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Tully Report Revived Through NASD's Proposed Salesperson Compensation Rules
emember the Tully Report? Issued in 1995, by an SEC appointed industry committee, it identified so-called "best practices"
relating to brokerage firm compensation practices that may create conflicts of interest with customers.
Of course, the Tully Report was not law, and many of the "best practices" amounted to little more than lip service.
A notable exception were the 1998 amendments to NASD rules which, for the first time, regulated non-cash compensation
arrangements in the sale of variable annuities and investment company securities.
Now, in 1999, some of those Tully Report "best practices" may become law. In Notice to Members 99-81, the NASD has proposed
three rules relating to salesperson compensation. Anyone can comment upon these proposals to the NASD, as long as they do so
in writing and the NASD receives those comments by October 29, 1999. There are several ways to respond, including e-mailing
of comments to pubcom.nasd.com.
What are the three NASD proposals? First, that there be a rule prohibiting the payment of higher payout ratios to salespersons
for the sale of proprietary investment company products. Second, that there be a rule prohibiting single security sale contests.
Third, that there be a rule requiring disclosure to customers of accelerated payout arrangements for salespersons who change firms.
Let's examine these rule proposals.
The first of the three rule proposals seeks to equalize broker payout ratios for both proprietary and non-proprietary mutual funds.
While the NASD is focusing upon mutual funds, because of their importance to retail investors, the NASD invites comments as to
whether the rule should extend to other products as well.
The NASD notes that another option may be to simply disclose the differential compensation arrangements at or before sale.
But the NASD wonders whether customers would be able to effectively evaluate such a disclosure. The NASD also questions whether
there may be legitimate business considerations justifying higher payouts, and whether the current rules (for example, Rule 2310
requiring brokers to have a reasonable basis to recommend an investment) may suffice.
I also would ask whether any such rule would be effective when, in fact, some firms already prohibit differential payouts but,
nonetheless, exert pressure on brokers to push proprietary products through branch office manager compensation, quotas and/or bonuses.
The second NASD proposal relates to prohibiting single security sales contests. As background, the Non-Cash Compensation rules
governing variable products and investment company products do not regulate contests that result in cash awards, nor obviously
do they regulate products besides variable and investment company products. The NASD thus proposes that all single security sales
contests, for all products (except a type or family of securities, such as mutual funds or a group of equities) be prohibited.
The NASD is seeking comments regarding whether customer disclosure is more appropriate than prohibition. Also, the NASD wonders
whether existing NASD rules, such as Rule 2310, sufficiently deal with the issue.
Perhaps the most controversial NASD rule proposal, though, is the third one. Should firms be required to disclose to customers that
the broker is receiving an accelerated payout? From a practice standpoint, we represent brokers who know, as the NASD recognizes,
that in moving from firm to firm, they will lose customers and will, for a time, experience reduced production, given the delays
associated with ACATs and other matters.
However, the NASD is concerned that there is a "perceived problem" with the practice. They are concerned, and request comments
regarding, whether the accelerated payouts create incentives for brokers to excessively trade customer accounts to generate as
much revenue as possible.
The NASD proposes that firms must disclose, in writing, the existence and general nature of the compensation arrangements. This
would not include the specific compensation formula or the amount paid to the broker. The written disclosure would have to be made
not only to customers whose accounts are being transferred but also to new customers for as long as the accelerated payout structure
is in effect.
The NASD seeks comments as to whether such disclosures are necessary or desirable. Interestingly, the NASD also requests comments on
the following. Would it be better simply to require firms to provide more supervision to brokers with accelerating payouts? And,
should a disclosure to customers similar to the one being proposed also apply to brokers who decide not to switch firms because they
accept an accelerated payout package?
All of these NASD rule proposals are important issues to many brokers. Interested brokers should send their comments to the NASD.
But do so before October 29, 1999.
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Sponsored by James J. Eccleston, an attorney representing stockbrokers, financial planners and
investors nationwide in arbitration, litigation and regulatory matters, and a shareholder with the law firm
Shaheen, Novoselsky, Staat, Filipowski & Eccleston
P.C.(www.snsfe-law.com). This Web site contains material
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