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News December 14, 2015 Issue

Holiday Warning: Giving Gifts May Be Just as Bad as Receiving Them

It may be the season of giving, but if you’re an investment adviser seeking to influence a client, investor, service provider or some other party, better think twice.

Giving what may seem like a harmless gift may instead cause portfolio managers, investment adviser representatives or your entire firm grief.

"It’s all about conflict of interest, and the perception of conflict of interest," said Richmond, VA-based Blue Edge Capital chief compliance officer Margaret Fretz. "We are fiduciaries. Is it really worth the reputational risk?"

While the SEC does not have a specific rule saying that gifts shall not be given, it brought at least one enforcement case against an adviser for violating its own compliance rules on gifts it, and issued guidance in February 2015 about gifts and fund advisory personnel. The Investment Company Act regulates fund advisory personnel in regard to accepting gifts and entertainment, and FINRA limits the practice for broker-dealers under its Rule 3220. There are also various local anti-bribery and/or anti-corruption statutes that come into play, said Shearman & Sterling partner Nathan Greene. When doing business overseas, these include the Foreign Corrupt Practices Act, which prohibits bribery of public officials.

Aside from the possibility of running afoul of laws and regulations, gift-giving also raises a number of potential practical problems:

  • Clients may not allow them. Many clients may have their own policies that do not allow gifts to be received. Pension funds, states and municipalities typically have such restrictions, said Greene. "If your primary contact who received the gift is, as a result, embarrassed or tainted, it doesn’t bode well for the health of the relationship."
  • Contractual issues. Particular clients may want it written into their advisory contracts that gifts may not be offered, said Greene. This becomes an issue for the adviser because it is just one more contractual obligation that has no benefit, but for which the adviser can be held accountable, he said.

De minimis gifts – those with a limit of $100 to $250 per person – are allowed by many firms, said Greene. Fretz said that her firm limits gift-giving to $100 per client per year, which allows it to send a bottle of wine to out-of-state clients, and a giant cookie basket to in-state clients. If an employee wants to provide a larger gift, he or she must get approval from the chief compliance officer. Employees who give within the $100 limit simply have to report the gift.

Also keep in mind that geographic differences matter when de minimis limits are set, Greene noted. $250 may buy a nice dinner for two in New York City, but far more than that in a rural area, so consider tailoring the limits accordingly.

Ethical issues

The question of whether a gift should be given at all is also worth exploring. "Why not just send a hand-written note?" suggested University of Wyoming’s College of Business professor of business ethics Tim Mazur, formerly chief operating officer of the Ethics and Compliance Officer Association. "If you really want to show you care, send a personal note. It will mean a lot more to the relationship than a free dinner."

Gift-giving, from Mazur’s point of view, violates what capitalism is all about. "That’s why we use the word ‘corruption’ for bribes and gifts, because they corrupt the way the system is supposed to work," he said. "Clients should choose an adviser because that adviser provides the best services at the best rates, nothing more. The system works because advisers compete for clients. Gift-giving ruins capitalism."

Unrealistic? Not necessarily. Fretz noted that the amount of gift-giving has dropped dramatically in the past
decade or so, the result of attention paid by the government and others to the practice of giving and receiving gifts. "Some firms just have a prohibition against gift-giving of any kind," she said.

"CCOs then have to deal with the reality of a slippery slope," Mazur said. "Where does it end? If someone gives a $250 gift one year, will the client expect more the next, and more after that?" Instead, he suggested, use those marketing dollars to promote a new product or service, which is what the money was intended for.

Best practices

Consider the following steps to prevent, monitor and audit for improper gift-giving:

  • Make sure that policies and procedures are complete. Most firms have something in writing about gift-giving, but make sure they press the right buttons. Policies and procedures should begin with general principles, saying that corporate gift-giving is for hospitality and general relationship-building purposes, not for inducements or rewards, and can never be part of a quid pro quo, said Greene. They should also list the types of clients that do not allow gifts, such as pension funds; state any de minimis gift limits; and any additional rules. Mazur suggested putting these policies and procedures not only on the firm’s intranet, but on the Internet, so clients, investors and others will have access to them and can read the firm’s rules on gifts.
  • Check employee expense reports. Be clear that employees need to be honest and accurate in their expense reports, said Mazur, then check them to see if any gifts are reported. "It’s amazing how few employees will pay out of their own pockets for gifts," he said. "They will charge them back to their employers." That’s because a firm may have multiple clients, and individual IARs may themselves have multiple clients. If a firm allows up to $250 for gifts and an IAR has, say, 10 clients, that $2,500 may well be more than the IAR wants to personally bear.
  • Make it part of training. The ethics of gift-giving and the firm’s policies and procedures on the subject should be part of employee training, Mazur suggested. A good practice, Greene said, might be for the CCO to re-visit limits and rules regarding gifts and entertainment as "news nuggets" during morning briefings.
  • Require pre-clearance. Just as Blue Edge Capital requires this from employees seeking to offer gifts above the firm’s gift ceiling, other advisory firms, if they opt to set limits on gifts, may want to consider pre-clearance policies for employees operating outside their firm’s own respective guidelines.
  • Consider recordkeeping. If you put in place a limit on acceptable gifts, make sure employees report each gift. Each entry should state whether a gift was given, to whom it was given, and the amount or value.
  • CCO outreach to clients. Be careful with this one, as the last thing a CCO wants is to undermine the firm’s IARs. But when a CCO contacts a client once every two or three years, and does so "strictly in the context of quality control and the overall relationship," it can be helpful, Mazur said. "Inform the client that ‘I just want to let you know that I am here and am part of the leadership team,’" he said. "The client may volunteer something like, ‘Oh, the IAR was great. He just came out here for our annual trip and paid for the ski lodge.’"
  • Ask IARs who is providing gifts. Consider challenging your IARs to let the CCO know if anyone else within the firm is providing gifts, suggested Mazur. "It’s in the IAR’s interest to let you know, because if another IAR is providing gifts, and if the IAR you are speaking with is not, that may mean that the IAR who provided gifts was able, through unethical means, to get the client and possibly a bonus, while the other IAR did not because he or she wanted to be ethical. Unethical conduct should not be rewarded."
  • Require certification. Have employees certify that they will abide by the firm’s code of ethics, suggested Fretz. That should minimize the chances that an employee will go beyond the de minimis gift limit in a surreptitious way, such as providing a $100 gift to a client ten times.
  • Ask in a questionnaire. Consider sending out an annual questionnaire to employees, with one of the questions being whether they received or gave any gifts, Greene said.
  • Conduct a drill-down audit. After the holiday season is over, have your accounting department conduct a spot check of employee expense reports. Unlike the expense report monitoring done by the CCO during the holiday season, Mazur said, this audit would check to see if fraud was committed by employees who may have given clients or others gifts, but then falsified the receipts.