Brokerage Firms Pay for Incentive Violations

NASD (formerly the National Association of Securities Dealers) has sanctioned several brokerage firms for running prohibited sales contests, and its investigation is broadening. Writing in the spring 2004 issue of The Journal of Investment Compliance, NASD enforcement officials report that “NASD is in the process of examining over 20 broker-dealers” to review their compliance with rules that prohibit brokerage firms from rewarding cash or noncash compensation (including group travel programs) to brokers for selling specific funds or annuities. Contests should instead reward brokers' overall sales efforts.

“Our expectation is that any of our members not aware of these rules, now should be,” said David Shellenberger, chief counsel for the New York region of NASD, speaking in the aftermath of the $100,000 fine and censure of David Lerner Associates Inc. levied by NASD in April. The regulatory agency sanctioned the Long Island brokerage firm for running sales contests promoting certain David Lerner proprietary mutual funds and other selected products in violation of NASD rules.

In announcing the fine and censure, Mary L. Schapiro, vice chairman and president of regulatory policy and oversight for NASD, said, “The sales contests engaged in by the firm increase the potential for investors to be steered into investments that are in the representatives' financial interests instead of the best interests of the customers.”

The compliance action against David Lerner Associates is the third of its type taken against member firms since last fall. In September, Morgan Stanley DW Inc. was fined $2 million for using contests to promote the sale of certain mutual funds and annuities. In October, NASD fined Wells Investment Securities $150,000 for rewarding brokers with travel and entertainment perquisites for selling Wells' real estate investment trusts.

Shellenberger says the three compliance actions reflect NASD's commitment to ensure that the rules — put into effect in 1999 — are being followed. “There is a heightened sensitivity to the issue of sales practices of mutual funds,” he says.

Jon Batterman, NASD regional counsel for Long Island and New York, says that in the case of David Lerner Associates, the violations were “not a case of deliberate violation of our sales contest rules. … The violations occurred because the firm did not have any supervisory system in place to ensure compliance.”

In the Lerner case, prizes for the six prohibited sales contests included three- and four-day group travel programs to destinations in Puerto Rico, the Bahamas, Las Vegas, and New York, as well as expensive merchandise such as large-screen televisions and digital cameras. In all, the estimated value of the contest awards totaled $700,000.

The fine that was levied against Morgan Stanley was substantially higher because of the greater number of contests and brokers involved, according to Batterman. In that case, the prizes included tickets to Britney Spears and Rolling Stones concerts, tickets to the NBA finals, and tuition for a high-performance automobile racing school.