June 11, 2007
Secretary, Securities and Exchange Commission
450 Fifth Street, N.W.,
Washington, D.C. 20549-0609
Re: 1st Global Capital Corp response to proposed IM 3060
File No. SR-NASD-2006-044
To Whom It May Concern:
1st Global Capital Corp. (1st Global) is a fully disclosed retail broker-dealer registered to conduct business in all domestic jurisdictions, with over 1200 Registered Representatives offering securities services through over 600 branch locations.
As the Chief Compliance Officer of 1st Global, I appreciate the opportunity to submit comments on the issues raised in the above captioned proposed rule change by the National Association of Securities Dealers, Inc (NASD).
1st Global is not in favor of the proposal as drafted. The simple economic fact is that most NASD firms do not have accounts that are of the magnitude that would create a temptation to attempt to influence the customer representative through improper business entertainment. In other words, they lack the economic ability to violate the rule because their accounts which have customer representatives are too small to justify providing business entertainment that would be so frequent or excessive as to raise questions of propriety. In order to limit the onerous new record-keeping requirements, that are a part of the interpretative material, to those situations which present the greater probability for concern, a more appropriate definition of customer is necessary so that the accounts affected are limited to the institutional setting. This would bring the interpretative material in line with the actual problematic conduct that brought rise to the proposal in the first instance, the historical situations that have given rise to enforcement in the context of Rule 3060 in the past and the previous guidance provided in the area via a June 24, 1999 interpretative letter that indicated that Rule 3060 does not govern or limit ordinary and usual business entertainment provided by a member or its associated persons to the member's clients and their guests so long as the business entertainment was neither so frequent nor so extensive as to raise any question of propriety. Instead, it appears the NASD is taking this opportunity to impose on its members a new, unnecessary, detailed record-keeping regime for certain business entertainment expenditures. It is doing so by defining customer to include any customer account with a customer representative rather than limiting the guidance specifically to the institutional area where the transgressions have occurred. The NASD maintains that there is no effect on a retail practice. That is, in fact, not the case as there are a number of account registration types that would be effected by this interpretation that are more retail than institutional. For example, a $50,000 corporate account for a manufacturing company, a $150,000 401(k) account and a $250,000 trust account. All such accounts have a customer representative and all are retail accounts. The interpretative material should specifically limit its application to institutional accounts.
For background to these comments it might be beneficial to highlight the problematic conduct used as the reason cited by the NASD for issuing this proposed interpretative guidance. The seminal case which brought this issue to the forefront of public attention involved Jefferies Company a member firm and traders from FMR Co., Inc., an investment advisor to the Fidelity family of mutual funds.
The following problematic gifts totaling $313,700 were referenced in the Jefferies case:
The following private charted flights
o from Bedford, MA, to Bermuda at a cost exceeding $17,000
o from Boston to Los Angeles and Florida, at a cost exceeding $70,000 and $31,000, respectively
o from Bedford, MA, to Puerto Rico at a cost exceeding $23,000
o from Bedford, MA, to Providenciales, Turks and Caicos Islands, at a cost exceeding $47,000.
The following sporting/entertainment events
o tickets to the Wimbledon tennis tournament at a cost exceeding $19,000,
o tickets to the men's and women's Wimbledon tennis finals at a cost exceeding $31,000,
o tickets to Wimbledon and hotel accommodations for the event at the Lanesborough Hotel in London, which cost $38,000 and $12,000, respectively.
o tickets to the U.S. Open tennis tournament at a cost exceeding $7,000
o tickets to a Justin Timberlake/Christina Aguilera concert at a cost of $1,200,
The following gifts of fine wine
o eight (8) bottles of wine at a cost of $5,900
o twelve (12) bottles of 1993 Chateau Petrus (Pomerol) wine at a cost exceeding $7,500
o six (6) bottles of 1998 Opus One wine, at a cost exceeding $2,600
The following miscellaneous gifts
o Golf clubs which cost $500
o a portable DVD player at a cost of approximately $1,000
The following problematic business entertainment totaling $722,000 was referenced in the Jeffries case:
A four-day golf outing in various locations on the West Coast (the "Fall Classic"), including Las Vegas, and Cabo San Lucas, Mexico which cost $225,000 for, among other things, private air charter flights between each destination and lodging for his guests, including as much as $5,000 per night, per bungalow at the Bellagio Hotel in Las Vegas, and a similar amount for each of two villas he used at the Esperanza Resort in Cabo San Lucas.
A second trip to the Fall Classic to entertain traders at a cost exceeding $140,000 and which included flying the guests to Las Vegas and Scottsdale, AZ by private air charter and paying for their lavish hotel accommodations.
Treating the trader and his family to a one-week vacation in Florida for which Jefferies reimbursed their employee more than $93,000 and $64,000, respectively. For each of the vacations, the trader and his family received a roundtrip private charter flight between Florida and Massachusetts, as well as costly lodging, meals and various additional resort expenses at the Breakers Hotel in Palm Beach, Florida.
A bachelor party in Miami for a trader, which cost more than $75,000 for a limousine service and private roundtrip chartered flights between Boston and Miami for several traders, including the bachelor and other guests.
A trip to the Super Bowl in Houston, where more than $125,000 was paid for Super Bowl weekend-related expenses for the group. Weekend expenses included Maxim and Playboy pre-game parties, a car service, private round-trip chartered flights, lodging and tickets to the game.
It might also be illustrative to point out that the bad actor in this case, the Jeffries employee, had a $1.5 million dollar annual business entertainment budget.
After reviewing that background information it might be beneficial to consider several thought-provoking questions.
Is there any debate as to whether these business entertainment expenses were so frequent or excessive as to raise questions of propriety?
Is there any debate as to whether the gifts provided were not compliant with the NASD gift rule?
Does the NASD really need to issue interpretative guidance that requires all firms including those that do not even engage in providing services to other financial services firms, to keep detailed client level records of every business entertainment expense of $50 or more that they provide to a customer representative?
How many firms have the financial resources to engage in the activities cited in the Jefferies case?
Would it not be more appropriate to have a well thought-out response to this issue rather a quick, politically expedient response that gives new meaning to the term over-inclusive?
Would it not be more appropriate to focus or tier this interpretative guidance so that its effect is felt primarily by those firms that might engage in truly problematic behavior?
It might also be beneficial to consider recent comments from the NASD Chairman and Vice Chairman that relate to their views on trying to minimize the cost and burden of regulation.
In an April 26 e-mail to NASD member firm executive representatives about two rule change proposals meant to ease the regulatory burden on small firms, NASD Chairman and CEO Mary Sharpiro made the following comments:
The changes are in keeping with NASDs commitment to improving regulatory efficiency for all firms.
These two actions are concrete steps NASD is taking to reduce the regulatory business for all members.
In the NASD 2006 Year in Review and Annual Financial Report, NASD Chairman and CEO Mary Sharpiro made the following remarks:
I want to reaffirm our intent to follow through on those promises to reduce short- and long-term regulatory costs for all member firms.
In his recent remarks to the audience at the 2007 SIFMA Independent Firms Conference, NASD Vice Chairman Doug Shulman made the following comments:
We are committed to making distinctions in regulation, where feasible, between firm size, business focus and business model. We believe that this tiered approach in our thinking about regulation should yield a rulebook better rationalized between intent and impact and, therefore, more efficient regulation. We plan to seriously explore this going forward. (emphasis added)
We must always be on the lookout for risk and developing problems. Waiting for a product or practice to blow up and then reacting is not effective investor protection. And it is no longer sufficient in this day and age. Proactive regulation means exploring all of our options for addressing emerging issues once we identify them. There should be no automatic response, such as writing a rule, when we see an issue emerge in the industry. We must consider a range of options, including best practices, guidance, education and task forces to help us understand the problem and propose effective solutions. (emphasis added)
Aside from helping firms comply with our rules by offering educational programs, we also need to make sure that we periodically step back and examine the impact of our rules. What we need to be asking ourselves on a regular basis is: Are the rules doing what we intended them to do? Are they protecting investors? At what cost? And finally, is there a better, more efficient way to achieve the benefit? One of the first rules we are focusing on for comprehensive review is our OATS rules. Are they meeting their intended goal, and if not, how should we adjust? We will continue to put other rules through this lens as we learn from the pilot. (emphasis added)
I implore the NASD staff to live up to the promises made by the Chairman and Vice Chairman by more carefully drafting this proposed interpretation so that the burden of compliance is borne exclusively by the segment of our industry that might violate the rule.
This can be accomplished through the following two modifications:
First, the definition of customer should be modified by including an account level minimum asset level. Perhaps that level should be $50 million or more so that it coordinates with the institutional client definition contained in NASD Conduct Rule 3110(c)(4). If that amount were deemed inappropriately high, there are other lower amounts that might still help to focus the guidance on the most appropriate accounts rather than just any corporate accounts (i.e., account with a customer representative). The root cause of this problem is that business entertainment is being used to chase highly lucrative institutional accounts. The focus of this interpretation and the record-keeping burdens associated with it should therefore be limited to this context.
As proposed, this interpretative material applies to any corporate account on which there is a customer representative responsible for providing investment instructions. Therefore, it applies as equally to the $1,000,000 account for XYZ Manufacturing Company as it does to the $50,000,000 account for ABC Investment Company. Therefore it will impact accounts that are actually more retail then institutional. A $1,000,000 account may typically produce $5,000 to $15,000 in revenue per year for a firm. A $50,000,000 account may typically produce $250,000-$500,000 in revenue per year per firm. In which of the two situations is it more likely that inappropriate business entertainment will occur? It should be obvious that the regulatory benefits of this proposal will be realized in the larger account scenario and the majority of the costs will be absorbed by firms that operate a large number of accounts in the smaller account scenario. The modification of this guidance through a minimum asset level will help limit this interpretation to the larger account scenario and therefore to the institutional sales setting which typically involves a member firm and the employee of another member firm or a member firm and the employee of another regulated financial institution (i.e., advisory firm, bank, commodity broker, NYSE firm, etc.).
This suggested modification will result in the interpretative material staying more in line with the June 24, 1999 interpretative letter in which the NASD indicated that Rule 3060 does not limit ordinary and usual business entertainment provided by a member or its associated persons to the member's clients and their guests so long as the business entertainment was neither so frequent nor so extensive as to raise any question of propriety since it will only require detailed record-keeping related to accounts that are of a level that are more likely to result in business entertainment expenditures that are too frequent or too extensive because the economics support such improprieties.
This suggested modification is in line with prior precedent in this area. The very few published cases dealing with Conduct Rule 3060 all seem to confirm that the primary concern has always been with one member firms dealings with the employees of another member firm in the institutional sales setting.
IN THE MATTER OF THE APPLCATION OF RENTZ COMPANY, INC. 43 S.E.C. 436, Release No. 8134, Release No. 34-8134, 1967 WL 86368 (S.E.C. Release No.) (July 27, 1967). This case involved the practice of members promoting securities business from institutional investors through the allocation of 'hot issues' to persons connected with the purchase of securities by the institutions. Footnote 3 pointed out that the 1959 version of the NASD's interpretation pointed out that "free-riding' permitted' to 'officers and employees in the buying department of institutions' had been criticized by the membership and district committees, and stated that sales by a member to such persons of new issues which command an immediate premium over the offering price may be violative of Section 10 in the absence of a history of normal investment practice with the member
IN THE MATTER OF THE APPLICATION OF H. C. KEISTER COMPANY H. C. KEISTER L. A. SORENSON (November 1, 1966) 43 S.E.C. 164, Release No. 7988, Release No. 34-7988, 1966 WL 84120 (S.E.C. Release No.). The case involved the SEC upholding a finding by the NASD that payments in an indeterminate amount were made to a senior order clerk of a member firm, to influence and reward him in directing over-the-counter business to another member firm which was providing the payments
IN THE MATTER OF PAULINE W. ROSENBLOOM doing business as THE JAMES COMPANY and ROBERT I. ROSENBLOOM (December 7, 1965) 42 S.E.C. 860, Release No. 7762, Release No. 34-7762, 1965 WL 87591 (S.E.C. Release No.). This case involved payments by the member firm charged to another members sales manager and office manager to influence them to direct trading business to the firm and
Of course, the seminal case which brought this issue to the forefront of public attention involved Jefferies Company a member firm and traders from FMR Co., Inc., an investment advisor to the Fidelity family of mutual funds.
Additionally, the NASD Report On Examination Findings Regarding Gifts and Gratuities contains references that only deal with this issue in the context of activity involving a member firm and the employee of another member firm or a member firm and the employee of another regulated financial institution. For example,
The genesis of the issue was a routine exam where the NASD noted a number of gifts and expensive entertainment conferred by certain registered representatives upon employees of a large investment advisory firm.
The press reports cited specifically focused on lavish entertainment events and significant gifts being bestowed on employees of institutional customers of NASD member firms, including employees of investment advisors.
The sweep examination conducted focused on 40 firms engaged in institutional sales and trading.
At the onset of the examination a request was made for a schedule of instances in which the firm or an associated person of the firm conferred a gift, gratuity, travel or entertainment to an employee of another firm.
The report concludes that NASD considers it essential that firms comply with the gift rule to avoid the improprieties that can result from excessive gifts and entertainment conferred to employees of institutional clients.
Second, while the recently added exemption provision for ultra small broker-dealers is a step in the right direction, it is only meaningful to an extremely small number of NASD member firms since it is set at $7,500 in business entertainment for a broker-dealer for a year. This exemption should be expanded by making it $7,500 per salesperson associated with the broker-dealer. For example, a broker-dealer with 10 salespersons who collectively spend $74,999 in total business entertainment annually should be exempt from the record-keeping requirements.
Modifications like the two being advocated in this comment letter would restrict the supervisory and record-keeping burdens to (i) the accounts that are more likely to be the subject of abuse – those that generate revenue that is economically worth chasing with outlandish business entertainment - and (ii) the sales personnel who might be more likely to fail to comply with the rule – those with business entertainment budgets that might truly impair the independence of the customer representatives with whom they interact. For this reason, 1st Global believes the NASD needs to further modify this interpretative material before it is approved by the SEC.
Again, we thank the Commission for the opportunity to comment on these important issues.
Michael A. Pagano
Executive Vice President, Compliance