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Exchanges Amend Entertainment Rules, In Principle

Taub Stephen | January 31, 2006

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.


The NASD Proposal

The excerpt below is from a NASD "request for comment," published in a January 2006 Notice To Members on Gifts and Business Entertainment:

The overriding principle of the proposed IM ["Interpretive Material"] is that a member or its associated persons
should not do or give anything of value to an employee of a customer that is intended
or designed to cause, or otherwise would be reasonably judged to have the likely effect
of causing, such employee to act in a manner that is inconsistent with the best interests
of the customer. The proposed IM provides guidance concerning the written policies
and procedures that members must adopt surrounding their business entertainment

  1. First, the member must determine and define the forms of business
    entertainment that are appropriate and inappropriate, including appropriate venues,
    nature, frequency, types and class of accommodation and transportation, and either
    firm dollar limits or thresholds requiring advance written approval...
  2. Second, the member’s written policies and procedures must promote conduct consistent
    with Rule 2110 and should not undermine the performance of an employee’s duty to
    a customer...
  3. Third, the written policies and procedures must provide for effective supervision and
    compliance with a member’s business entertainment policies...
  4. Fourth, members must maintain detailed records of business entertainment expenses
    and make such information available to the customer in respect of its employees upon
    written request...
  5. Fifth, the member must establish standards to ensure that persons designated to
    supervise, approve and document business entertainment expenses are sufficiently
    qualified and that periodic monitoring for compliance with the written policies and
    procedures is conducted...
  6. Finally, the proposed IM expressly states that firms may not offer anything of value,
    including, but not limited to, business entertainment, which comprises conduct that
    is illegal under any applicable law or would expose the member, customer or recipient
    to any civil liability to any governmental authority or agency...


NASD Requests Comment On Proposed Interpretive
Material Addressing Gifts And Business

The NYSE Proposal

The NYSE proposal had not been filed with SEC at press time; the excerpt below is from the exchange's Jan. 23 announcement:

The rule will require each member or member organization to develop written policies and procedures, tailored to that organization's business model, designed to define forms of entertainment that are appropriate and inappropriate and to detect and prevent entertainment that is intended as an inducement for obtaining customer business, or could give rise to a conflict of interest. Each firm is expected to develop specific dollar limits or require supervisory approval at certain dollar thresholds. The rule will require firms to effectively supervise compliance with these policies and to provide for periodic verification and testing. Further, the firms will be expected to train all applicable personnel. Members and member organizations will also be required to maintain detailed records of these expenses. The rule will also require member organizations to give notice to clients, acting in a fiduciary capacity, that detailed information on the entertainment of their employees is available upon request.


NYSE Regulation To File Proposed Rule On Business Entertainment Rule With SEC

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.”