The New York Stock Exchange and the NASD may have unveiled extensive guidance last week to clarify their rules on gift-giving and entertainment between company and client, but their advice really boils down to three words: use your head.
Answering a question that has vexed compliance officers and bar-hopping traders alike, the two trading exchanges ordered their member companies to devise, document and implement their own prudent policies—but left the exact definition of “prudent” to the companies themselves.
Despite the ambiguity, legal experts welcomed such a principles-based approach rather than a rules-based diktat that spelled out precisely what businesses had to obey.
“It’s a very broad set of guideposts whose touchstone is reasonableness,” says Daniel Alonso, a white-collar crime defense lawyer at Kaye Scholer. Dana Fleischman, another corporate lawyer at Cleary Gottlieb Steen & Hamilton, goes further; principles-based governance, she says, “is the only way to deal with this.”
The NYSE and NASD did not change their rules for gift-giving. Those still bar members from giving anything worth more than $100 to a person with whom they have a business relationship. Rather, the changes address the more opaque part of the rules that do not prohibit “ordinary and usual business entertainment,” such as an occasional meal, sports game, theater production or other entertainment, so long as the entertainment is “neither so frequent nor so extensive as to raise any question of propriety,” the NASD explained last week.
For example, the NASD proposes, if a member gives tickets to a sporting event but does not accompany the recipient to the event, the tickets are deemed to be a gift rather than business entertainment. At the same time, it stresses the definition of “business entertainment” expressly includes transportation and lodging expenses provided by a member.
"The purpose of the rule is to prohibit the employees of a broker-dealer from providing business entertainment to a client, particularly one who is acting in a fiduciary capacity, that is intended to cause the client to act in a manner inconsistent with the best interests of his or her employer or customer," Grace Vogel, an NYSE executive vice president, said in a press release to echo the NASD’s sentiments.
The proposals also provide guidance for creating written policies and procedures that members must adopt surrounding their business entertainment practices, the NASD notes. Members must define the forms of business entertainment that are appropriate or not, such as the nature of the entertainment, its frequency, any accommodation and its type, and either firm dollar limits or thresholds requiring advance approval. What the proposal doesn’t do: impose hard limits, nor require that all members adopt the same limits or even treat all recipients equally.
Lawyers praise the flexibility that comes with a principles-based approach, noting that what is reasonably priced in cities such as New York and San Francisco could be shockingly expensive in smaller, Midwestern cities.
Under the rules, the onus is on broker-dealers (rather than their individual salespeople) to define the guidelines and then create policies and procedures to enforce them. “They pushed the function to the firm, not to the individual,” emphasizes Margaret Sheehan, co-leader of the financial services practice at Alston & Bird in Washington.
How To Be Principled
When devising entertainment polices, Sheehan first recommends that companies form a task force that includes legal, compliance and business people, to review and develop the company’s policy and procedures. Those policies and procedures should then be incorporated into the company’s supervisory system.
Dennis Hensley of Sidley Austin Brown & Wood stresses, however, that companies must analyze the principles and facts of their individual businesses before reaching a conclusion. “Document the conclusion and the procedures, as well as the rationale for them,” he explains. “If regulators come in and question the conclusion, you want to be able to demonstrate the rationale for reaching the conclusion.”
Fleischman says companies should set a specific dollar limit on different categories of entertainment. Another wise move: a review process to determine whether some event is too lavish or hosts too many people. “It’s hard to set absolute prohibitions with so many different scenarios where something is appropriate and management approves the event,” she says.
Despite those precautions, the proposals still leave some questions unanswered. Fleischman laments that the NASD and NYSE ignored the $100 cap on gifts altogether, calling it “unworkable.” She says other questions abound, such as when an individual wants to give a client a wedding or baby gift. For example, if several individuals within an organization do business with the same person, collectively they can only send gifts worth up to $100. “If you don’t send a gift, it’s not good,” she asserts.
Hensley paints another scenario: a broker takes to dinner a client who winds up having several drinks, and is then not safe to drive home. Can the broker put the client in a cab if it costs more than $100? Under the rules, if he is not accompanying the client, the cab ride is deemed to be a gift.
Hensley is also troubled by a provision that requires broker-dealers to make their records available to customers. So if a mutual fund’s employees are entertained by the broker-dealer, the fund company can ask the broker-dealer to turn over the records related to entertainment to mutual fund employees. “It changes the dynamic,” Hensley asserts. “It now brings management of the clients into the equation.”
Ultimately, however the regulators care about one thing: assuring that fewer conflicts that harm investors. Said NASD Chairman and CEO Robert R. Glauber in a press release: "The foundational principle of this rule is that conduct cannot undermine the performance of an employee's duty to a customer.”