August 11, 2000
David M. Rappaport, Esq.
Associate General Counsel
15450 New Barn Road
Miami Lakes, Florida 33014
Dear Mr. Rappaport:
This letter responds to your November 17, 1999 letter and subsequent conversations in which you request clarification of Notice to Members 96-33 (May 1996), Question and Answer #4, and a previous interpretive letter from Jean Feeney dated October 27, 1997, as they relate to a registered investment adviser who also is registered as a Limited Representative – Investment Company and Variable Contracts Products ("Series 6 Representative") and receives non-commission, fee-based compensation from the registered investment adviser firm for referrals of clients. Specifically, your letter requests clarification of the application of NASD Rules to the following two scenarios.
First, you inquire whether a Series 6 Representative, registered with an unaffiliated broker/dealer, who becomes registered under your broker/dealer’s registered investment advisory affiliate ("Series 6/IA") may, with the written approval of his or her broker/dealer, receive fee-based compensation for making referrals to your broker/dealer’s General Securities Representatives ("Series 7 Representatives"). The Series 7 Representatives would complete an investor profile questionnaire and assist the client in setting up an account with a third-party money manager program. The Series 6/IA would receive an asset-based referral fee from a portfolio where the underlying transactions would include stocks and bonds. The Series 6/IA would not receive a fee based on transactions or commissions. The client would pay an annual fee to the third-party money manager based on a percentage of the assets in the account. The third-party money manager would have full discretion with respect to the client "wrap fee" accounts and would pay the investment advisory affiliate a referral fee pursuant to Rule 206(4)-3 under the Investment Advisers Act of 1940 ("Advisers Act") equal to a portion of the annual fee based upon a percentage of the managed assets. The investment advisory affiliate would pay the Series 7 Representative and the Series 6/IA a portion of the fee based upon the client referral and the servicing function they perform. The Series 6/IA would not participate in the execution of securities transactions for the money manager account, nor would the Series 6/IA receive transaction-based compensation.
Second, you inquire whether the Series 6/IA may make client referrals to a Series 7 Representative who is also registered with an investment adviser ("Series 7/IA"). The Series 7/IA would offer the referred clients the opportunity to open a fee-based brokerage account with the investment adviser’s affiliated broker/dealer under their own in-house "TARGET Program." Under this program, the Series 7/IA may execute trades in stocks, bonds, mutual funds and other securities based upon an annual fee. The Series 6/IA would not engage in the purchase or sale of the individual securities nor receive a fee based on the execution of such purchases or sales. However, as we discussed, the Series 6/IA would receive a referral fee pursuant to Rule 206(4)-3 under the Advisers Act from the investment adviser equal to a portion of the ongoing asset-based annual fee.
Notice to Members 96-33 provides that a limited registered representative may not execute transactions in securities not covered by his or her registration. Your letter, however, indicates that the Series 6/IA will neither (1) engage in the purchase or sale of individual stocks or bonds, nor (2) receive a fee based on the execution of such purchases or sales. Rather, the Series 6/IA will receive asset-based referral fees from the investment adviser pursuant to Rule 206(4)-3 under the Advisers Act. Therefore, it does not appear that Series 7 registration is required for the activities under the scenarios described in your letter. In addition, the analysis would not change if the broker/dealer was unaffiliated with the investment advisory firm and the broker/dealer provided written approval for the Series 6/IA to engage in this activity.
It is important to note, however, that where Series 6 registered persons are receiving asset-based referral fees from a portfolio where the underlying transactions include stocks and bonds, the member must supervise the activities of the Series 6 registered persons to ensure that these representatives do not conduct activities that would otherwise require Series 7 registration, including, but not limited to, discussing the nature or details of particular stocks or bonds, recommending the purchase or sale of individual stocks or bonds, or accepting or executing orders for the purchase or sale of individual stocks or bonds. The member should be able to demonstrate that its supervisory procedures are reasonably designed to prevent violative conduct by such registered persons.
I hope this is responsive to your inquiry. Please note that the opinions expressed herein are staff opinions only and have not been reviewed or endorsed by the Board of Directors of NASD Regulation. This letter responds only to the issues that you have raised based on the facts you have described, and does not address any other rule or interpretation of the Association, or all the possible regulatory and legal issues involved.
Stephanie M. Dumont
Assistant General Counsel
Daniel M. Sibears, Senior Vice President
Alan M. Wolper, District Director