* NASD Notice to Members 97-50 (August 1997).
[9172]
August 15, 1997
TO: BOARD OF GOVERNORS No. 48-97
CLOSED-END INVESTMENT COMPANY COMMITTEE No. 29-97
UNIT INVESTMENT TRUST COMMITTEE No. 52-97
RE: NASDR REQUESTS COMMENT ON CASH COMPENSATION
______________________________________________________________________________
NASD Regulation, Inc. ("NASDR") is soliciting comment on how the payment and
receipt of various forms of incentive-based cash compensation for the sale and distribution of
investment company and variable contract securities should be regulated. A copy of the Notice
is attached,* and it is summarized below.
Comments on NASDRs request for comment must be submitted by October 15, 1997.
If there are issues you would like the Institute to consider addressing in its comment letter,
please contact Frances Stadler by phone at (202) 326-5822, by fax at (202) 326-5827, or by e-
mail to frances@ici.org by September 10th.
The Notice notes that NASD Conduct Rule 2830 currently requires disclosure of cash
and non-cash payments to NASD members in fund prospectuses. In the case of "special
compensation arrangements," which are not generally made available to all dealers, more
detailed disclosure, including the identity of particular dealers, is required. The Notice
acknowledges, however, that Rule 2830 does not define "special compensation arrangements"
and that different issuers interpret the term differently.
As indicated in the Notice, the SEC previously solicited comment on an NASDR
proposal to restrict non-cash compensation arrangements (e.g., those involving trips and
merchandise). That proposal restated the NASD rules regarding prospectus disclosure
requirements for cash compensation arrangements. It also would have treated certain cash
incentive arrangements similar to non-cash compensation. The Notice states, however, that this
latter provision has been dropped from the proposal as resubmitted to the SEC.
The Notice notes that there exists a broad range of cash compensation practices, which
are grouped into three general categories: (1) differential commission payouts to retail
broker/dealers; (2) payments to retail broker/dealers in exchange for a variety of services, such
as carrying a fund as a "preferred fund" or providing subaccounting services; and
2(3) reimbursement to retail broker/dealers to cover business costs, such as, for example,
insurance, licensing fees, and office expenses. The Notice notes that the Tully Report on
compensation practices covered some of these practices, although it was not limited to sales of
investment company shares.
The Notice states that NASDR believes that certain cash compensation practices could
create incentives to inappropriately favor one product over another, which could compromise
customer suitability determinations or create a perception that a brokers interests might not, in
some circumstances, be fully aligned with those of its customers. The Notice discusses three
general approaches to regulating cash compensation arrangements. The first would be through
disclosure. This raises questions such as which information should be disclosed, in which
documents should the disclosure be made, and who should make the disclosure (e.g., the fund
or the dealer). A second approach would involve substantive standards, such as limiting
payments of different compensation. (In this regard, the Notice discusses multiple class funds
in particular.) A third approach would be to treat cash compensation as a sales practice issue
and attempt to regulate it by, for instance, providing more guidance on brokers suitability
requirements.
In addition to generally requesting comments on the nature of various cash
compensation arrangements, their harms and benefits, and the appropriate regulatory
approach, the Notice asks a series of specific questions, including whether such arrangements
raise specific investor protection concerns, which types of arrangements may warrant
substantive regulation, and whether individual investors are interested in disclosure of these
arrangements.
Barry E. Simmons
Assistant Counsel
Attachment