Payments by an investment adviser to broker-dealers in the form of rights to receive cash compensation upon the occurrence of specific corporate events (e.g., initial public offering of shares of the adviser) do not constitute "non-cash compensation" under NASD Rule 2830(l).


June 18, 2001

 

Philip J. Fina, Esq.
Kirkpatrick & Lockhart LLP
75 State Street
Boston, MA 02109

 

Re: Request for Interpretation – Rule 2830(l)

 

Dear Mr. Fina:

 

I am responding to your letter of April 24, 2001, in which you requested interpretive advice as to whether the receipt of deferred cash compensation under the circumstances described below would constitute the receipt of a "security" in violation of Rule 2830(l)(2), and whether such compensation would be deemed "non-cash compensation" for purposes of Rule 2830(l)(5).

 

Request for Interpretation

 

Your letter states that a registered investment adviser ("Management Company") is the adviser to fifteen Accessor Funds ("Funds"). Neither Management Company nor any affiliate is registered as a broker-dealer under the Securities Exchange Act of 1934 or a member of the NASD. The Funds are fifteen series of a single investment company registered under the Investment Company Act of 1940 ("Investment Company Act"). The Funds consist of nine series, each with a specific investment objective or type of portfolio holding ("Underlying Funds"), and six series that operate as "funds of funds" and acquire mixes of shares of the Underlying Funds.

 

Your letter indicates that the Funds are offered with no front-end or deferred sales charges. Each Fund offers two classes of shares: Adviser class shares bear no administrative service or Rule 12b-1 fees; investor class shares bear an administrative service fee of 0.25% and a Rule 12b-1 distribution fee of 0.25%. Shares are offered principally to and through Financial Institutions (as defined below), as well as broker/dealers and fund "supermarkets." "Financial Institutions" may include banks, holding companies, state-chartered banks, state-chartered trust companies, and investment advisers; and, may (subject to receipt of interpretive advice from NASD Regulation Office of General Counsel) include broker-dealers.

 

Your letter indicates that Management Company would like to develop a mechanism to incent and reward Financial Institutions that assist the Funds and Management Company in the offering, distribution and retention of the Funds' shares. Management Company believes it can enhance the distribution of shares of the Funds and increase assets under management through strategic alliances with Financial Institutions if Management Company and/or its stockholders share some of the benefits that would accrue to Management Company and/or its stockholders upon an initial public offering ("IPO") of stock of Management Company or the sale of Management Company. Accordingly, Management Company proposes to adopt a program that will be offered to selected Financial Institutions ("Participants") that enter into strategic alliances with Management Company. The program will provide, in substance, that upon the occurrence of a "liquidation event" – essentially, either an IPO or sale of Management Company – the Participants will receive cash compensation in an amount based upon certain client assets invested by the Participant in the Funds. All cash compensation received by the Participants will be derived from cash that otherwise would be received by Management Company and/or Management Company's stockholders; no payment will be made by investors, the Funds or the Funds' shareholders.

 

Your letter states that the Participant's contractual right to receive cash compensation upon the occurrence of a liquidation event will be denominated as an "Equity Unit." However, it will not carry with it any ownership or other interest in Management Company. In particular, it will carry no voting or dividend rights, and no rights to preferences or payments in the event Management Company's business is terminated by other than a liquidation event.

 

Your letter asks that we confirm your views that the Equity Unit is neither a "security" within the prohibition of Rule 2830(l)(2) nor "non-cash compensation" subject to the restrictions of Rule 2830(l)(5). Your letter states that although denominated as an "Equity Unit," the only "right" that accompanies this unit is the contractual right to receive a deferred cash payment. No voting, dividend or other interest in Management Company is conferred by the Equity Unit. Accordingly, you do not believe the Equity Unit is a "security" for purposes of Rule 2830(l)(2). Your letter also states that the sole thing of value that is conferred is the right to a cash payment. Accordingly, you do not believe that the Equity Unit constitutes "non-cash compensation" for purposes of Rule 2830(l)(5).

 

Response

 

NASD Rule 2830(l)(2) provides that no member or person associated with a member shall, in connection with the sale and distribution of investment company securities, accept any compensation from an offeror that is in the form of securities of any kind. For purposes of Rule 2830, we interpret the term "security" to have the same meaning as it has under the federal securities laws. Accordingly, we recommend that you consult with the staff at the Securities and Exchange Commission for guidance on this issue.

 

Assuming the Equity Units are not securities under the federal securities laws, we would regard the payment of Equity Units to Participants as an award of cash compensation. NASD Rule 2830(b)(1)(C) provides that "cash compensation" shall mean any discount, concession, fee, service fee, commission, asset-based sales charge, loan, override or cash employee benefit received in connection with the sale and distribution of investment company securities. NASD Regulation's Office of General Counsel believes that this definition generally includes the right to receive a cash payment at a point in the future, and therefore views, assuming the Equity Units are not securities under the federal securities laws, the Equity Units described in your letter as cash compensation. Because cash compensation is excluded from the definition of "non-cash compensation" set forth in NASD Rule 2830(b)(1)(D), the staff believes the Equity Units are not subject to the provisions of Rule 2830(l)(5). The staff notes, however, that because the Equity Units would meet the definition of cash compensation, the Equity Units would have to be disclosed in a current prospectus of the Funds pursuant to NASD Rule 2830(l)(4).

 

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, Inc. 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 address any other rule or interpretation of the NASD, or all the possible regulatory and legal issues involved.

 

Sincerely,

 

Sarah J. Williams

cc: Thomas Selman, Senior Vice President
Investment Companies Regulation/Corporate Financing

Frederick F. McDonald, District Director
NASD Regulation, Inc., District No. 11