Gifts, Gratuities, and Non-Cash Compensation Rules

In December 2014, FINRA published a report on its review of its gifts, gratuities and non-cash compensation rules.  The report concluded that the rules could benefit from some updating to better align the investor protection benefits and the economic impacts of the rules.

To that end, FINRA has recently proposed amendments to the gifts, gratuities and non-cash compensation rules to as described in FINRA Regulatory Notice 16-29.  Below as some of the highlights of the proposed rule changes.

Gifts and Gratuities

FINRA Rule 3220 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.  FINRA has proposed an increase in the gift limit from $100 to $175 per person per year.  FINRA believes that an increase in the gift limit to $175 is appropriate because it takes into account the rate of inflation since adoption of the $100 gift limit.

In addition, FINRA has proposed to incorporate guidance in NTM 06-69 as well as its interpretation regarding the application of the Gifts Rule to bereavement gifts into FINRA Rule 3220 as Supplementary Material. Thus, the Supplementary Material would provide that:

  • there is no express exclusion from the Gifts Rule for gifts given during the course of business entertainment, unless the gift is of de minimis value, or a promotional or commemorative item;
  • gifts must be valued at the higher of cost or market value;
  • members must aggregate all gifts given by the member and each associated person of the member to a particular recipient over the course of the year;
  • bereavement gifts that are customary and reasonable are not considered to be in relation to the business of the recipient and, therefore, are not subject to the restrictions of the Gifts Rule or its recordkeeping requirements;
  • gifts given for infrequent life events (e.g., a wedding gift or congratulatory gift for the birth of a child) are not subject to the restrictions of the Gifts Rule or its recordkeeping requirements provided the gifts are customary and reasonable, personal in nature and not in relation to the business of the employer of the recipient; and
  • gifts of a de minimis value, promotional items of nominal value and commemorative items are not subject to the restrictions of the Gifts Rule or its recordkeeping requirements provided they meet the conditions specified in the Supplementary Material.

Restrictions on Non-Cash Compensation

FINRA and NASD rules generally prohibit members and their associated persons from directly or indirectly accepting or making payments or offers of non-cash compensation in connection with the sale of variable insurance contracts, investment company securities, DPPs and the public offerings of debt and equity securities.

These prohibitions are subject to specified exceptions that permit:

  • gifts that do not exceed an annual amount per person (currently $100) and are not preconditioned on achievement of a sales target;
  • an occasional meal, a ticket to a sporting event or the theater, or comparable entertainment which is neither so frequent nor so extensive as to raise any question of propriety and is not preconditioned on achievement of a sales target;
  • payment or reimbursement by “offerors” (product issuers, advisers, underwriters and their affiliates) in connection with training or education meetings, subject to specified conditions, including meeting location restrictions and not preconditioning attendance on achievement of a sales target; and
  • internal firm non-cash compensation arrangements that are based on total production and equal weighting of product sales.

FINRA believes that the general prohibitions regarding the payment or receipt of non-cash compensation should be extended beyond investment company securities, variable insurance contracts, DPPs and public offerings of securities as the conflicts underlying these prohibitions exist with respect to all securities.  Accordingly, FINRA has proposed to eliminate the existing non-cash compensation rules and replace them with proposed FINRA Rule 3221, which would apply to the payment or receipt of non-cash compensation in connection with the sale of any security.  Specifically, proposed FINRA Rule 3221(b) would provide that “No member or person associated with a member shall directly or indirectly accept or make payments or offers of payments of any non-cash compensation in connection with the sale of securities.”  This prohibition would also be subject to the exceptions discussed above.

However, unlike the existing non-cash compensation rules, the proposed rule would not permit product-specific internal sales contests.  FINRA believes that internal sales contests that favor one security or one type of security potentially create an incentive to engage in sales conduct contrary to the best interests of customers.  Consequently, “stock of the day” and similar promotions would be impermissible under the proposal.

Although the proposed rule change relating to internal sales contests is a significant substantive change to the existing rules, FINRA’s impression is that product-specific internal sales contests for non-cash compensation are not widely used today.  Moreover, to the extent that firms engage in internal sales contests, FINRA believes that requiring payment or reimbursement to be based on the total production of associated persons with respect to all securities distributed by the member and not be based on conditions that would encourage an associated person to recommend particular securities or categories of securities would reduce the potential for conflicts of interest and risk of abuse.

Business Entertainment

In 1999, FINRA staff issued an interpretive letter stating that the Gifts Rule 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.”

FINRA has proposed to replace the business entertainment standard in the existing non-cash compensation rules and 1999 letter with proposed FINRA Rule 3222, which would require each member to adopt written policies and supervisory procedures relating to business entertainment tailored to its business needs.

Specifically, proposed FINRA Rule 3222 would require that each member’s written policies and supervisory procedures:

  • are designed to detect and prevent business entertainment that is intended as, or could reasonably be perceived as intended as, an improper quid pro quo;
  • define forms of permissible and impermissible business entertainment based on the location, nature, frequency and dollar amount of the business entertainment provided, as well as the type and dollar amount of any accommodations or transportation provided in connection with such business entertainment;
  • require that the offeror, member or one or more of the member’s associated persons hosts the business entertainment;
  • specify that the business entertainment must not be preconditioned on the achievement of a sales target; and
  • require appropriate training and education of all personnel who supervise, administer or are subject to the written policies and supervisory procedures.

In addition, the proposed rule change would require that each member’s written policies and supervisory procedures must require the maintenance of detailed records of business entertainment expenses, including the names of all persons providing and receiving business entertainment, the location, nature, frequency and dollar amount of the business entertainment, and the type and dollar amount of any accommodations or transportation provided.

In this blog, we have discussed many of the highlights of the proposed rule changes.  Please refer to FINRA Regulatory Notice 16-29 for further details.

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