Beware of Watchdog

How one agency holds sway over insurance industry events

Watchdog illustrationPlanners don’t have any easy time of it these days. And if tough contract negotiations, complex logistics and increasing scrutiny by procurement aren’t enough of a challenge, insurance meeting planners have yet another minefield to cross: the threat that their incentive programs will run afoul of the watchdogs at the National Association of Securities Dealers.
    Even insurance industry planners who don’t organize incentive sales contests must follow rules set forth by New York City-based NASD for training and education meetings, gift giving, entertainment expenses and record keeping.
    “We follow NASD rules and regulations in that we don’t offer tours or pay for spouse travel or give any incentive-type gifts,” says Sharon Chapman, CMP, CMM, travel and corporate events planner with the Berkshire Life Insurance Company of America, based in Pittsfield, Mass. “And we do the mandatory number of hours of business meetings throughout the day. In other words, our business meetings are meetings.”
    While Chapman is upfront about adherence to NASD requirements, other planners contacted by M&C for this story would not give their names for fear of attracting undue attention from the regulatory body. Which leads to the  inevitable question: Just what or who is NASD, anyway?

An appetite for discipline
NASD isn’t a government agency; rather, it is the biggest private-sector provider of regulatory services in the world, working at the behest of the Securities and Exchange Commission, the U.S. government’s regulator of securities brokers nationwide. (A “security” is a stock certificate or bond, held as evidence of debt or of ownership, that may be traded in a market.)
With a $500 million annual budget and 2,000 employees, NASD oversees thousands of brokerage firms and registered securities dealers. The organization licenses individuals and firms and writes the rules that govern their activities. In recent years, however, the agency has become a very aggressive disciplinarian.
    “Before, it was sort of the fox guarding the chicken coup, but now they have toughened up,” says Jonathan T. Howe, Esq., a contributing editor of M&C and Chicago-based senior partner in the law firm of Howe & Hutton Ltd., which specializes in meetings, travel and hospitality law. And in this case, “toughened up” means doling out punishment.
    “NASD decided it would rather be in charge of discipline than let the government be the sole source,” Howe continues. “Now, about once a month, you pick up The Wall Street Journal, and there is a full-page article about people who have been disciplined.”
    For meeting planners to be subject to NASD oversight, they must work at companies that sell variable life and annuity insurance products. These give the investor an opportunity to gain from their potential capital appreciation and also subject the investor to risks from the marketplace the characteristics of a security.
    To sell a security or a security-like product, “you have to be a broker/dealer,” explains Larry Kosciulek, associate director for investment companies regulation for NASD. “All broker/dealers in the United States who have retail accounts have to be members of NASD.” As a result, that agency performs federal oversight affecting meeting planners at scores of companies nationwide.

GOLF: NASD’S FORE-LETTER WORD?
The regulators at the National Association of Securities Dealers turn a keen, Tiger Woods-like focus on golf outings, but instead of pins, they tend to see red flags at every hole on the course. While insurance planners under NASD’s purview can pay for an associated attendee’s meals, transportation and lodging (within reason) during an education meeting, golf is a definite no-no, unless attendees themselves are paying for the pleasure of putting.
    In 2001, Mary L. Shapiro, NASD vice chairman, sent a reminder to members who sell variable and investment company products, complaining that some offerors of these products “sponsor trips that are laden with golf outings, cruises, tours or other entertainment, all under the umbrella of training or education meetings.”
    “Of course,” Shapiro wrote, “associated persons themselves may play golf or enjoy other forms of entertainment organized by the offeror while attending these meetings, provided that the offeror does not pay for or reimburse the costs of these events.”
    In other words: You can plan a game of golf for attendees, but don’t pay for any greens fees or equipment (and especially not the perk of playing with a pro), or you could wind up deep in NASD’s regulatory rough. -- B.M.L.

Variable ethics?
Unfortunately, many planners working for companies considered broker/dealers are getting caught up in a vortex of controversy concerning the way variable policies are sold.
    According to a joint SEC/NASD report issued in June 2004, “NASD and other regulators have received a large number of complaints from individual investors about variable insurance products. Many of these complaints indicate the investor was sold a variable product without fully understanding the product, and express concern that the product was not appropriate for them, given their investment objectives.”
    The report further explains that “high fees and surrender charges combined with other factors” make variable insurance products a bad choice for many investors. But such investors often are given the hard sell because sales of variable products are driven by high commissions for salespeople, typically above 5 percent.
    That’s where the regulators and their enforcement actions become most relevant to meeting planners. Both NASD officials and independent lawyers agree it makes sense for insurance planners not only to pay attention to the letter of the regulations, but also to examine specific enforcement actions that might draw a more distinct line than sometimes vague regulatory language.
    “As lawyers, we look at what the court is going to do to interpret a particular law,” says Jonathan Howe. “It’s the same with regulation. You can read a rule but how is that rule being interpreted by those doing the enforcement? What do they find and what do they not find as objectionable?”
    A look at NASD’s enforcement actions provides some answers. In July of this year, the agency fined a Horsham, Pa.-based insurance company $325,000 for running an inappropriate travel incentive program for its brokers. According to NASD, the firm Hornor, Townsend & Kent created improper incentives for brokers to sell certain insurance products, rather than focusing  on the quality of the individual investment based upon the customer’s unique financial needs.
    “By favoring the sale of some variable life and annuity products over others, these contests created conflicts of interest that could undermine the broker’s obligation to recommend suitable investments based on the needs of the customer,” noted NASD vice chairman Mary L. Shapiro in a statement. “NASD rules are designed to prevent such conflicts between the broker’s self-interest and the customer’s.”
    How did Hornor, Townsend & Kent run afoul of NASD? Between 2001 and 2003, the firm conducted six national and multiple branch office sales contests designed to boost sales of specific variable life and variable annuity products those of Penn Mutual Life rather than a contest that promoted the sale of all products the firm offers within the product line, as NASD requires.
    The prizes offered to the broker’s sales force included weekend getaways to Las Vegas, New Orleans and New York City; cash vouchers for personal entertainment and education, and gift cards. The value of these incentive awards was more than $200,000, according to the regulators. Prizes for the branch office incentive contests included golf trips, tickets to sports events, meals and electronic goods like HDTV sets.
    Regulators from NASD also objected to the fact that e-mails relating to the incentive program and exchanged between 83 different employees, including the firm’s president and other senior management, had been discarded. NASD further ruled that the supervisory system for the entire program was inadequate, per the agency’s rules governing non-cash compensation.
    As part of its settlement with NASD, Hornor, Townsend & Kent agreed to bar any sales contests for the sale of variable life or annuity products for three years.

The “non-cash” factor
NASD enforcement of variable products could get even tougher. “Variable insurance products have always been subject to the suitability, disclosure and other requirements that apply to all securities,” said NASD chairman and CEO Robert R. Glauber last year. “But given the examination findings, the large number of enforcement cases over the last couple of years and the complexity of these products, we feel we can best protect investors by establishing stronger, more specific rules that apply specifically to variable annuities.”      
    In the meantime, insurance conference planners would do well to scrutinize current NASD Rule 2820, which deals with agency members who sell variable insurance products and the kind of non-cash compensation that such companies might provide to their sales forces. (“Non-cash compensation” is NASD’s term for merchandise, entertainment, gifts and prizes, travel expenses, meals and lodging, with a special emphasis on incentive contests and training meetings.)
    In 1999, NASD warned members that “increased use of non-cash compensation for the sale of variable contracts heightens the potential for loss of supervisory control over sales practices and increases the perception of inappropriate practices, which may result in a loss of investor confidence.”
    Since then, NASD has overhauled its rules governing non-cash compensation to make sure insurance industry incentive contests, training meetings, gifts and entertainment expenses don’t adversely affect the choice or quality of products offered to consumers.

Q&A WITH NASD’S LARRY KOSCIULEK
M&C recently spoke with Larry Kosciulek, associate director for investment companies regulation with the National Association of Securities Dealers, the organization charged with overseeing firms that market variable insurance products.
 
M&C: How does NASD work with the Securities and Exchange Commission in formulating regulations for meetings, training and incentive programs? 

Kosciulek: The SEC is the federal government, and we’re a self-regulating organization. The SEC delegates responsibility to us to examine and investigate our members. The SEC approves all our rules.

M&C: Should meeting planners pay as much attention to enforcement actions as to the letter of the rules, which can be open to interpretation?

Kosciulek: If you want an indication of our focus, look at our enforcement actions.

M&C: Some of NASD’s regulations and notices can be difficult to understand. What can planners do to cope?

Kosciulek: They should work with their broker/dealer compliance officers. They’re on the front lines of these issues, dealing with interpretations and proposals. The terminology is too difficult for an outsider to understand.

M&C: How can planners stay up-to-date about changes?

Kosciulek: Monitor our website, www.nasd.com. Every Wednesday we have an e-mail blast that gives running totals of issues and proposals going out.

M&C: What raises red flags for your regulators?

Kosciulek: Location and venue. As far as training meetings, we have concerns that they not become entertainment events. If it looks very expensive, that would be a red flag. 

M&C: How much of a training meeting must be devoted to work-related activities? Is it inadvisable to schedule one afternoon of leisure over the course of a three-day meeting, for example?

Kosciulek: A training meeting is substantially all of a workday, and any outside entertainment cannot be provided by that training sponsor.

M&C: Can a meeting sponsor pay for a spouse to attend a training meeting?

Kosciulek: No, that would have to be on his or her dime.

M&C: Can an insurance company pay for training attendees to play golf?

Kosciulek: No.

M&C: What’s the most important thing for meeting planners to understand about sales incentive contests and trips?

Kosciulek: You can’t have a sales incentive contest that favors a product; you have to include all your products in sales contests. We’re trying to ensure that a salesperson makes a recommendation that is appropriate to an investor. The product should be sold to fulfill that customer’s needs and not because the sale may mean a boat trip for the salesperson.

M&C: Why are variable insurance products getting so much attention from regulators?

Kosciulek: Variable annuities have been around since the 1950s and variable life insurance since the 1970s. They’re attracting more attention because the growth in variable contracts has become associated with growth in the stock market, and there’s been more regulatory focus on that in the past five to 10 years. There’s certainly extra focus on conflicts in sales practices and the like.

M&C: What else should meeting planners be aware of?

Kosciulek: Pressure is increasing on broker/dealers in terms of what kinds of events they can offer, and there might be fewer conferences as a result. -- B.M.L.

Learning the ropes
All of this has not escaped the attention of Chicago-based ICPA, an Association of Insurance and Financial Services Conference Planners: “We included a session on NASD regulations at last year’s annual meeting,” says Steve Bova, CAE, the association’s executive director. “To move forward, we want to improve the educational content.”
    Indeed, at the 2004 Northeast Regional Meeting of ICPA, held at The Sagamore in Bolton Landing, N.Y., a panel moderated by Sheryl Krongold of Prudential Financial looked at “the gray area that lies around rules and regulations for holding a meeting within the financial industry. Fines and bad press have been incurred by many financial firms who have not abided by the IRS/NASD regulations for their meetings in the past,” according to ICPA’s program for the event.
    Among the rules most pertinent to insurance meeting planners are those concerning record keeping, site selection and gift giving as it relates to variable insurance products. While the following isn’t a comprehensive listing of NASD rules, it is meant to enlighten planners to aspects of meetings and events NASD regulates, and how the agency applies these rules to its members.
    " Record keeping. NASD expects records to show if non-cash compensation was received in connection with a sales incentive program or a training and education meeting. For such events, regulations suggest that records “should include information demonstrating that the requirements of a training and education meeting were complied with, including the date and location of the meeting, the fact that attendance at the meeting is not conditioned on the achievement of a previously specified sales target, [and] the fact that the payment is not applied to the expenses of guests.”
    Elsewhere, regarding training meetings, NASD regulations state, somewhat obliquely, “Members should establish a procedure so that their records reflect that appropriate approval has been provided to associated persons in connection with such meetings.”
    " Gifts and entertainment. NASD provisions allow the giving of gifts to sales staff so long as they do not amount to more than $100 per year, per person. However, some items seem to be exempt from this restriction. The NASD spending limit doesn’t apply to “promotional items of nominal value that display the offeror’s logo, such as golf balls, shirts, towels and pens.”
    As for when entertainment expenses go over the line, NASD’s language again is rather vague. In addition to $100 worth of gifts per year, the rules say an insurance company can give salespeople “an occasional meal, ticket to a sporting event or the theater, or comparable entertainment for persons associated with a member and, if appropriate, their guests, which is neither so frequent nor so extensive as to raise any question of propriety.”
    For all gifts and entertainment, care should be made that their provision is not part of an incentive program which requires the recipient meet specific sales goals, but rather as a “recognition of past sales or encouragement for future sales.”
    " Locating training meetings. While NASD recognizes insurance companies often pay for travel and expenses associated with introducing salespeople to new products and updating them on “portfolio changes or structural changes to a current product,” it monitors such events to make sure they don’t conflict with the interests of consumers.
    For meetings associated with training a sales force to sell a viable insurance product, the rules seem to leave a large gray area. “The location of the meeting must be appropriate to its purpose. A showing of appropriate purpose is demonstrated where the location is the office of the offeror or member, or facility located in the vicinity of such office.”
    This provision is clearly open to some interpretation, as are many NASD regulations. Legal experts caution that working with in-house compliance officers or a legal department is de rigueur.
    “As a former president of the United States once said, it all depends on what ‘is’ means,” says Howe. “Or, as a former Supreme Court justice said when asked to define pornography, ‘I know it when I see it.’ In other words, a lot of this is going to be extremely subjective, and it makes sense to look at the decisions or enforcement, not only the regulations.”
    The rules get harder still to interpret with precision when a company has multiple offices. “In order to address meetings where attendees are from a number of offices in a region of the county, the meeting may be in a regional location.”
    The way NASD’s Larry Kosciulek puts it, “We haven’t drawn lines or brought out the Rand McNally atlas, but [a training meeting] should be in the approximate area of the office of whomever is providing the meeting.”

Incentive sales contests
Because NASD sees a danger that incentive sales contests involving variable insurance products might motivate salespeople to recommend products on the basis of enticing personal incentives rather than a desire to meet the needs of the customer, the agency pays particular attention to such contests. Incentive programs (considered “non-cash compensation arrangements”) are allowable only if they meet the following four conditions:
    1. Incentive rewards must be based on the “total production of associated persons with respect to all investment company or variable product securities distributed by that member.” This means the sales staff has been involved with a variety of products without putting undue emphasis on any without regard to a customer’s needs.
    2. “The credit received for each investment company or variable contract security must be equally weighted,” meaning each product sold has equal value toward the total points or credits earned toward incentive prizes.
    3. No unaffiliated nonmember company (that is, a company that is neither a NASD member nor owned by or under common control of a NASD member company) or other unaffiliated member may directly or indirectly participate in the member’s or nonmember’s organization of a sales incentive contest. This is a byzantine way of saying the contest is for NASD members only.
    4. NASD’s specific record-keeping requirements must be met.