who are familiar with the applicable regulatory requirements and are sufficiently senior and experienced to entrust with the approval obligations envisioned by the member’s policies and procedures. (v) Training and Education: A member’s business entertainment policies and procedures must require appropriate training and education to all applicable personnel. A member also must be able to demonstrate that it trains persons associated with the member who supervise, administer, and are subject to such written business entertainment policies and procedures in all applicable requirements. (E) Recordkeeping: The only effective way for a member to ensure that persons associated with the member are following the firm’s policies and procedures is to establish a system to track their business entertainment expenses. Consequently, a member’s policies and procedures are required to include procedures regarding the maintenance of detailed records of business entertainment expenses provided to any customer representative. NASD recognizes that recordkeeping requirements present compliance burdens for firms, and NASD has sought to address the potential burden by providing a recordkeeping carve-out for small expenditures, none of which would reasonably be expected to influence the behavior of the recipient. PO 00000 Frm 00083 Fmt 4703 Sfmt 4703 Consequently, the proposed rule change provides that members are not required to maintain records of (1) Business entertainment when the total value of the business entertainment, including all expenses associated with the business entertainment, does not exceed $50 per day or (2) additional expenses incurred in connection with otherwise recorded business entertainment that do not, in the aggregate, exceed $50 per day.20 The $50 threshold would apply only to events or activities with a total cost that did not exceed $50 per day (e.g., an inexpensive lunch) or to minor expenses related to an otherwise reported business entertainment event (such as a hot dog at an NBA basketball game, where the basketball game ticket is reported as a business entertainment expense). Firms may not allow persons associated with the member to disaggregate business entertainment expenses relating to an activity or event in an effort to avoid recordkeeping obligations. Thus, a dinner expense of $40 followed by a sporting event with a ticket price of $40 would need to be tracked under the member’s recordkeeping system. The proposed rule change also requires that a member’s written policies and procedures include provisions reasonably designed to prevent persons associated with the member from circumventing the recordkeeping requirements in contravention of the spirit and purpose of proposed IM–3060. Thus, for example, members should seek to prevent associated persons of the member from engaging in patterns of providing business entertainment that falls below the $50 reporting threshold. One of the key elements of the proposed rule change is the ability of a customer to request from the member information regarding the business entertainment expenses provided to the customer representatives of the customer. Although members are permitted to establish reasonable guidelines regarding a customer’s ability to request this information, such guidelines must not impair the ability of the customer to obtain, on a reasonable and regular basis, information concerning the member’s business entertainment expenses pertaining to 20 Members should be aware, however, that they may need to track such expenses under other NASD or SEC rules. There is no express exclusion from Rule 3060 for gifts given during the course of business entertainment. See Notice to Members 06– 69 (December 2006). NASD staff has, however, provided guidance that Rule 3060 does not apply to certain promotional items of nominal value that display the firm’s logo. See id. E:\FR\FM\22MYN1.SGM 22MYN1 Federal Register / Vol. 72, No. 98 / Tuesday, May 22, 2007 / Notices jlentini on PROD1PC65 with NOTICES the customer representatives of such customer. (F) Exemption for Members with Business Entertainment Expenses Below $7,500: The concerns that the proposed interpretation seeks to address are not presented by those members that, in the aggregate, do not devote significant resources to business entertainment. Consequently, the interpretation provides for a partial exemption for those members with annual business entertainment expenses below $7,500. The provision provides that the $7,500 ceiling should be measured on a fiscal year basis. Each member that relies on the exemption must evidence that its business entertainment expenses were below the threshold. Importantly, the exemption is not a total exemption from all aspects of the proposed interpretation. All members (except those members that do not engage in any business entertainment) are required to abide by the interpretation’s general requirements as set forth in paragraph (a) and are required to have written policies and supervisory procedures that are designed to detect and prevent business entertainment that is intended as, or could reasonably be perceived to be intended as, an improper quid pro quo or that could otherwise give rise to a potential conflict of interest or undermine the performance of a customer representative’s duty to a customer or any person to whom the customer owes a fiduciary duty, and establish standards to ensure that persons designated to supervise and administer such policies and procedures are sufficiently qualified. The effective date of the proposed rule change will be six months following Commission approval. NASD will announce the effective date of the proposed rule change in a Notice to Members to be published no later than 60 days following Commission approval. 2. Statutory Basis NASD believes that the proposed rule change is consistent with the provisions of Section 15A(b)(6) of the Act,21 which requires, among other things, that NASD rules must be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, and, in general, to protect investors and the public interest. NASD believes that the proposed rule change clarifies existing obligations of members with respect to the provision of business entertainment and will help prevent conduct by associated persons 21 15 U.S.C. 78o–3(b)(6). VerDate Aug<31>2005 18:21 May 21, 2007 Jkt 211001 of a member that could undermine the performance of an employee’s duty to the member’s customer. B. Self-Regulatory Organization’s Statement on Burden on Competition NASD does not believe that the proposed rule change will result in any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act. C. Self-Regulatory Organization’s Statement on Comments on the Proposed Rule Change Received From Members, Participants, or Others The proposed rule change was published for comment in NASD Notice to Members 06–06 (January 2006). NASD received 28 comments in response to the Notice.22 A copy of the Notice to Members was attached to the original rule filing as Exhibit 2a. Copies of the comment letters received in response to the Notice were attached to the original rule filing as Exhibit 2b. Of the 28 comment letters received, 12 were generally in favor of the proposed 22 Letter from Pinnacle Taxx Advisors, Inc. (‘‘Pinnacle’’), dated Jan. 26, 2006; Letter from Keefe, Bruyette & Woods (‘‘KBW’’), dated Jan. 26, 2006; Letter from J.P. Morgan, dated Jan. 30, 2006; Letter from Evolve Securities, Inc. (‘‘Evolve’’), dated Jan. 31, 2006; Letter from Seasongood & Mayer, LLC (‘‘Seasongood’’), dated Feb. 2, 2006; Letter from Plexus Consulting (‘‘Plexus’’) o/b/o International Association of Small Broker Dealers and Advisers, dated Feb. 6, 2006; Letter from Dominion Investor Services, Inc. (‘‘Dominion’’), dated Feb. 13, 2006; Letter from National Regulatory Services (‘‘NRS’’), dated Feb. 6, 2006; Letter from T. Rowe Price Investment Services, Inc. (‘‘T. Rowe Price’’), dated Feb. 17, 2006. Letter from Maplewood Investment Advisors, Inc. (‘‘Maplewood’’), dated Feb. 22, 2006; Letter from Financial Services Institute, Inc. (‘‘FSI’’), dated Feb. 23, 2006; Letter from Transamerica Financial Advisors, Inc. (‘‘Transamerica’’), dated Feb. 23, 2006; Letter from H.D. Vest Financial Services (‘‘H.D. Vest’’), dated Feb. 23, 2006; Letter from ING U.S. Financial Services (‘‘ING’’), dated Feb. 23, 2006; Letter from The Investment Company Institute (‘‘ICI’’), dated Feb. 23, 2006; Letter from Hines Real Estate Securities, Inc. (‘‘Hines’’), dated Feb. 21, 2006; Letter from The National Society of Compliance Professionals (‘‘NSCP’’), dated Feb. 23, 2006; Letter from Financial Network, dated Feb. 23, 2006; Letter from Coker Palmer, dated Feb. 23, 2006; Letter from Griffin, Kubik, Stephens & Thompson, Inc. (‘‘Griffin’’), dated Mar. 2, 2006; Letter from Debevoise & Plimpton LLP (‘‘Debevoise’’) o/b/o The Midtown Regulatory Group, dated Mar. 3, 2006; Letter from Transamerica Capital, Inc. (‘‘Transamerica Capital’’), dated Mar. 3, 2006; Letter from The Bond Market Association (‘‘BMA’’), dated Mar. 3, 2006; Letter from Goodwin Browning & Luna Securities, Inc. (‘‘GB&L’’), dated Mar. 3, 2006; Letter from The ABA Securities Association (‘‘ABASA’’), dated Mar. 3, 2006; Letter from Wachovia Capital Markets, LLC (‘‘Wachovia’’), dated Mar. 3, 2006; Letter from Neal E. Nakagiri (‘‘Nakagiri’’), dated Mar. 3, 2006; and Letter from The Self-Regulation and Supervisory Practices Committee of the Securities Industry Association (‘‘SIA’’), dated Mar. 7, 2006. PO 00000 Frm 00084 Fmt 4703 Sfmt 4703 28749 rule change, 13 were opposed, and three took no clear position. A number of commenters raised concerns with NASD’s general, principles-based approach to the proposed rule change 23 and questioned the overall need for the IM.24 As indicated above, the proposed rule change was undertaken in response to requests by NASD members for clarity concerning appropriate business entertainment. Both NASD and the NYSE undertook to provide members with additional guidance following these requests. To the extent some commenters questioned whether NASD should seek to ‘‘regulate’’ the employees of their members’ customers, these commenters fail to recognize that NASD staff guidance in the 1999 Letter already prohibits business entertainment for employees of customers that is so frequent or excessive as to raise questions of propriety. Moreover, as discussed above, NASD is not seeking to regulate the behavior of the representatives of a member’s customers; 25 rather, NASD is requiring each member to develop and enforce some appropriate degree of limitation on the business entertainment that persons associated with the member provide to its customers’ representatives. In achieving this end, both NASD and the NYSE believe that a general, principles-based approach is more appropriate than a restrictive, onesize-fits-all regulatory scheme. Given the significant variation in broker-dealer business models and size, and regional differences in what may be considered appropriate business entertainment, NASD concluded that a fixed-dollar standard or similar specific mandate would prove unworkable. One commenter suggested that NASD exempt certain small broker-dealers, at 23 See, e.g., Letters from Dominion, Financial Network, H.D. Vest, Hines, Plexus, and NRS. 24 See, e.g., Letters from Evolve, Financial Network, FSI, GB&L, H.D. Vest, ING, Maplewood, Nakagiri, and Transamerica Capital. Several commenters indicated that the proposed rule change should be made through notice and comment rulemaking with the Commission. As the Notice to Members stated, Section 19 of the Securities Exchange Act of 1934 requires that proposed rule changes such as IM–3060 be approved by the Commission following publication for public comment in the Federal Register. See Notice to Members 06–06, at 2 & n.2. 25 NASD recognizes that customers whose representatives receive business entertainment have the responsibility to ensure that their representatives do not engage in improper conduct. However, NASD believes that the person providing business entertainment cannot disclaim any responsibility for improper conduct that flows directly from business entertainment its employee provided when the employee either intended for the business entertainment to have that effect or could reasonably have judged that the business entertainment would be likely to have that effect. E:\FR\FM\22MYN1.SGM 22MYN1 28750 Federal Register / Vol. 72, No. 98 / Tuesday, May 22, 2007 / Notices jlentini on PROD1PC65 with NOTICES least in part because they lack the resources to affect decision-making in the manner the IM seeks to prohibit and that such extravagant and extensive business entertainment is localized among larger firms and does not occur in rural or small-market areas.26 In response to this comment, NASD has included a limited exemption for members whose total business entertainment expenses in the course of their fiscal year are below $7,500. The exemption provides relief from the recordkeeping requirements of the rule, as well as many of the specific requirements regarding written policies and supervisory procedures. NASD believes, however, that the general requirements of the proposed rule change should apply to all members that engage in business entertainment. In addition, members that engage in business entertainment should have written policies and supervisory procedures that are designed to detect and prevent improper conduct. As noted above, the proposed rule change does not apply to any member firm that does not engage in any form of business entertainment. Several commenters suggested that NASD identify in the IM the specific factors to be considered by firms in developing their written policies and procedures, such as those identified by the NYSE in its rule filing. NASD staff does not believe it is necessary to identify specific factors in the IM and that doing so may undermine the flexibility the proposed rule change is designed to achieve.27 NASD staff will consider whether additional guidance concerning the IM is necessary when announcing the proposed rule change in a Notice to Members. Several commenters expressed concern that the proposed rule change, including some of the defined terms, was too vague and may, in application, prove overly broad. Among other things, these commenters suggested that the proposed rule change could disadvantage firms with more conservative policies and procedures,28 effectively require pre-approval of all business entertainment,29 and introduce disadvantages among different types of firms and other industry participants.30 Other commenters believed that the principles-based approach proposed by NASD is the appropriate manner to 26 Letter from Evolve. Letter from BMA. 28 See, e.g., Letters from Hines and ING. 29 See Letter from Transamerica Capital. 30 See, e.g., Letters from Dominion and Seasongood. 27 See VerDate Aug<31>2005 18:21 May 21, 2007 Jkt 211001 address the needed clarification of business entertainment.31 While NASD recognizes that there will be distinctions among each member’s written policies and procedures, NASD concluded that member firms were in the best position to determine appropriate limitations and restrictions on the business entertainment provided by persons associated with a member. After considering the various comments concerning the definitions of ‘‘customer’’ and ‘‘business entertainment’’ in the proposed rule change,32 NASD has determined not to amend the definitions substantively.33 While several commenters recommended that the definition of customer track the definition of ‘‘accredited investor’’ as defined in SEC Rule 501 under the Securities Act of 1933, NASD staff does not believe that the application of the IM should be dependent on any particular level of assets. While member firms may choose to treat certain types of customers or certain types of business entertainment differently for purposes of their written policies and procedures, NASD believes that, for purposes of the proposed rule change, a broad definition of each is appropriate. With respect to one comment, NASD believes that it would be appropriate for a member’s written policies and procedures to allow case-by-case review and approval for types of entertainment not specifically set forth in the member’s policies and procedures.34 One commenter was concerned that a registered representative may not be aware whether a recipient of business entertainment is a representative of a customer of the firm.35 If a person is entertained in his personal capacity as a natural person client, and the firm has information barriers that would prevent the person providing the business entertainment from knowing that the person represents another customer as a representative, and the person providing business entertainment has no knowledge that such person is a representative of a customer at the time of the business entertainment, then such entertainment would fall outside the scope of the IM. Several commenters raised suggestions concerning Rule 3060’s 31 See Letters from BMA, Griffin, NSCP, and Wachovia. 32 See, e.g., Letters from BMA, Financial Network, FSI, ING, and Transamerica Capital. 33 As noted in footnote 2 above, although the language in the definitions has been modified, the substance and breadth has been retained. 34 See Letter from Debevoise. 35 See Letter from FSI. PO 00000 Frm 00085 Fmt 4703 Sfmt 4703 limitation on gifts and gratuities, ranging from comments focused on increasing the $100 limitation, moving from a hard figure standard to a principles-based approach, and providing guidance on the types of gifts and incidental expenses that should be included or excluded from any limitation.36 The proposed rule change is focused on business entertainment, which is excepted from the limitation on ‘‘gifts,’’ and NASD is not currently considering amending the rule regarding gifts and gratuities.37 NASD has long recognized that gifts—in contrast to business entertainment—are not incidental to the transaction of business. NASD requires that any gifts be de minimis and sees no reason to depart from this long-held view. NASD does not believe that the proposed rule change is the appropriate forum for providing interpretive advice on other aspects of Rule 3060; however, NASD staff recently published additional guidance on Rule 3060 regarding gifts and gratuities. See Notice to Members 06–69 (December 2006). Two commenters expressed concern that the IM shifts the burden of proof required under NASD Rules and suggested that any change to Rule 3060 be done through a separate rule proposal rather than through an IM.38 As discussed in footnote 2 and the accompanying text of Notice to Members 06–06, the IM, which is the equivalent of a rule provision, is being proposed in accordance with the procedures for a proposed rule change under Section 19 of the Act.39 Rule 3060 and IM–3060 are two separate provisions, and the burden of proof under Rule 3060 is not affected by the proposed IM. Several commenters appeared concerned that the discussion in footnote 5 of Notice to Members 06–06 would prohibit entertaining friends and relatives. This misconstrues the meaning of footnote 5, which says: ‘‘Members cannot circumvent this proposed interpretive material by providing business entertainment to a natural person customer who also is an employee, agent or representative of a customer by claiming that such business 36 See, e.g., Letters from ABASA, BMA, Debevoise, Evolve, Financial Network, and Wachovia. 37 The one exception is the one noted above with respect to exigent circumstances. Numerous commenters requested that NASD adopt the exigent circumstances exception from the gift rule similar to the exception that the NYSE has proposed. See, e.g., Letters from ABASA, BMA, and Wachovia. As discussed above, NASD has determined that it is appropriate to provide for such an exception. 38 See Letters from Financial Network and ING. 39 15 U.S.C. 78s. E:\FR\FM\22MYN1.SGM 22MYN1 jlentini on PROD1PC65 with NOTICES Federal Register / Vol. 72, No. 98 / Tuesday, May 22, 2007 / Notices entertainment applies only to the ‘natural person’ relationship.’’ What is required by footnote 5 is that an associated person of a member not avoid the application of the firm’s business entertainment policies by claiming such entertainment is ‘‘personal’’ rather than business. Firms are, however, likely to include policies in their business entertainment procedures to address personal entertainment of a customer representative where there is a family or some other personal relationship, much the way firms do today for gifts and gratuities under Rule 3060 that are not in relation to the business of the employer of the recipient. Many commenters requested clarification on whether an ‘‘independent’’ review could be conducted by an independent department within, or affiliated with, the member.40 NASD has removed the specific review sections of the proposed rule change because it was redundant of existing obligations. A member firm’s responsibility to supervise business entertainment exists under Rule 3010(a), and a member firm’s responsibility to test and verify that its supervisory policies and procedures are achieving their intended purpose and complying with the federal securities laws and regulations and NASD rules exists under Rule 3012(a)(1). Many commenters expressed concern with the breadth of the recordkeeping requirement and requested a lengthy implementation time for the recordkeeping requirements.41 In response to these comments, NASD provided an exception from the recordkeeping obligations for expenses under $50. However, as discussed above, NASD believes that a member’s policies and procedures should prevent persons associated with the member from intentionally avoiding the $50 requirement by breaking up what are otherwise connected costs or by engaging in frequent, repeated business entertainment at amounts below the $50 threshold. For example, a firm’s policies and procedures may require associated persons of the member to submit all business entertainment expenses for review; however, the firm may decide to record and track only amounts over $50. NASD also is providing for an effective date of six months following the Commission’s approval of the proposed rule change. Members should provide the Commission with specific comments 40 See, e.g., Letters from Debevoise, Evolve, ICI, KBW, NRS, Transamerica Capital, and Wachovia. 41 See, e.g., Letters from Evolve, Financial Network, FSI, H.D. Vest, ICI, ING, Maplewood, and Transamerica Capital. VerDate Aug<31>2005 18:21 May 21, 2007 Jkt 211001 as to whether this is sufficient time to implement recordkeeping systems to comply with the proposed rule change and, if it is not sufficient, offer reasons why and suggest an appropriate implementation period. One commenter suggested that NASD permit a member’s procedures to include prompt review of business entertainment after the event.42 The commenter offered an example of a dinner that unexpectedly exceeds the firm’s threshold. NASD does not believe that a member’s policies and procedures should allow for post-event approval because there does not appear to be an effective means of rescinding business entertainment that has already been provided. Rather, persons associated with a member who are concerned that the cost of an event may exceed the threshold should request approval in advance to go over the firm’s limit. In such a situation, the member should impose another dollar limit rather than simply waive the requirement. Finally, several commenters requested that NASD and the NYSE harmonize their proposed rule changes or, in the alternative, include a provision that a dual member that complies with one of the SRO’s rule will be deemed to be in compliance with the other SRO’s rule.43 In filing this Amendment No. 1, NASD has sought to address substantive disparities between its rule and that of the NYSE. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action Within 35 days of the date of publication of this notice in the Federal Register or within such longer period (i) As the Commission may designate up to 90 days of such date if it finds such longer period to be appropriate and publishes its reasons for so finding or (ii) as to which the self-regulatory organization consents, the Commission will: (A) By order approve such proposed rule change, or (B) Institute proceedings to determine whether the proposed rule change should be disapproved. IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. The Commission notes that the NYSE’s proposed Rule 350A(e) provides that a NYSE member organization must 42 See Letter from T. Rowe Price. e.g., Letters from BMA and SIA. 43 See, PO 00000 Frm 00086 Fmt 4703 Sfmt 4703 28751 have a system in place to give notice (e.g., via the member organization’s Web site, a disclosure document, or other appropriate means) to customers that use customer representatives that upon a customer’s written request, the NYSE member organization will provide detailed information regarding the manner and expense of any business entertainment provided by the NYSE member organization to the customer representative,44 while the NASD’s proposal does not contain a similar notice provision.45 The Commission is soliciting comment on this difference between the NYSE and NASD proposed rules and specifically whether NASD should have a similar notification provision for customers utilizing customer representatives. Comments may be submitted by any of the following methods: Electronic Comments • Use the Commission’s Internet comment form (http://www.sec.gov/ rules/sro.shtml); or • Send an e-mail to rulecomments@sec.gov. Please include File Number SR–NASD–2006–044 on the subject line. Paper Comments • Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549–1090. All submissions should refer to File Number SR–NASD–2006–044. This file number should be included on the subject line if e-mail is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s Internet Web site (http://www.sec.gov/ rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission’s Public Reference Room. Copies of the filing also will be available for inspection and copying at 44 NYSE believes that the notice provision would encourage the expansion of monitoring and controls on business entertainment beyond broker-dealers to the employers of business entertainment recipients. See supra note 5. 45 See supra note 5. E:\FR\FM\22MYN1.SGM 22MYN1 28752 Federal Register / Vol. 72, No. 98 / Tuesday, May 22, 2007 / Notices the principal office of the Exchange. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR–NASD–2006–044 and should be submitted on or before June 12, 2007. For the Commission, by the Division of Market Regulation, pursuant to delegated authority.46 Jill M. Peterson, Assistant Secretary. [FR Doc. E7–9742 Filed 5–21–07; 8:45 am] BILLING CODE 8010–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–55770; File No. SR–NSCC– 2007–05] Self-Regulatory Organizations; National Securities Clearing Corporation; Notice of Filing and Immediate Effectiveness of Proposed Rule Change Relating to Its Ability To Receive Transaction Data From Trade Reporting Facilities That Are Facilities of a Self-Regulatory Organization May 15, 2007. jlentini on PROD1PC65 with NOTICES Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’), 1 notice is hereby given that on March 26, 2007, the National Securities Clearing Corporation (‘‘NSCC’’) filed with the Securities and Exchange Commission (‘‘Commission’’) the proposed rule change described in Items I, II, and III below, which items have been prepared primarily by NSCC. NSCC filed the proposed rule change pursuant to Section 19(b)(3)(A)(i) of the Act 2 and Rule 19b–4(f)(1) thereunder 3 so that the proposal was effective upon filing with the Commission. The Commission is publishing this notice to solicit comments on the proposed rule change from interested parties. I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change The purpose of the proposed rule change is to clarify NSCC’s Rule 7, ‘‘Comparison and Trade Recording Operation,’’ in order to make clear that NSCC may accept transaction data on behalf of NSCC members from trade reporting facilities that are affiliated 46 17 CFR 200.30–3(a)(12). U.S.C. 78s(b)(1). 2 15 U.S.C. 78s(b)(3)(A)(i). 3 17 CFR 240.19b–4(f)(1). with and operated as a facility of a selfregulatory organization (‘‘Trade Reporting Facilities’’ or ‘‘TRFs’’). II. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change In its filing with the Commission, NSCC included statements concerning the purpose of and basis for the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. NSCC has prepared summaries, set forth in sections (A), (B), and (C) below, of the most significant aspects of these statements.4 (A) Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change The purpose of this filing is to clarify NSCC’s Rule 7, ‘‘Comparison and Trade Recording Operation,’’ in order to make clear that NSCC may accept transaction data on behalf of NSCC Members from Trade Reporting Facilities. Background NSCC’s Rule 7 permits NSCC in its discretion to accept transaction data from self-regulatory organizations (‘‘SROs’’), as defined in the Securities Exchange Act of 1934 (and, similarly, from derivatives clearing organizations registered or deemed registered with the Commodities Futures Trading Commission). Such data may be provided directly by an SRO or through subsidiary or affiliated organizations. In conjunction with the recent separation of the National Association of Securities Dealers, Inc. (‘‘NASD’’) and The Nasdaq Stock Market, Inc. (‘‘Nasdaq’’), the Commission approved the establishment by NASD and Nasdaq of the NASD/Nasdaq Trade Reporting Facility, which provides NASD members with an alternative means for reporting transactions in exchangelisted securities effected otherwise than on an exchange. Since then, NASD has established several additional new TRFs in conjunction with other registered securities exchanges, each of which provides NASD members with alternate means for reporting transactions in exchange-listed securities effected otherwise than on an exchange. All of these TRFs will operate as joint ventures with the relevant exchanges, but NASD, the ‘‘SRO Member’’ of each such venture, will have sole regulatory 1 15 VerDate Aug<31>2005 18:21 May 21, 2007 4 The Commission has modified the text of the summaries prepared by NSCC. Jkt 211001 PO 00000 Frm 00087 Fmt 4703 Sfmt 4703 responsibility for each TRF. As such, the TRFs are facilities ‘‘of NASD and subject to NASD’s registration as a national securities association.’’5 At the current time, NASD filed proposed rule changes with the Commission relating to the establishment of the following TRFs: The NASD/Nasdaq TRF; the NASD/ National Securities Exchange (NSX) TRF; the NASD/Boston Stock Exchange (BSE) TRF; and the NASD/New York Stock Exchange (NYSE) TRF. Currently, all the TRFs are operational. The rules governing the operations of these facilities are contained in NASD Rule 4000 and 6100 Series for the NASD/ Nasdaq TRF, NASD Rule 4000C and 6000C Series for the NASD/NSX TRF, NASD Rule 4000D and 6000D Series for the NASD/BSE TRF, and NASD Rule 4000E and 6000E Series for the NASD/ NYSE TRF. With the exception of the NASD/NYSE TRF, the applicable rules permit the TRFs, at the option of their NASD member participant, to submit the data relating to reported trades to NSCC for clearance and settlement. In order to accommodate the NASD and to promote the efficient processing of securities transactions, NSCC proposes to clarify its Rule 7, Section 5 6 to make clear that it may accept transaction data from such TRFs as facilities of the NASD, the applicable SRO. For this purpose, the proposed clarification provides that the TRF be affiliated with and operated as a facility of the SRO and that the rules and operation of the TRF be the subject of a rule change of the SRO that has been duly filed with the Commission and is effective.7 By allowing NSCC to receive transaction data for clearing purposes from these facilities with respect to NSCC’s members, broker-dealers will be able to report transactions for both reporting/regulatory and clearing purposes in a single report to the TRFs. 5 See e.g., Securities Exchange Act Release Nos. 54084 (June 30, 2006), 71 FR 38935 (July 10, 2006) [SR–NASD–2005–087] (establishment of the NASD/ Nasdaq TRF); 54715 (November 6, 2006), 71 FR 66354 (November 14, 2006) [SR–NASD–2006–108] (establishment of the NASD/NSX TRF); and 54931 (December 13, 2006), 71 FR 76409 (December 20, 2006) [SR–NASD–2006–115] (establishment of the NASD/BSE TRF). 6 Rule 7, Section 5 is proposed to be renumbered as part of other changes pending pursuant to File No. SR–NSCC–2006–04. 7 NASD filed a proposed rule change relating to the establishment of the NASD/NYSE TRF for immediate effectiveness, asserting that such proposed rule change was ‘‘non-controversial’’ because it was substantially similar to the rules relating to the other TRFs, which were subject to notice and comment and approved by the Commission. Securities Exchange Act Release No. 55325 (February 21, 2007), 72 FR 8820 (February 27, 2007) [SR–NASD–2007–011]. E:\FR\FM\22MYN1.SGM 22MYN1

Agencies

[Federal Register Volume 72, Number 98 (Tuesday, May 22, 2007)]
[Notices]
[Pages 28743-28752]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E7-9742]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-55765; File No. SR-NASD-2006-044]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Notice of Filing of Proposed Rule Change and Amendment 
Nos. 1 and 2 Thereto Relating to Interpretive Material to NASD Rule 
3060 To Require Members To Adopt Policies and Procedures Addressing 
Business Entertainment

May 15, 2007.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on April 11, 2006, the National Association of Securities Dealers, Inc. 
(``NASD'') filed with the Securities and Exchange Commission (``SEC'' 
or ``Commission'') the proposed rule change as described in Items I, 
II, and III below, which Items have been prepared by NASD. On April 17, 
2007, NASD filed Amendment No. 1 to the proposed rule change.\3\ On May 
1, 2007, NASD filed Partial Amendment

[[Page 28744]]

No. 2 to the proposed rule change.\4\ The Commission is publishing this 
notice to solicit comments on the proposed rule change, as amended, 
from interested persons.\5\
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    \1\ 15 U.S.C. 78s(b)(1).1
    \2\ 17 CFR 240.19b-4.
    \3\ Amendment No. 1 replaced and superseded the original rule 
filing in its entirety.3
    \4\ Partial Amendment No. 2 attached Exhibit 4 of Amendment No. 
1, which shows changes of the proposed rule text from the 
immediately preceding filing.
    \5\ The Commission also is separately publishing a notice by the 
New York Stock Exchange LLC (``NYSE'') to propose new NYSE Rule 350A 
on business entertainment, which is substantially similar to NASD's 
proposed rule text. See Securities Exchange Act Release No. 55766 
(May 15, 2007) (SR-NYSE-2006-06). The NYSE proposal and the NASD 
proposal primarily differ in that the NYSE proposal contains a 
``Notice to Customers'' provision. See discussion infra Part IV, 
Solicitation of Comments section.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    NASD is proposing to adopt Interpretive Material (``IM'') to NASD 
Rule 3060 to require members to adopt policies and procedures 
addressing business entertainment. Below is the text of the proposed 
rule change. Proposed new language is in italics.
* * * * *

IM-3060. Business Entertainment

    The NASD Board of Governors is issuing this interpretation 
concerning the obligations of a member in connection with any business 
entertainment of a customer representative. This interpretation does 
not apply to any non-cash compensation that falls within Rule 2820(g) 
or Rule 2830(l) (i.e., entertainment provided by offerors to associated 
persons of a member in connection with the sale and distribution of 
variable contracts or investment company securities). This 
interpretation does not apply to any member that does not engage in 
business entertainment. For any member that engages in business 
entertainment, this interpretation applies only with respect to 
business entertainment provided to customer representatives. This 
interpretation supersedes any prior interpretive letters or statements 
of NASD staff regarding business entertainment under Rule 3060.

(a) General Requirements

    No member or person associated with a member shall, directly or 
indirectly, provide any business entertainment to a customer 
representative pursuant to the establishment of, or during the course 
of, a business relationship with any customer that is intended or 
designed to cause, or would be reasonably judged to have the likely 
effect of causing, such customer representative to act in a manner that 
is inconsistent with:
    (1) The best interests of the customer; or
    (2) The best interests of any person to whom the customer owes a 
fiduciary duty.

(b) Definitions

    For purposes of this interpretation, the following definitions 
shall apply:
    (1) The term ``customer'' means:
    (A) A person that maintains a business relationship with a member 
via the maintenance of an account, through the conduct of investment 
banking, or pursuant to other securities-related activity; or
    (B) A person whose customer representative receives business 
entertainment for the purpose of encouraging such person to establish a 
business relationship with the member by opening an account with the 
member or by conducting investment banking or other securities-related 
activity with the member.
    (2) The term ``customer representative'' means a person who is an 
employee, officer, director, or agent of a customer, unless such person 
is a family member of the customer.
    (3) The term ``family member'' means a person's parents, mother-in-
law or father-in-law, spouse, brother or sister, brother-in-law or 
sister-in-law, son-in-law or daughter-in-law, and children.
    (4) The term ``business entertainment'' means any social event, 
hospitality event, sporting event, entertainment event, meal, leisure 
activity, or event of like nature or purpose, including business 
entertainment offered in connection with a charitable event, 
educational event or business conference, as well as any transportation 
or lodging related to such activity or event, in which an associated 
person of a member accompanies a customer representative.
    (A) If a customer representative is not accompanied by an 
appropriate associated person of the member, any expenses associated 
with the business entertainment will be considered a gift under Rule 
3060 unless exigent circumstances make it impractical for an associated 
person of the member to attend. All instances where such exigent 
circumstances are invoked must be clearly and thoroughly documented and 
be subject to the prior written approval of a designated supervisory 
person or, in very limited circumstances where such prior approval 
cannot reasonably be obtained, to a prompt post-event review to be 
conducted and documented by such supervisory person.
    (B) Anything of value given or provided to a customer 
representative that does not fall within the definition of ``business 
entertainment'' is a gift under Rule 3060.
    (C) In valuing business entertainment expenses pursuant to this 
interpretation, a member's written policies and procedures must specify 
the methodology to be used by the member to calculate the value of 
business entertainment. In general, business entertainment expenses 
should be valued at the higher of face value or cost to the member.

(c) Written Policies and Procedures

    (1) Each member must have written policies and supervisory 
procedures that:
    (A) Define forms of business entertainment that are appropriate and 
inappropriate using quantitative and/or qualitative standards that 
address the nature and frequency of the entertainment provided, as well 
as the type and class of any accommodations or transportation provided 
in connection with such business entertainment; and
    (B) Make clear that anything of value given or otherwise provided 
to a customer representative that does not fall within the definition 
of ``business entertainment'' is a gift under Rule 3060; and
    (C) Impose either specific dollar limits on business entertainment 
or require advance written supervisory approval beyond specified dollar 
thresholds; and 
    (D) Are designed to detect and prevent business entertainment that 
is intended as, or could reasonably be perceived to be intended as, an 
improper quid pro quo or that could otherwise give rise to a potential 
conflict of interest or undermine the performance of a customer 
representative's duty to a customer or any person to whom the customer 
owes a fiduciary duty; and
    (E) Establish standards to ensure that persons designated to 
supervise and administer the written policies and procedures are 
sufficiently qualified; and
    (F) Require appropriate training and education for all personnel 
who supervise, administer, or are subject to the written policies and 
procedures.
    (2) A member's written policies and procedures may distinguish, and 
set specifically tailored standards for, business entertainment in 
connection with events that are deemed to be primarily educational, 
charitable, or philanthropic in nature, provided that such standards 
comply with the requirements of this interpretation and

[[Page 28745]]

are explicitly addressed in the written policies and procedures.

(d) Recordkeeping

    (1) Each member's written policies and procedures must require the 
maintenance of detailed records of business entertainment expenses 
provided to any customer representative. The member is not required to 
maintain records of:
    (A) Business entertainment when the total value of the business 
entertainment, including all expenses associated with the business 
entertainment, does not exceed $50 per day; or
    (B) Additional expenses incurred in connection with otherwise 
recorded business entertainment that do not, in the aggregate, exceed 
$50 per day.
    (2) Each member's written policies and procedures must include 
provisions reasonably designed to prevent associated persons of the 
member from circumventing the recordkeeping requirements in 
contravention of the spirit and purpose of this interpretation (e.g., a 
pattern of providing a customer representative with business 
entertainment valued at $48).
    (3) Each member's written policies and procedures must require 
that, upon a customer's written request, the member will promptly make 
available to the customer any business entertainment records regarding 
business entertainment provided to customer representatives of that 
customer.

(e) Exemption for Members With Business Entertainment Expenses Below 
$7,500

    A member whose business entertainment expenses in the course of its 
fiscal year are below $7,500 shall be subject only to paragraphs (a), 
(b), and (c)(1)(D) and (E) of this interpretation, and shall be exempt 
from paragraphs (c) (other than (c)(1)(D) and (E) as noted above) and 
(d). Each member that relies on this exemption must evidence that its 
business entertainment expenses are below the $7,500 threshold.
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, NASD included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. NASD has prepared summaries, set forth in sections A, B, 
and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    (A) Background: NASD Rule 3060 prohibits any member or person 
associated with a member, directly or indirectly, from giving anything 
of value in excess of $100 per year to any person where such payment is 
in relation to the business of the recipient's employer. In 1999, NASD 
staff issued an interpretive letter stating that Rule 3060 does not 
prohibit ``ordinary and usual business entertainment'' (such as an 
occasional meal, sporting event, theater production, or comparable 
entertainment event) provided that the entertainment ``is neither so 
frequent nor so extensive as to raise any question of propriety.'' \6\ 
The 1999 Letter noted that the interpretation was based, in part, on 
NASD's rules governing non-cash compensation in connection with the 
offer and sale of investment company shares and variable annuities.
---------------------------------------------------------------------------

    \6\ 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''), available at http://www.nasd.com/
web/idcplg?IdcService=SS_GET_PAGE&ssDocName=NASDW_002715.
---------------------------------------------------------------------------

    Recently, NASD members have requested more guidance on the rules 
concerning gifts and business entertainment in the wake of press 
reports of enforcement actions regarding gifts and gratuities.\7\ In 
response to these requests, NASD is proposing interpretive material to 
NASD Rule 3060 to outline the policies and procedures that a member 
must adopt in connection with its business entertainment practices.\8\ 
The proposed rule change would supersede any prior guidance of NASD 
staff regarding business entertainment under Rule 3060, including the 
1999 Letter. The proposed rule change would not supersede any guidance 
provided under other NASD rules.\9\ NASD has also clarified that any 
non-cash compensation falling under Rule 2820(g) or Rule 2830(l) would 
be subject to the standards imposed by those rules.\10\
---------------------------------------------------------------------------

    \7\ See, e.g., Jenny Anderson, Fidelity Disciplines 16 Traders 
Over Gifts From Brokers, N.Y. Times, Dec. 17, 2004, at C5; Andrew 
Caffrey & Jeffrey Krasner, Probe of Gifts Said to Focus on Fidelity, 
Boston Globe, Dec. 7, 2004, at A1; Probe on Gifts to Fund Officials 
Is Said to Include Jefferies, Los Angeles Times, Dec. 3, 2004, at 
C4; Jenny Anderson, On Wall Street, A Closer Look At Giving Gifts, 
N.Y. Times, Nov. 24, 2004, at C1; Greg Farrell, Brokerages' gifts to 
mutual fund managers scrutinized, USA Today, Nov. 24, 2004, at B2.
    \8\ In addition, NASD also recently published guidance 
concerning gifts and gratuities under Rule 3060. See Notice to 
Members 06-69 (December 2006).
    \9\ For example, the proposed rule change would not supersede 
the guidance given by NASD staff in Notice to Members 99-55 (July 
1999) concerning NASD Rules 2820 and 2830.
    \10\ NASD published a Notice to Members requesting comment on a 
proposed rule change to replace Rules 2820(g) and 2830(l), among 
others, with a new Rule 2311. See Notice to Members 05-40 (June 
2005). If such a rule change is proposed and approved, NASD will 
amend the language of proposed IM-3060 to reflect the change.
---------------------------------------------------------------------------

    Rule 3060 is intended to prevent improprieties that may arise when 
a member or an associated person of a member gives gifts or gratuities 
to employees of a customer. To guard against these improprieties, Rule 
3060 imposes a $100 annual limit on gifts and gratuities that a member 
or person associated with a member can give to an employee of a 
customer in relation to the employer firm's business. However, ordinary 
and usual business entertainment is not considered a gift or gratuity 
and is permitted ``so long as it is neither so frequent nor so 
extensive as to raise any question of propriety.'' \11\ The proposed 
rule change is intended to replace this statement regarding business 
entertainment with an approach that permits each member to adopt 
specific policies and procedures tailored to its business needs. The 
proposed rule change also seeks to provide members with general 
guidance concerning the types of issues that a firm's policies and 
procedures must address and mandates that each member maintain 
appropriate records to ensure that persons associated with the member 
are complying with the written policies and procedures.
---------------------------------------------------------------------------

    \11\ See 1999 Letter.
---------------------------------------------------------------------------

    In general, NASD, working closely with the New York Stock Exchange 
(the ``NYSE''), concluded that, in clarifying a member's obligation 
under Rule 3060, a specific standard was unworkable and 
impractical.\12\ As NASD noted in the Notice to Members seeking comment 
on the proposed rule change, ``the proposed IM does not impose hard 
limits, nor does it require that all members adopt the same limits or 
even treat all recipients equally.'' \13\ Rather, the proposed rule 
change requires that each member assess its use of business 
entertainment, determine what limitations are appropriate and meet the 
general guidelines set forth in the proposed rule change, and adopt 
written

[[Page 28746]]

policies and procedures to ensure that persons associated with the 
member are following those limitations. The introductory paragraph in 
the proposed interpretation also makes clear that the interpretation 
does not apply to any member that does not engage in business 
entertainment.
---------------------------------------------------------------------------

    \12\ The NYSE also has filed a proposed rule change with the 
Commission addressing business entertainment. See supra note 5.
    \13\ See Notice to Members 06-06 (January 2006).
---------------------------------------------------------------------------

    While, as discussed below, some commenters criticized a general, 
principles-based approach as lacking clarity and uniform standards, 
NASD and the NYSE both concluded that such an approach was more 
appropriate. The proposed rule change expands upon the existing 
principles-based approach to business entertainment established in the 
1999 Letter but specifically addresses the content of a member's 
written policies and procedures.
    (B) General Requirements: The observance of ``high standards of 
commercial honor and just and equitable principles of trade'' required 
of a member in the conduct of its business under NASD Rule 2110 
includes the obligation of a member not to act in a manner contrary to 
the best interests of a customer in the conduct of business with or for 
such customer. Consequently, when a member interacts with an employee--
or any other agent--of a customer, the member should not give that 
person anything of value that is intended or designed to cause, or 
otherwise would be reasonably judged to have the likely effect of 
causing, such person to act in a manner that is inconsistent with the 
best interests of the customer or any person to whom the customer owes 
a fiduciary duty.\14\ Paragraph (a) of the proposed rule change 
codifies this concept by explicitly setting forth the general purpose 
behind proposed IM-3060.
---------------------------------------------------------------------------

    \14\ NASD Rule 2110 precludes the offering of any thing of 
value, including but not limited to business entertainment, that 
comprises conduct that, to any degree, is either illegal under any 
applicable law or would expose the member, customer, or recipient of 
the member's business entertainment to any civil liability. For 
example, any business entertainment that violated the Foreign 
Corrupt Practices Act or any commercial bribery statutes and laws 
would, in turn, violate Rule 2110.
---------------------------------------------------------------------------

    NASD believes that the guiding principle in navigating the concern 
of placing a customer representative in conflict with his duty to a 
customer is that members should compete for business on the basis of 
providing the best professional services. While it is not inappropriate 
for business entertainment to foster an environment for the member to 
promote or educate the customer representative with respect to such 
professional services, it is inconsistent with the terms of proposed 
IM-3060 to use business entertainment to provide incentives to customer 
representatives to conduct customer business with and/or through the 
member without due consideration as to whether the nature and terms of 
such professional services meet the objectives and are in the best 
interests of the account.
    (C) Definitions: There are three defined terms that are integral to 
an understanding of the proposed rule change.\15\ First, ``customer'' 
is defined as (1) ``a person that maintains a business relationship 
with a member via the maintenance of an account, through the conduct of 
investment banking, or pursuant to other securities-related activity'' 
or (2) ``a person whose customer representative receives business 
entertainment for the purpose of encouraging such person to establish a 
business relationship with the member by opening an account with the 
member or by conducting investment banking or other securities-related 
activity with the member.'' \16\ The definition of ``customer'' has 
been amended from the previous rule filing; however, the changes do not 
affect those persons considered ``customers'' for the purpose of the 
proposed rule change.
---------------------------------------------------------------------------

    \15\ Terms used in the interpretation have the same meaning as 
those defined in NASD's By-Laws and rules unless otherwise 
specified.
    \16\ NASD Rule 0120(n) defines the term ``person'' to ``include 
any natural person, partnership, corporation, association, or other 
legal entity.''
---------------------------------------------------------------------------

    Second, for purposes of the proposed rule change, a ``customer 
representative'' means ``a person who is an employee, officer, 
director, or agent of a customer, unless such person is a family member 
of the customer.'' The term ``customer representative'' replaces the 
term ``employee'' in the previous rule filing to clarify that the term 
includes persons other than employees. The term also now conforms to 
the terminology in the NYSE's proposed rule change. Moreover, the 
definition has been amended to exclude certain family members from the 
definition of customer representative.\17\ This exclusion has been 
added to the definition to address situations where a close family 
member has power-of-attorney or similar authority over another family 
member's account (e.g., an adult child with authority over his or her 
elderly parent's account). NASD believes that these situations are 
unlikely to result in the types of conflicts of interest the proposed 
rule change seeks to address.
---------------------------------------------------------------------------

    \17\ The term ``family member'' means a person's parents, 
mother-in-law or father-in-law, spouse, brother or sister, brother-
in-law or sister-in-law, son-in-law or daughter-in-law, and 
children.
---------------------------------------------------------------------------

    This definition, when coupled with the general requirements set 
forth in paragraph (a) of the proposed rule change, limit the proposed 
rule change to business entertainment provided to a customer 
representative. This point is explicitly addressed in the preamble to 
the interpretation, which states: ``This interpretation does not apply 
to any member that does not engage in business entertainment. For any 
member that engages in business entertainment, this interpretation 
applies only with respect to business entertainment provided to 
customer representatives.'' Thus, the proposed rule change does not 
address business entertainment provided to a natural person 
customer.\18\ It addresses only business entertainment provided to a 
customer representative of the customer (although such customer may be 
a natural or non-natural person).
---------------------------------------------------------------------------

    \18\ As discussed in footnote 5 of Notice to Members 06-06, and 
as noted below, natural persons who are both natural person 
customers and customer representatives should be treated as customer 
representatives. That is, associated persons of a member cannot 
avoid the application of the firm's business entertainment policies 
by claiming that business entertainment provided to a person who is 
both a natural person customer and a customer representative was 
provided to that individual solely in his or her ``personal,'' 
rather than business, capacity.
---------------------------------------------------------------------------

    Third, ``business entertainment'' is defined as ``any social event, 
hospitality event, sporting event, entertainment event, meal, leisure 
activity, or event of like nature or purpose, including entertainment 
offered in connection with a charitable event, educational event or 
business conference, as well as any transportation or lodging related 
to such activity or event, in which an associated person of a member 
accompanies a customer representative.'' This definition codifies 
NASD's long-standing position that an associated person of a member 
must accompany or participate in an event for it to be deemed 
``business entertainment'' rather than a ``gift.'' In addition, NASD 
has deleted the portion of the definition that stated that it is not 
necessary for business to be conducted for an event to be ``business 
entertainment.'' The definition of business entertainment encompasses 
all the events enumerated provided that the customer representative is 
accompanied by an associated person of the member; because the clause 
did not further define business entertainment, it has been deleted.
    As noted above, the definition of ``business entertainment'' 
generally prescribes that if a customer representative is not 
accompanied by an appropriate associated person of a member, any 
expenses associated with the business entertainment will be

[[Page 28747]]

considered a gift under Rule 3060. An exception to this requirement is 
proposed to address instances when exigent circumstances make it 
impractical for an associated person of a member to attend a business 
entertainment event. All instances where such exigent circumstances are 
invoked must be clearly and thoroughly documented and be subject to the 
prior written approval of a designated supervisory person or, in very 
limited circumstances where such prior approval cannot reasonably be 
obtained, to a prompt post-event review to be conducted and documented 
by such supervisory person.
    NASD believes that the ``exigent circumstances'' exception provides 
necessary flexibility in light of real-world, last minute emergency 
situations that could arise that would make it difficult, if not 
impossible, for an appropriate associated person of a member to attend 
a business entertainment event with a customer representative. Examples 
of exigent circumstances would be a sick child, an accident, or some 
other sudden, overriding circumstance. NASD does not believe this 
provision would lead to circumvention of the spirit or substance of the 
proposed rule change since all such occurrences are subject to detailed 
documentation such that any patterns of abuse would become quickly 
apparent to supervisory personnel.
    Paragraph (b)(4)(C) of the proposed rule change provides guidance 
to members on the valuation of business entertainment. The proposed 
rule change requires that a member's written policies and procedures 
specify how the firm will calculate the value of business 
entertainment. In general, business entertainment items should be 
valued at the greater of face value or cost to the member.
    NASD has been asked about the extent to which the proposed rule 
change reaches business entertainment conducted outside the United 
States, particularly entertainment provided by persons who are employed 
in commonly controlled affiliates of a financial services company 
operating in the United States and/or foreign jurisdictions. As an 
initial matter, proposed IM-3060 reaches all business entertainment of 
a member firm and persons associated with a member, even if such 
entertainment occurs outside of the United States or is provided to 
foreign individuals. However, NASD does not believe that all persons 
who are employed in commonly controlled affiliates of a financial 
services company operating in the United States and/or foreign 
jurisdictions are necessarily associated persons of the member, even if 
they report to a person who, in another capacity, is an associated 
person of a member.
    An associated person of a member may have management and 
supervisory responsibilities for non-member affiliates of a financial 
services company, located within or outside of the United States, 
without the result that the persons being managed and supervised in the 
non-member affiliates would necessarily be deemed associated persons of 
the member. It is the view of NASD that in such instances the following 
factors establish that an employee of a non-member affiliate is not an 
associated person of the member: (1) The manager/supervisor of that 
employee is recognized in the organization as having a scope of 
responsibilities outside of the member firm; (2) the exercise of the 
management and supervision over that employee by such manager/
supervisor is not controlled by the member, is reviewable for purposes 
of performance and compensation outside of the member, and is not 
conducted for the benefit of the member; and (3) the employee of the 
non-member affiliates is not otherwise employed or engaged in the 
investment banking or securities business of the member and controlled 
by the member in respect of such activities.
    (D) Written Policies and Procedures: A member's policies and 
procedures must be designed to promote conduct consistent with NASD 
Rule 2110 and should not undermine the performance of a customer 
representative's duty to a customer. The proposed rule change requires 
members to adopt written policies and procedures concerning business 
entertainment that: (1) Define forms of business entertainment that are 
appropriate and inappropriate using quantitative and/or qualitative 
standards that address the nature and frequency of the entertainment 
provided, as well as the type and class of any accommodation or 
transportation provided in connection with such business entertainment; 
(2) impose either specific dollar limits on business entertainment or 
require advance written supervisory approval beyond specified dollar 
thresholds; (3) are designed to detect and prevent business 
entertainment that is intended as, or could reasonably be perceived to 
be intended as, an improper quid pro quo or that could otherwise give 
rise to a potential conflict of interest or undermine the performance 
of a customer representative's duty to a customer; (4) establish 
standards to ensure that persons designated to supervise and administer 
the written policies and procedures are sufficiently qualified; and (5) 
require appropriate training and education for all personnel who 
supervise, administer, or are subject to the written policies and 
procedures.
    (i) Define Forms of Appropriate and Inappropriate Business 
Entertainment: A member's written policies and procedures concerning 
business entertainment must define forms of business entertainment that 
are appropriate and inappropriate using quantitative and/or qualitative 
standards that address the nature and frequency of the entertainment 
provided, as well as the type and class of any accommodations or 
transportation provided in connection with such business entertainment. 
A member's policies and procedures should include provisions regarding 
appropriate venues, nature, frequency, and types and class of 
accommodation and transportation.
    A member may determine that certain activities, though legal, are 
nevertheless inappropriate for business entertainment. NASD believes 
that the standards of business entertainment adopted by members must 
meet the requirements of Rule 2110 that members and persons associated 
with a member adhere to high standards of commercial honor. 
Consequently, a member would violate proposed IM-3060 not only if it 
failed to adopt procedures, but also if the procedures set standards 
that are so unbounded or vague that no reasonable determination of 
propriety can be discerned.
    The proposed rule change also would allow, but not require, members 
to establish different standards for business entertainment in 
connection with events that are educational, charitable, or 
philanthropic in nature. If a member chooses to distinguish between 
forms of business entertainment in its policies and procedures, it 
should ensure that these types of business entertainment nonetheless 
comply with Rule 2110 and the general requirements set forth in 
paragraph (a) of the proposed rule change.
    (ii) Impose Either Specific Dollar Limits on Business Entertainment 
or Require Advance Written Supervisory Approval Beyond Specified Dollar 
Thresholds: A member's written policies and procedures must impose 
either specific dollar limits on business entertainment or require 
advance written supervisory approval beyond specified dollar 
thresholds. The proposed rule change does not impose hard dollar limits 
or require that all

[[Page 28748]]

members adopt the same dollar limits or treat all recipients equally.
    (iii) Designed to Detect and Prevent Business Entertainment That Is 
Intended As, or Could Reasonably Be Perceived To Be Intended As, an 
Improper Quid Pro Quo: A member's written policies and procedures must 
include procedures designed to detect and prevent business 
entertainment that is intended as, or could reasonably be perceived to 
be intended as, an improper quid pro quo. For example, members should 
develop written policies and procedures reasonably designed to preclude 
providing business entertainment that is so lavish or extensive in 
nature that a customer representative would likely feel compelled to 
place order flow on behalf of the customer without due regard to best 
execution or other transaction pricing considerations. NASD does not 
intend that this standard would establish a per se violation of the 
proposed IM if a customer representative who received business 
entertainment from the member is later found to have violated his or 
her obligations to his or her employer; however, such actions by a 
customer representative may warrant further investigation by the member 
firm as to whether the member's policies and procedures are, in fact, 
reasonably tailored to prevent these types of violations.\19\ While an 
NASD member is not ultimately responsible for the conduct of its 
customers' employees or agents, the member is responsible for ensuring 
that persons associated with the member do not engage in activities 
that are designed to, or reasonably likely to, cause the recipient to 
engage in improper conduct. Moreover, a member's compliance with its 
policies and procedures would not serve to automatically shield the 
member from all liability under the proposed IM for any misconduct by a 
customer representative.
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    \19\ NASD Rule 3012(a) requires members to test and verify their 
supervisory procedures and ``create additional or amend supervisory 
procedures where the need is identified by such testing and 
verification.''
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    (iv) Supervision: As is the case with every NASD rule, supervision 
is a critical component of business entertainment policies and 
procedures. Members are free to define the approach and method of their 
written policies and procedures provided they are reasonably designed 
to comport with the principles stated in the proposed rule filing. 
Irrespective of the manner in which a member crafts its procedures, it 
must be clear from the supervisory policies and procedures what factors 
determine appropriate levels of business entertainment and how those 
determinations are executed, monitored, and enforced. This is 
particularly true if members elect to use qualitative, rather than 
quantitative, standards. In addition, such supervisory procedures 
should provide a method for evidencing both the breadth of supervisory 
activities as well as the information upon which such supervision is 
conducted. For example, a member's policies and procedures must 
evidence the basis upon which a supervisor will determine that business 
entertainment does not violate a member's standards as to the nature, 
frequency, and dollar amounts of entertainment. A member's policies and 
procedures must establish standards to ensure that persons designated 
to supervise and administer the member's written policies and 
procedures are sufficiently qualified. The requirement that the persons 
designated to supervise business entertainment expenses be 
``sufficiently qualified'' is not intended to impose a registration 
requirement or similar obligation on these individuals; rather, the 
requirement is intended to ensure that the member's designation is of 
persons who are familiar with the applicable regulatory requirements 
and are sufficiently senior and experienced to entrust with the 
approval obligations envisioned by the member's policies and 
procedures.
    (v) Training and Education: A member's business entertainment 
policies and procedures must require appropriate training and education 
to all applicable personnel. A member also must be able to demonstrate 
that it trains persons associated with the member who supervise, 
administer, and are subject to such written business entertainment 
policies and procedures in all applicable requirements.
    (E) Recordkeeping: The only effective way for a member to ensure 
that persons associated with the member are following the firm's 
policies and procedures is to establish a system to track their 
business entertainment expenses. Consequently, a member's policies and 
procedures are required to include procedures regarding the maintenance 
of detailed records of business entertainment expenses provided to any 
customer representative.
    NASD recognizes that recordkeeping requirements present compliance 
burdens for firms, and NASD has sought to address the potential burden 
by providing a recordkeeping carve-out for small expenditures, none of 
which would reasonably be expected to influence the behavior of the 
recipient. Consequently, the proposed rule change provides that members 
are not required to maintain records of (1) Business entertainment when 
the total value of the business entertainment, including all expenses 
associated with the business entertainment, does not exceed $50 per day 
or (2) additional expenses incurred in connection with otherwise 
recorded business entertainment that do not, in the aggregate, exceed 
$50 per day.\20\
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    \20\ Members should be aware, however, that they may need to 
track such expenses under other NASD or SEC rules. There is no 
express exclusion from Rule 3060 for gifts given during the course 
of business entertainment. See Notice to Members 06-69 (December 
2006). NASD staff has, however, provided guidance that Rule 3060 
does not apply to certain promotional items of nominal value that 
display the firm's logo. See id.
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    The $50 threshold would apply only to events or activities with a 
total cost that did not exceed $50 per day (e.g., an inexpensive lunch) 
or to minor expenses related to an otherwise reported business 
entertainment event (such as a hot dog at an NBA basketball game, where 
the basketball game ticket is reported as a business entertainment 
expense). Firms may not allow persons associated with the member to 
disaggregate business entertainment expenses relating to an activity or 
event in an effort to avoid recordkeeping obligations. Thus, a dinner 
expense of $40 followed by a sporting event with a ticket price of $40 
would need to be tracked under the member's recordkeeping system.
    The proposed rule change also requires that a member's written 
policies and procedures include provisions reasonably designed to 
prevent persons associated with the member from circumventing the 
recordkeeping requirements in contravention of the spirit and purpose 
of proposed IM-3060. Thus, for example, members should seek to prevent 
associated persons of the member from engaging in patterns of providing 
business entertainment that falls below the $50 reporting threshold.
    One of the key elements of the proposed rule change is the ability 
of a customer to request from the member information regarding the 
business entertainment expenses provided to the customer 
representatives of the customer. Although members are permitted to 
establish reasonable guidelines regarding a customer's ability to 
request this information, such guidelines must not impair the ability 
of the customer to obtain, on a reasonable and regular basis, 
information concerning the member's business entertainment expenses 
pertaining to

[[Page 28749]]

the customer representatives of such customer.
    (F) Exemption for Members with Business Entertainment Expenses 
Below $7,500: The concerns that the proposed interpretation seeks to 
address are not presented by those members that, in the aggregate, do 
not devote significant resources to business entertainment. 
Consequently, the interpretation provides for a partial exemption for 
those members with annual business entertainment expenses below $7,500. 
The provision provides that the $7,500 ceiling should be measured on a 
fiscal year basis. Each member that relies on the exemption must 
evidence that its business entertainment expenses were below the 
threshold.
    Importantly, the exemption is not a total exemption from all 
aspects of the proposed interpretation. All members (except those 
members that do not engage in any business entertainment) are required 
to abide by the interpretation's general requirements as set forth in 
paragraph (a) and are required to have written policies and supervisory 
procedures that are designed to detect and prevent business 
entertainment that is intended as, or could reasonably be perceived to 
be intended as, an improper quid pro quo or that could otherwise give 
rise to a potential conflict of interest or undermine the performance 
of a customer representative's duty to a customer or any person to whom 
the customer owes a fiduciary duty, and establish standards to ensure 
that persons designated to supervise and administer such policies and 
procedures are sufficiently qualified.
    The effective date of the proposed rule change will be six months 
following Commission approval. NASD will announce the effective date of 
the proposed rule change in a Notice to Members to be published no 
later than 60 days following Commission approval.
2. Statutory Basis
    NASD believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\21\ which requires, among 
other things, that NASD rules must be designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest. NASD believes that the proposed rule change clarifies 
existing obligations of members with respect to the provision of 
business entertainment and will help prevent conduct by associated 
persons of a member that could undermine the performance of an 
employee's duty to the member's customer.
---------------------------------------------------------------------------

    \21\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on Competition

    NASD does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    The proposed rule change was published for comment in NASD Notice 
to Members 06-06 (January 2006). NASD received 28 comments in response 
to the Notice.\22\ A copy of the Notice to Members was attached to the 
original rule filing as Exhibit 2a. Copies of the comment letters 
received in response to the Notice were attached to the original rule 
filing as Exhibit 2b. Of the 28 comment letters received, 12 were 
generally in favor of the proposed rule change, 13 were opposed, and 
three took no clear position.
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    \22\ Letter from Pinnacle Taxx Advisors, Inc. (``Pinnacle''), 
dated Jan. 26, 2006; Letter from Keefe, Bruyette & Woods (``KBW''), 
dated Jan. 26, 2006; Letter from J.P. Morgan, dated Jan. 30, 2006; 
Letter from Evolve Securities, Inc. (``Evolve''), dated Jan. 31, 
2006; Letter from Seasongood & Mayer, LLC (``Seasongood''), dated 
Feb. 2, 2006; Letter from Plexus Consulting (``Plexus'') o/b/o 
International Association of Small Broker Dealers and Advisers, 
dated Feb. 6, 2006; Letter from Dominion Investor Services, Inc. 
(``Dominion''), dated Feb. 13, 2006; Letter from National Regulatory 
Services (``NRS''), dated Feb. 6, 2006; Letter from T. Rowe Price 
Investment Services, Inc. (``T. Rowe Price''), dated Feb. 17, 2006. 
Letter from Maplewood Investment Advisors, Inc. (``Maplewood''), 
dated Feb. 22, 2006; Letter from Financial Services Institute, Inc. 
(``FSI''), dated Feb. 23, 2006; Letter from Transamerica Financial 
Advisors, Inc. (``Transamerica''), dated Feb. 23, 2006; Letter from 
H.D. Vest Financial Services (``H.D. Vest''), dated Feb. 23, 2006; 
Letter from ING U.S. Financial Services (``ING''), dated Feb. 23, 
2006; Letter from The Investment Company Institute (``ICI''), dated 
Feb. 23, 2006; Letter from Hines Real Estate Securities, Inc. 
(``Hines''), dated Feb. 21, 2006; Letter from The National Society 
of Compliance Professionals (``NSCP''), dated Feb. 23, 2006; Letter 
from Financial Network, dated Feb. 23, 2006; Letter from Coker 
Palmer, dated Feb. 23, 2006; Letter from Griffin, Kubik, Stephens & 
Thompson, Inc. (``Griffin''), dated Mar. 2, 2006; Letter from 
Debevoise & Plimpton LLP (``Debevoise'') o/b/o The Midtown 
Regulatory Group, dated Mar. 3, 2006; Letter from Transamerica 
Capital, Inc. (``Transamerica Capital''), dated Mar. 3, 2006; Letter 
from The Bond Market Association (``BMA''), dated Mar. 3, 2006; 
Letter from Goodwin Browning & Luna Securities, Inc. (``GB&L''), 
dated Mar. 3, 2006; Letter from The ABA Securities Association 
(``ABASA''), dated Mar. 3, 2006; Letter from Wachovia Capital 
Markets, LLC (``Wachovia''), dated Mar. 3, 2006; Letter from Neal E. 
Nakagiri (``Nakagiri''), dated Mar. 3, 2006; and Letter from The 
Self-Regulation and Supervisory Practices Committee of the 
Securities Industry Association (``SIA''), dated Mar. 7, 2006.
---------------------------------------------------------------------------

    A number of commenters raised concerns with NASD's general, 
principles-based approach to the proposed rule change \23\ and 
questioned the overall need for the IM.\24\ As indicated above, the 
proposed rule change was undertaken in response to requests by NASD 
members for clarity concerning appropriate business entertainment. Both 
NASD and the NYSE undertook to provide members with additional guidance 
following these requests. To the extent some commenters questioned 
whether NASD should seek to ``regulate'' the employees of their 
members' customers, these commenters fail to recognize that NASD staff 
guidance in the 1999 Letter already prohibits business entertainment 
for employees of customers that is so frequent or excessive as to raise 
questions of propriety. Moreover, as discussed above, NASD is not 
seeking to regulate the behavior of the representatives of a member's 
customers; \25\ rather, NASD is requiring each member to develop and 
enforce some appropriate degree of limitation on the business 
entertainment that persons associated with the member provide to its 
customers' representatives. In achieving this end, both NASD and the 
NYSE believe that a general, principles-based approach is more 
appropriate than a restrictive, one-size-fits-all regulatory scheme. 
Given the significant variation in broker-dealer business models and 
size, and regional differences in what may be considered appropriate 
business entertainment, NASD concluded that a fixed-dollar standard or 
similar specific mandate would prove unworkable.
---------------------------------------------------------------------------

    \23\  See, e.g., Letters from Dominion, Financial Network, H.D. 
Vest, Hines, Plexus, and NRS.
    \24\ See, e.g., Letters from Evolve, Financial Network, FSI, 
GB&L, H.D. Vest, ING, Maplewood, Nakagiri, and Transamerica Capital. 
Several commenters indicated that the proposed rule change should be 
made through notice and comment rulemaking with the Commission. As 
the Notice to Members stated, Section 19 of the Securities Exchange 
Act of 1934 requires that proposed rule changes such as IM-3060 be 
approved by the Commission following publication for public comment 
in the Federal Register. See Notice to Members 06-06, at 2 & n.2.
    \25\ NASD recognizes that customers whose representatives 
receive business entertainment have the responsibility to ensure 
that their representatives do not engage in improper conduct. 
However, NASD believes that the person providing business 
entertainment cannot disclaim any responsibility for improper 
conduct that flows directly from business entertainment its employee 
provided when the employee either intended for the business 
entertainment to have that effect or could reasonably have judged 
that the business entertainment would be likely to have that effect.
---------------------------------------------------------------------------

    One commenter suggested that NASD exempt certain small broker-
dealers, at

[[Page 28750]]

least in part because they lack the resources to affect decision-making 
in the manner the IM seeks to prohibit and that such extravagant and 
extensive business entertainment is localized among larger firms and 
does not occur in rural or small-market areas.\26\ In response to this 
comment, NASD has included a limited exemption for members whose total 
business entertainment expenses in the course of their fiscal year are 
below $7,500. The exemption provides relief from the recordkeeping 
requirements of the rule, as well as many of the specific requirements 
regarding written policies and supervisory procedures. NASD believes, 
however, that the general requirements of the proposed rule change 
should apply to all members that engage in business entertainment. In 
addition, members that engage in business entertainment should have 
written policies and supervisory procedures that are designed to detect 
and prevent improper conduct. As noted above, the proposed rule change 
does not apply to any member firm that does not engage in any form of 
business entertainment.
---------------------------------------------------------------------------

    \26\ Letter from Evolve.
---------------------------------------------------------------------------

    Several commenters suggested that NASD identify in the IM the 
specific factors to be considered by firms in developing their written 
policies and procedures, such as those identified by the NYSE in its 
rule filing. NASD staff does not believe it is necessary to identify 
specific factors in the IM and that doing so may undermine the 
flexibility the proposed rule change is designed to achieve.\27\ NASD 
staff will consider whether additional guidance concerning the IM is 
necessary when announcing the proposed rule change in a Notice to 
Members.
---------------------------------------------------------------------------

    \27\ See Letter from BMA.
---------------------------------------------------------------------------

    Several commenters expressed concern that the proposed rule change, 
including some of the defined terms, was too vague and may, in 
application, prove overly broad. Among other things, these commenters 
suggested that the proposed rule change could disadvantage firms with 
more conservative policies and procedures,\28\ effectively require pre-
approval of all business entertainment,\29\ and introduce disadvantages 
among different types of firms and other industry participants.\30\ 
Other commenters believed that the principles-based approach proposed 
by NASD is the appropriate manner to address the needed clarification 
of business entertainment.\31\
---------------------------------------------------------------------------

    \28\ See, e.g., Letters from Hines and ING.
    \29\ See Letter from Transamerica Capital.
    \30\ See, e.g., Letters from Dominion and Seasongood.
    \31\ See Letters from BMA, Griffin, NSCP, and Wachovia.
---------------------------------------------------------------------------

    While NASD recognizes that there will be distinctions among each 
member's written policies and procedures, NASD concluded that member 
firms were in the best position to determine appropriate limitations 
and restrictions on the business entertainment provided by persons 
associated with a member. After considering the various comments 
concerning the definitions of ``customer'' and ``business 
entertainment'' in the proposed rule change,\32\ NASD has determined 
not to amend the definitions substantively.\33\ While several 
commenters recommended that the definition of customer track the 
definition of ``accredited investor'' as defined in SEC Rule 501 under 
the Securities Act of 1933, NASD staff does not believe that the 
application of the IM should be dependent on any particular level of 
assets. While member firms may choose to treat certain types of 
customers or certain types of business entertainment differently for 
purposes of their written policies and procedures, NASD believes that, 
for purposes of the proposed rule change, a broad definition of each is 
appropriate.
---------------------------------------------------------------------------

    \32\ See, e.g., Letters from BMA, Financial Network, FSI, ING, 
and Transamerica Capital.
    \33\ As noted in footnote 2 above, although the language in the 
definitions has been modified, the substance and breadth has been 
retained.
---------------------------------------------------------------------------

    With respect to one comment, NASD believes that it would be 
appropriate for a member's written policies and procedures to allow 
case-by-case review and approval for types of entertainment not 
specifically set forth in the member's policies and procedures.\34\ One 
commenter was concerned that a registered representative may not be 
aware whether a recipient of business entertainment is a representative 
of a customer of the firm.\35\ If a person is entertained in his 
personal capacity as a natural person client, and the firm has 
information barriers that would prevent the person providing the 
business entertainment from knowing that the person represents another 
customer as a representative, and the person providing business 
entertainment has no knowledge that such person is a representative of 
a customer at the time of the business entertainment, then such 
entertainment would fall outside the scope of the IM.
---------------------------------------------------------------------------

    \34\ See Letter from Debevoise.
    \35\ See Letter from FSI.
---------------------------------------------------------------------------

    Several commenters raised suggestions concerning Rule 3060's 
limitation on gifts and gratuities, ranging from comments focused on 
increasing the $100 limitation, moving from a hard figure standard to a 
principles-based approach, and providing guidance on the types of gifts 
and incidental expenses that should be included or excluded from any 
limitation.\36\ The proposed rule change is focused on business 
entertainment, which is excepted from the limitation on ``gifts,'' and 
NASD is not currently considering amending the rule regarding gifts and 
gratuities.\37\ NASD has long recognized that gifts--in contrast to 
business entertainment--are not incidental to the transaction of 
business. NASD requires that any gifts be de minimis and sees no reason 
to depart from this long-held view. NASD does not believe that the 
proposed rule change is the appropriate forum for providing 
interpretive advice on other aspects of Rule 3060; however, NASD staff 
recently published additional guidance on Rule 3060 regarding gifts and 
gratuities. See Notice to Members 06-69 (December 2006).
---------------------------------------------------------------------------

    \36\ See, e.g., Letters from ABASA, BMA, Debevoise, Evolve, 
Financial Network, and Wachovia.
    \37\ The one exception is the one noted above with respect to 
exigent circumstances. Numerous commenters requested that NASD adopt 
the exigent circumstances exception from the gift rule similar to 
the exception that the NYSE has proposed. See, e.g., Letters from 
ABASA, BMA, and Wachovia. As discussed above, NASD has determined 
that it is appropriate to provide for such an exception.
---------------------------------------------------------------------------

    Two commenters expressed concern that the IM shifts the burden of 
proof required under NASD Rules and suggested that any change to Rule 
3060 be done through a separate rule proposal rather than through an 
IM.\38\ As discussed in footnote 2 and the accompanying text of Notice 
to Members 06-06, the IM, which is the equivalent of a rule provision, 
is being proposed in accordance with the procedures for a proposed rule 
change under Section 19 of the Act.\39\ Rule 3060 and IM-3060 are two 
separate provisions, and the burden of proof under Rule 3060 is not 
affected by the proposed IM.
---------------------------------------------------------------------------

    \38\ See Letters from Financial Network and ING.
    \39\ 15 U.S.C. 78s.
---------------------------------------------------------------------------

    Several commenters appeared concerned that the discussion in 
footnote 5 of Notice to Members 06-06 would prohibit entertaining 
friends and relatives. This misconstrues the meaning of footnote 5, 
which says: ``Members cannot circumvent this proposed interpretive 
material by providing business entertainment to a natural person 
customer who also is an employee, agent or representative of a customer 
by claiming that such business

[[Page 28751]]

entertainment applies only to the `natural person' relationship.'' What 
is required by footnote 5 is that an associated person of a member not 
avoid the application of the firm's business entertainment policies by 
claiming such entertainment is ``personal'' rather than business. Firms 
are, however, likely to include policies in their business 
entertainment procedures to address personal entertainment of a 
customer representative where there is a family or some other personal 
relationship, much the way firms do today for gifts and gratuities 
under Rule 3060 that are not in relation to the business of the 
employer of the recipient.
    Many commenters requested clarification on whether an 
``independent'' review could be conducted by an independent department 
within, or affiliated with, the member.\40\ NASD has removed the 
specific review sections of the proposed rule change because it was 
redundant of existing obligations. A member firm's responsibility to 
supervise business entertainment exists under Rule 3010(a), and a 
member firm's responsibility to test and verify that its supervisory 
policies and procedures are achieving their intended purpose and 
complying with the federal securities laws and regulations and NASD 
rules exists under Rule 3012(a)(1).
---------------------------------------------------------------------------

    \40\ See, e.g., Letters from Debevoise, Evolve, ICI, KBW, NRS, 
Transamerica Capital, and Wachovia.
---------------------------------------------------------------------------

    Many commenters expressed concern with the breadth of the 
recordkeeping requirement and requested a lengthy implementation time 
for the recordkeeping requirements.\41\ In response to these comments, 
NASD provided an exception from the recordkeeping obligations for 
expenses under $50. However, as discussed above, NASD believes that a 
member's policies and procedures should prevent persons associated with 
the member from intentionally avoiding the $50 requirement by breaking 
up what are otherwise connected costs or by engaging in frequent, 
repeated business entertainment at amounts below the $50 threshold. For 
example, a firm's policies and procedures may require associated 
persons of the member to submit all business entertainment expenses for 
review; however, the firm may decide to record and track only amounts 
over $50. NASD also is providing for an effective date of six months 
following the Commission's approval of the proposed rule change. 
Members should provide the Commission with specific comments as to 
whether this is sufficient time to implement recordkeeping systems to 
comply with the proposed rule change and, if it is not sufficient, 
offer reasons why and suggest an appropriate implementation period.
---------------------------------------------------------------------------

    \41\ See, e.g., Letters from Evolve, Financial Network, FSI, 
H.D. Vest, ICI, ING, Maplewood, and Transamerica Capital.
---------------------------------------------------------------------------

    One commenter suggested that NASD permit a member's procedures to 
include prompt review of business entertainment after the event.\42\ 
The commenter offered an example of a dinner that unexpectedly exceeds 
the firm's threshold. NASD does not believe that a member's policies 
and procedures should allow for post-event approval because there does 
not appear to be an effective means of rescinding business 
entertainment that has already been provided. Rather, persons 
associated with a member who are concerned that the cost of an event 
may exceed the threshold should request approval in advance to go over 
the firm's limit. In such a situation, the member should impose another 
dollar limit rather than simply waive the requirement.
---------------------------------------------------------------------------

    \42\ See Letter from T. Rowe Price.
---------------------------------------------------------------------------

    Finally, several commenters requested that NASD and the NYSE 
harmonize their proposed rule changes or, in the alternative, include a 
provision that a dual member that complies with one of the SRO's rule 
will be deemed to be in compliance with the other SRO's rule.\43\ In 
filing this Amendment No. 1, NASD has sought to address substantive 
disparities between its rule and that of the NYSE.
---------------------------------------------------------------------------

    \43\ See, e.g., Letters from BMA and SIA.
---------------------------------------------------------------------------

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) As the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (A) By order approve such proposed rule change, or
    (B) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act.
    The Commission notes that the NYSE's proposed Rule 350A(e) provides 
that a NYSE member organization must have a system in place to give 
notice (e.g., via the member organization's Web site, a disclosure 
document, or other appropriate means) to customers that use customer 
representatives that upon a customer's written request, the NYSE member 
organization will provide detailed information regarding the manner and 
expense of any business entertainment provided by the NYSE member 
organization to the customer representative,\44\ while the NASD's 
proposal does not contain a similar notice provision.\45\ The 
Commission is soliciting comment on this difference between the NYSE 
and NASD proposed rules an