NASD Proposal on Wholesalers Attracting Attention

Today marks the end of the comment period for the NASD proposal requiring more stringent rules governing gift and entertainment practices on Wall Street and, while the NASD won’t say what the response has been until Thursday, the proposal is getting attention.

Today marks the end of the comment period for the NASD proposal requiring more stringent rules governing gift and entertainment practices on Wall Street and, while the NASD won’t say what the response has been until Thursday, the proposal is getting attention.

A panel discussion at the National Investment Company Service Association’s (NICSA) 24th annual convention and expo last week provided one significant forum. In the discussion, two chief compliance officers shared their experiences with NASD examiners on keeping a tight watch on wholesalers.

“You don’t want to violate the rules of your third-party distributors,” said panelist David Martin, senior compliance officer at Phoenix Investments. “If you break the rules, they might terminate the relationship.” And in order to stay out of regulators’ cross hairs and be prepared for an exam, Martin advised fund personnel to use spreadsheets to track wholesaler activity and spell out research costs clearly. “Make sure your wholesalers are not going overboard,” he said. “You have to make sure ‘research’ is not golf,” he added.

While recent enforcement actions over excessive gifts and entertainment have served as fair warning to money managers to get their records in order, surprisingly many shops have been slow to get it done. Proof that times have changed was evident just outside the conference hall where one mutual fund firm’s executives had to pay half their greens fees even when a vendor tried to pay for a round of golf.

To tighten up practices and appease regulators, Martin stressed the importance of maintaining detailed gift logs for each wholesaler and setting up strict limits on what is acceptable and what is not. The best defense against violations, he says, is providing training or a “mini compliance meeting” during orientation in which sales managers cite specific examples of prohibited practices and expenses. In addition, sales managers should conduct regular audits and require wholesalers to sign certification forms that show they understand the rules and are in compliance with the firm’s code of ethics. “Never before have they had that kind of training,” he said.

“Wholesalers continually need training and reminders,” said Karen Becker, chief compliance officer at the Calvert Funds. “The damage of giving a $150 gift could be the same as a $1,000 gift.” She advised that there should be someone at the supervisor level monitoring expense accounts at all times. The Web, she said, can be a useful tool in making presentations about acceptable gift and entertainment practices.

Martin and Becker strongly urged attendees to look for red flags and conduct frequent testing comparing expenses across the entire sales force. “Make sure the same two guys are getting the [baseball] tickets every month,” Martin said.

The concern is how perks may skew the brokerage selection process and compromise fund managers' fiduciary duty to achieve best execution for shareholders. In late January, the NASD and NYSE proposed stricter rules to rein in spending on longstanding methods of winning business. Under the amended version of Rule 3060, member firms would be required to have a written policy for entertainment, one that identifies which forms of entertainment are appropriate and which aren’t. Further terms require each brokerage firm to keep detailed records of the nature and expense of entertainment to be made available upon written request. (See “NASD, NYSE Propose Stiffer Rule on Entertainment Spending” http://registeredrep.com/news/nyse-nasd-entertainment/index.html and “Dinosaurs Roaming the Earth”, February 2006).

In addition, firms would have to conduct periodic monitoring for compliance and training for its employees. The record-keeping provision requires more sharing of information about expenses between investment companies and brokerage houses and helps bring the customer into the loop.

Marketing materials were another hot button issue with examiners, members of the panel said. Becker suggested attaching the NASD’s sweep letter to the firm’s marketing materials to ensure that they’re up to snuff. She also advised attendees to “check the trunk” of a wholesaler’s car for stale stationary, brochures and knick-knacks. Martin agreed, adding that fund firms should look into automating the process of updating performance data to their marketing literature.

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