NASD Proposes Curbs on Broker Sales Contests and Other Commission Boosters

For years it has been common practice for brokers to earn extra commissions and perks for selling their own firm's proprietary mutual funds.

But with three new rule proposals posted to its Web site Wednesday, the National Association of Securities Dealers has sent out a clear message to brokerage firms that offer these and similar incentives: The party is over.

However, the proposals are expected to run into significant opposition from the brokerage industry and they could wind up looking very different when ultimately adopted.

In addition to discouraging extra incentives for selling in-house funds, the NASD also wants to prohibit sales contests where brokers who sell the most shares of a given security earn noncash compensation ranging from golf balls to better offices to better access to new clients.

Firms also would be required to disclose to clients if they have used the promise of higher commissions to lure their broker away from a competing firm. These boosted commission levels typically last from one to six months.

Many industry insiders believe the proposals are overdue given that the promotional tactics they target are widespread, virtually unknown to investors and can create significant conflicts of interest.

"I don't think most people have any idea this goes on or how common it is. When you go to a car dealer, you expect tricks and gimmicks. But when you go to a broker, you expect sound financial advice. I'm surprised this sort of thing has gone on as long as it has," says Marilyn Capelli Dimitroff, owner of a Bloomfield Hills, Mich., financial planning firm and former owner of a Chicago brokerage.

"They're chipping away at a system that is totally corrupt. These are baby steps in the right direction, but [brokerage firms] still have an enormous variety of carrots to direct the broker's behavior," says Frank Armstrong, a Miami-based planner and another former broker.

There remain a number of sales incentives that the proposals do not address. For example, the proposals don't address dealer reallowance, where a mutual fund company allows a broker or his firm to keep an extra portion of a fund's sales charge as an incentive for selling the fund.

"This [the proposals] covers what the NASD wants to cover at this point," says Amy Hyland, an NASD spokeswoman.

The proposals appear to be part of the fallout from the 1995 Tully Report, an examination of broker compensation policies requested by Security and Exchange Commission chairman Arthur Levitt. The report found several policies, including those targeted in the NASD's proposals, that could motivate brokers to sell inferior or unsuitable products.

To many, these practices raise fundamental questions about whether or not brokers' pay structure motivates them to act in the best interest of their clients.

"I think brokers today are still set up as salespeople, not advisors," says Dimitroff. She advises clients to research their advisor's pay structure as closely as they'd research a potential investment.

The proposal documents posted on the NASD Web site indicate many member brokerages believe the questionable practices cited in the Tully Report require little or no added disclosure.

Resistance to the proposals from member brokerages could lead to amendments that dilute their impact, says Hyland. Investors also shouldn't expect the proposed rules to take effect anytime soon. Hyland estimates that once member firm comments are received, and the NASD and SEC draft, redraft and exchange comments on the rules, it could be a year before they are finalized.

NASD member firms have until Oct. 29 to submit their comments on the proposals. Those comments will be made public two weeks later, says Hyland.

In the meantime, how can you find out if your broker or brokerage firm have participated in promotional payouts or sales contests?

It seems the best -- and perhaps only -- way to know if you're being pitched a product that is being promoted is to ask your broker. Keep in mind, neither your broker nor his or her firm is required to tell whether there is a current compensation-based product promotion.