Proposed Amendments to FINRA Gifts, Gratuities and Non-Cash Compensation Rules

In Regulatory Notice 16-29 (Regulatory Notice),¹ the Financial Industry Regulatory Authority (FINRA) requested comments on proposed amendments to Rule 3220² – its “Gift Rule” – as well as new proposed FINRA Rule 3221 (Restrictions on Non-Cash Compensation) and new proposed FINRA Rule 3222 (Business Entertainment) – that would consolidate a patchwork of rules and guidance on non-cash compensation related to the sale of securities and on business entertainment. The proposed amendments and new rules (collectively, Proposal) are intended to protect U.S. investors while reducing member compliance costs. 

The Regulatory Notice indicates that the Gift Rule “seeks both to avoid improprieties that may arise when a member firm or its associated persons give anything of value to an employee of a customer or counterparty and to preserve an employee’s duty to act in the best interests of that customer.” The proposed amendments to the Gift Rule update the gift limit for inflation and add a de minimis threshold. Proposed FINRA Rule 3221 extends – to the sale of all securities – the current limitations on payment or receipt of non-cash compensation. Proposed FINRA Rule 3222 requires firms to adopt written policies and procedures to govern business entertainment. 

Comments on the Proposal are due by September 23, 2016. Proposed rule changes become effective after the FINRA Board of Governors authorizes a filing with the Securities and Exchange Commission (SEC), which then considers approval of the proposed rule changes after publication for public comment in the Federal Register. 

Proposed Rule Amendments 

Background 

FINRA launched “a retrospective review of its gifts, gratuities and non-cash compensation rules to assess their effectiveness and efficiency” in April 2014, and published the results of its review in a report later that year (Retrospective Report).³ The Retrospective Report found the current FINRA rules governing gifts, gratuities and non-cash compensation⁴ to be generally effective in protecting investors, but also indicated that: the $100 gift limit was too low; the related tracking was overly inclusive and costly; and compliance with existing rules was complicated because they are spread throughout the FINRA rulebook and certain rules are specific to particular types of securities. The Regulatory Notice also indicated that FINRA’s examination staff found instances of poor recordkeeping in logs of gifts and business entertainment. 

The Proposal would: consolidate the existing rules under a single rule series in the FINRA rulebook; incorporate existing guidance and interpretive letters into the rules; change specific aspects of the regulation of gifts, non-cash compensation and business entertainment; and prescribe recordkeeping requirements. 

Gifts 

FINRA is proposing to amend the Gift Rule to increase the gift limit from $100 to $175 per person per year and to add a de minimis threshold below which firms would not need to record gifts. Further, by incorporating existing guidance, the amended Gift Rule would continue to: include gifts given during the course of business entertainment; value gifts at the higher of cost or market value; and provide for annual aggregation of all gifts from members (and associated persons) to a recipient. Subject to certain conditions, the amended Gift Rule would continue to allow: 

• Bereavement gifts that are customary and reasonable; 
• Personal gifts for infrequent life events (e.g., wedding or birth) that are customary, reasonable and personal (i.e., not in relation to the employer’s business); 
• De minimis gifts (e.g., pens or notepads) valued at less than $50;⁵ 
• Promotional items (e.g., umbrellas or tote bags) if the item is valued at less than $50 and displays the member’s logo; and 
• Commemorative items for business transactions (e.g., lucite stones or plaques) if the item is solely decorative. 

The proposed amended Gift Rule would continue the existing requirements related to supervision and record retention, by requiring FINRA members’ systems and procedures to be reasonably designed to ensure: that a recipient’s gratuity is reported to the member; reviewed for compliance;⁶ and maintained in the member’s records. However, gifts that are de minimis gifts and promotional or commemorative items are not subject to the recordkeeping requirements. 

Restrictions on Non-Cash Compensation 

Proposed FINRA Rule 3221 extends the current prohibition on offers or payments of non-cash compensation to the sale of any security. Currently, FINRA rules only apply to offers or payments of non-cash compensation with respect to investment company securities, variable insurance contracts, direct participation programs and public offerings of securities.⁷ Proposed FINRA Rule 3221 would continue to define the following as permissible non-cash compensation arrangements: 

• Gifts from offerors⁸ that: 
  • Do not exceed $175 per individual per year; and 
  • Are not preconditioned on the achievement of a sales target.⁹ 
• Training or education meetings by offerors where the offeror pays for associated persons’ expenses, provided that: 
  • Prior approval to attend is not preconditioned on the achievement of a sales target; 
  • The location is appropriate in light of the purpose of the meeting as defined in the Proposal;¹⁰ 
  • An offeror may only pay for certain (i.e., training, education, meals, lodging and transportation) expenses, and not for entertainment or for guests. 
• Internal sales contests between permitted participants¹¹ where the arrangement is either: 
  • Not preconditioned on achievement of a sales target; or 
  • “Preconditioned on achievement of a sales target [where the arrangement is] based on the total production with respect to all securities [distributed by the member], and not based on conditions that would encourage an associated person to recommend particular securities or categories of securities.”¹² 

Further, by incorporating existing guidance as supplementary material to FINRA Rule 3221, FINRA proposes to continue existing interpretations related to: gifts incidental to business entertainment; the valuation of gifts at the higher of cost or market value; the aggregation of gifts per recipient per year; permitted personal gifts; and permitted de minimis gifts and promotional or commemorative items.¹³ In addition, the supplementary material includes training and education meetings that must “first and foremost be intended to provide training or education to an associated person” where training must occupy “substantially all” of the work day.¹⁴ 

FINRA also proposes to require members to retain records of non-cash compensation provided or received by a member (or its associated persons).¹⁵ 

Business Entertainment 

Proposed FINRA Rule 3222, which would apply to business entertainment provided by a member (or its associated persons) and to the receipt of business entertainment by a member (or its associated persons) from an offeror,¹⁶ would include an occasional meal, a ticket to a sporting event and other comparable entertainment, among other events.¹⁷ 

Proposed FINRA Rule 3222 requires principles-based written policies and supervisory procedures to: 

• Detect and prevent business entertainment intended (or reasonably perceived as intended) as an improper quid pro quo; 
• Define forms of business entertainment, as either permissible or impermissible, based on specified factors;¹⁸ 
• Require the offeror or member (or its associated persons) to host the business entertainment; 
• Specify that the business entertainment is not preconditioned on the achievement of a sales target; 
• Require appropriate training and education of all relevant personnel; and 
• Require the maintenance of detailed records, including the factors used to determine permissibility. 

Specific Requests for Comment 

In addition to requesting comments on all aspects of the Proposal, FINRA seeks comments on the following specific questions, including whether: 

• Risks to customers might increase as a result of raising the gift limit to $175, and whether this limit is appropriate; 
• $50 is an appropriate de minimis threshold for recordkeeping; 
• The Gift Rule should be broadened to encompass gifts given by member firms (or their associated persons) to their own employees or gifts by member firms’ employees to their retail clients or customers; 
• Disallowance of product-specific internal sales contests for non-cash compensation is appropriate; 
• Training and education meetings should allow entertainment; 
• Proposed recordkeeping requirements are appropriately tailored to allow compliance monitoring; 
• Consolidation of regulation in the Proposal simplifies and affects the costs of compliance; and Compliance programs might be impacted – including consideration of the estimated costs of drafting policies and procedures covering business entertainment, as well as the economic impact of extending the non-cash compensation rules to all securities. 

Footnotes 

_{1) FINRA Regulatory Notice 16-29, Gifts, Gratuities and Non-Cash Compensation Rules (Aug. 2016). 
2) FINRA Rule 3220, Influencing or Rewarding Employees of Others.
3) FINRA, Retrospective Rule Review Report: Gifts, Gratuities and Non-Cash Compensation (Dec. 2014).
4) See, e.g., FINRA Rule 3220 (Influencing or Rewarding Employees of Others) (formerly National Association of Securities Dealers (NASD) Rule 3060); FINRA Notice to Members 06-69, Gifts and Guidance, NASD Issues Additional Guidance on Rule 3060 (Influencing or Rewarding Employees of Others) (Dec. 2006) (Notice to Members 06-69); Amal Aly, Managing Director & Associate General Counsel, SIFMA (Reasonable and Customary Bereavement Gifts), FINRA Interpretive Letter (Dec. 17, 2007) (Aly Letter); FINRA Rule 2320(g)(4) (Variable Contracts of an Insurance Company) (formerly NASD Rule 2820(g)(4)); FINRA Rule 2341(l)(5) (Investment Company Securities) (formerly NASD Rule 2830(l)(5)); FINRA Rule 2310(c) (Direct Participation Programs) (formerly NASD Rule 2810(c)); FINRA Rule 5110(h) (Corporate Financing Rule – Underwriting Terms and Arrangements); NASD Regulatory & Compliance Alert 14.2, Non-Cash Compensation – Training or Education Meetings (Summer 2000), at 13; Henry H. Hopkins and Sarah McCafferty, T. Rowe Price Inv. Serv., Inc., NASD Interpretive Letter (June 10, 1999) (1999 Interpretive Letter).
5) The de minimis gift exemption will not apply if there is a pattern of providing gifts of less than $50 to circumvent the Gift Rule’s restrictions and recordkeeping requirements.
6) The procedures must also require the member’s supervisory personnel make a determination regarding whether a gratuity is personal.
7) FINRA Rule 2320(g)(4) (Variable Contracts of an Insurance Company) (formerly NASD Rule 2820(g)(4)); FINRA Rule 2341(l)(5) (Investment Company Securities) (formerly NASD Rule 2830(l)(5)); FINRA Rule 2310(c) (Direct Participation Programs) (formerly NASD Rule 2810(c)); FINRA Rule 5110(h) (Corporate Financing Rule – Underwriting Terms and Arrangements).
8) Based on the current definition of offeror, the proposed rule defines an “offeror” as “(A) with respect to the sale and distribution of variable contracts, an insurance company, a separate account of an insurance company, an investment company that funds a separate account, any adviser to a separate account of an insurance company or an investment company that funds a separate account, a fund administrator, an underwriter and any affiliated person (as defined in Section 2(a)(3) of the Investment Company Act of 1940) of such entities; (B) with respect to the sale and distribution of investment company securities not sold through variable contracts, an investment company, an adviser to an investment company, a fund administrator, an underwriter and any affiliated person (as defined in Section 2(a)(3) of the Investment Company Act of 1940) of such entities; and (C) with respect to the sale and distribution of any other type of security, an issuer, a sponsor, an adviser to an issuer or sponsor, an underwriter and any affiliated person of such entities.” Proposed FINRA Rule 3221(a)(4).
9) Consistent with existing non-cash compensation rules, the term “preconditioned on the achievement of a sales target” refers to an advance communication, either explicit or implicit, that non-cash compensation will be provided by an offeror or member to an associated person if either: a selling goal (in dollars) is achieved or the associated person becomes a “top seller.” Proposed FINRA Rule 3221(a)(5). Recognition of past sales is permissible where a goal is not stated in advance and where the selection criteria is not reasonably apparent to participants. Regulatory Notice at note 18.
10) The Proposal would establish an “appropriate” location as “a United States office of the offeror or the member holding the meeting, or a facility located in the vicinity of such office, or a United States regional location … [of associated persons’ workplace], or … a United States location at which a significant or representative asset of [a direct participation] program or real estate investment trust is located.” Proposed FINRA Rule 3221(b)(2)(B).
11) Such an arrangement would include internal sales contests held by a member for its associated persons, or by a non-member for its sales personnel (who are associated persons of an affiliated member). However, the arrangement cannot include participants from unaffiliated non-members or other unaffiliated members.
12) As such, proposed FINRA Rule 3221 does not permit product-specific internal sales contests.
13) The treatment of de minimis gifts and promotional or commemorative items is consistent with the Gifts Rule.
14) Proposed FINRA Rule 3221, Supplementary Material .06. This guidance is consistent with existing guidance. Regulatory Notice at note 19.
15) This information includes: names of the providers (offeror, non-member or other member); names of associated person recipients; nature and value of non-cash compensation; location of meeting; and any other information that evidences compliance with the Proposal.
16) The term “offeror” is proposed to have the same meaning in Proposed FINRA Rule 3222 as in Proposed Rule 3221. Proposed FINRA Rule 3222, Supplementary Material .01.
17) Proposed FINRA Rule 3222, Supplementary Material .02. 
18) These factors include: location, nature, frequency and dollar amount of business entertainment; and type and dollar amount of accommodation or transportation.}