June 18, 1998
Willkie Farr & Gallagher
One Citicorp Center
153 East 53rd Street
New York, NY 10022-4677
Re: Referral Fees
Dear Mr. Schloendorn:
I am responding to your request for guidance with respect to whether Shoreline Pacific, the Institutional Division of Financial West Group ("Shoreline Pacific" or "Shoreline"), a member firm of the National Association of Securities Dealers, Inc. ("NASD"), can pay referral fees to a joint venture in connection with corporate finance activities to be conducted by Shoreline in the United States.
Your letter provides the following background information. Shoreline Pacific is engaged principally in the business of raising capital for growth companies through the placement on an agency basis of debt and equity securities with institutional investors, typically in a privately-placed transaction. In most cases, Shoreline Pacific is compensated upon the closing of the financing based upon a percentage of the amounts raised, with no upfront fees or commissions. Shoreline Pacific does not engage in any brokerage transactions with retail customers.
Affiliates of Shoreline Pacific currently are engaged in discussions with a European-based group regarding forming a joint venture ("Joint Venture") to provide investment banking services through a Belgium-domiciled corporation. Upon securing the necessary license from the Belgian authorities, the Joint Venture will be able to engage in the placement, sale, distribution, and trading of securities throughout the European Union. There are no plans to register the Joint Venture as a broker/dealer with the U. S. Securities and Exchange Commission ("SEC"); thus, the Joint Venture will not engage in any investment banking activities in the U.S.
If any potential corporate finance transactions in the U.S. come to the attention of the Joint Venture, the parties wish to be able to refer clients that are potential issuers of securities to Shoreline Pacific or a non-affiliated registered broker/dealer. You state that the Joint Venture’s involvement in any U.S.-based transaction will be sufficiently limited, consistent with SEC staff positions, so as not to require registration as a broker/dealer under Section 15(a) of the Securities Exchange Act of 1934 ("Exchange Act"). Upon the successful completion of any such transaction, Shoreline Pacific wishes to share a percentage of the corporate finance fees it earns with the Joint Venture as compensation for the referral.
You have asked that NASD Regulation, Inc. ("NASDR") confirm that Shoreline Pacific may make payments of finder’s or referral fees to the Joint Venture for referring issuers that are potential corporate finance clients to Shoreline Pacific. You have cited a rule proposed in Notice to Members 89-3 in support of your argument that such fees are permitted under NASD rules. As you know, the rule discussed in that Notice was never adopted. Therefore, I have responded to your question by referring to Rule 2710, an NASD rule that currently is in effect.
Rule 2710, the Corporate Financing Rule, includes "finders" as one of the persons within the definition of "Underwriters and Related Persons." The type of finder contemplated by this definition is a person that refers issuers that are potential corporate finance clients to the member; the definition does not encompass a finder that refers potential purchasers of the securities in the offering. Thus, the NASD has recognized that such a finder may receive a fee from the broker/dealer for its services and has not, in its review of underwriting terms and arrangements, objected to the payment of "finder’s fees." Therefore, if Shoreline Pacific pays the Joint Venture a finder’s fee as compensation for referring issuer clients, this payment would not violate Rule 2710.
You also have asked NASDR to confirm that the provisions of Rule 2420 would not prohibit the contemplated referral fee payments, assuming that the Joint Venture will conduct its affairs in a manner that does not require broker/dealer registration. Rule 2420, among other things, prohibits the payment of selling concessions, discounts, and other allowances to any registered broker/dealer that is a non-member of the NASD. Rule 2420 also has been interpreted to apply equally to entities that are not registered, but are required to be registered under the Exchange Act. However, the Rule has been interpreted as not applying to entities that are not registered and are not required to be registered under the Exchange Act. In the past, the NASD has deferred to the SEC as to when an entity is required to be registered as a broker/dealer. Thus, if the non-member entity, such as the Joint Venture, that receives commission or other payments from a member is not required to be registered pursuant to a SEC "no-action position," then the member’s payment of commissions to such entity would not violate NASD Rule 2420.
I hope this letter is responsive to your inquiry. Please note that the opinions expressed in this letter are staff opinions only and have not been reviewed or endorsed by the Board of Directors of NASDR. This letter responds only to the issues you have raised based on the facts as you have described them in your letter, and does not necessarily address any other rule or interpretation of the NASD or all the possible regulatory and legal issues involved.
Mary N. Revell
cc: John Ramsay, Vice President and Deputy General Counsel