Direct payments of securities-based compensation by a member to the associated persons of another member are not permitted under NASD Rules 2820(g) and 2830(l) absent an SEC No-action letter or interpretive release. Further, proposed arrangement may require dual registration of associated persons.
February 3, 2003
Pamela M. Krill, Esquire
Godfrey & Kahn, S.C.
780 North Water Street
Milwaukee, WI 53202-3590
Re: NASD Rules 2820(g)(1) and 2830(l)(1)
Dear Ms. Krill:
I am responding to your letter dated February 7, 2002 to NASD wherein you request interpretive advice on behalf of your client Companies Agency, Inc. (“CAI”), an insurance agency and an indirect subsidiary of Liberty Mutual Insurance Company, regarding the application of NASD Rule 2820(g)(1) (Variable Contracts of an Insurance Company) and Rule 2830(l)(1) (Investment Company Securities).
Based on your letter and our subsequent phone conversations, I understand the facts to be as follows: To be able to sell both variable insurance products and mutual fund shares, and retain commissions on the sale thereof, CAI intends to become registered as a broker/dealer with the Securities and Exchange Commission (the “SEC” or the “Commission”) and the various states in which it intends to conduct business, and will become a member of NASD. CAI is considering a proposal with Walnut Street Securities, Inc., a registered broker/dealer and member of the NASD (“Walnut Street”), which you state is designed to alleviate some of the compliance burdens associated with becoming a registered broker/dealer.
As described in your letter, CAI would become registered as a broker/dealer and a member of NASD, but would maintain only the minimum required number of principals/registered representatives. Employees of CAI, who are currently licensed insurance agents, would, pursuant to a services agreement to be entered into between CAI and Walnut Street (the “Agreement”), become registered representatives of, and subject to the supervision, training, and control of Walnut Street with respect to their securities-related activities.
You state further that, commissions generated from the sale of variable insurance products and mutual fund shares would be paid by the issuer or principal underwriter of the securities to Walnut Street, and Walnut Street, in accordance with the terms of the Agreement, would then remit the commissions to CAI for payment to the registered representatives of Walnut Street. Alternatively, when required by law or by the selling agreement with a particular insurance company, issuer, or principal underwriter, the commissions would be paid directly to CAI which, in turn, would use such funds to pay the registered representatives of Walnut Street. In either case, CAI would retain a portion of the commission revenue. For Walnut Street’s supervision, training, and administrative services, the Agreement would require CAI to pay Walnut Street a flat fee.
Finally, you state that CAI would like to maintain control over the payment of commission dollars to the registered representatives of Walnut Street who, according to your letter, are employees of CAI primarily for administrative convenience. Because these registered representatives are employees of CAI, they are entitled to the benefit programs offered by CAI, including long and short-term disability insurance, group life insurance, retirement plans and bonus programs. Each employee’s level of benefits is based on total compensation earned. You state that if the compensation these employees earn as a result of their securities activities is not allowed to flow through CAI’s payroll system, it would be impossible to credit these employees for such compensation when computing the amount of benefits to which they are entitled.
You ask in you letter whether, assuming CAI becomes registered with the SEC and the various states as a broker/dealer and becomes a member of NASD, CAI can pay commissions generated from the sale of variable insurance products and mutual funds shares to its employees when such employees will be registered representatives of Walnut Street. Specifically, you cite NASD Rules 2820(g)(1) and 2830(l)(1).
NASD Rule 2820(g) and Rule 2830(l)
NASD Rules 2820(g) and 2830(l) generally provide that, in connection with the sale and distribution of variable contracts and investment company securities, respectively, an associated person of an NASD member may not accept any compensation from anyone other than the member with which the person is associated. An exception from this general prohibition permits the receipt of compensation by an associated person from a non-member company if the member agrees to the arrangement, the receipt is treated as compensation received by the member for purposes of NASD rules, the recordkeeping requirement in the rule is satisfied, and the member relies on an interpretive or no-action letter by the Commission staff that specifically permits such an arrangement. See NASD Notice to Members 98-75 and NASD Notice to Members 99-55, Question 21.
As you state in your letter, both CAI and Walnut Street are, or will be, NASD member firms. Therefore, they do not satisfy the conditions of the limited exceptions created in Rules 2820(g) and 2830(l), which apply only to payments by non-members to associated persons of a member firm. As noted in the rule filing regarding the adoption of Rules 2820(g) and 2830(1), these limited exceptions were particularly intended to reflect those situations where SEC interpretations permit direct payments by an insurance company to associated persons as a “ministerial service” or because state insurance law prohibits payments of commissions on sales of variable products to a broker/dealer.1 The staff does not interpret the exceptions in the Rule to include payments by one member firm to the associated persons of another member firm. In addition, as you further state in your letter, you are not able to provide any SEC no-action letter, interpretive release, or interpretive letter issued by the Commission that applies to the specific fact situation of the arrangement you describe in your letter and, therefore, subsection 1(B) of Rules 2820(g) and 2830(l) cannot be satisfied. For these reasons, it is the position of NASD staff that the proposal described in your letter would not satisfy the exceptions provided for in NASD Rules 2820(g)(1)(B) and 2830(l)(1)(B).
NASD By-Laws – Associated Persons
Based on the facts described in your letter and subsequent telephone conversations, it is the staff’s position that, as a result of the proposed activities of the Walnut Street registered representatives and the control exercised by CAI over the securities-related activities of these individuals, these individuals would be deemed associated persons of CAI and would be required to be registered representatives of CAI.
In this regard, Article I, paragraph (dd) of the NASD By-Laws defines a “person associated with a member” or “associated person of a member” as (1) a natural person who is registered or has applied for registration under the NASD Rules; (2) a sole proprietor, partner, officer, director, or branch manager of a member, or other natural person occupying a similar status or performing similar functions, or a natural person engaged in the investment banking or securities business who is directly or indirectly controlling or controlled by a member, whether or not any such person is registered or exempt from registration with NASD under the NASD By-Laws or NASD Rules; and (3) for purposes of Rule 8210, any other person listed in Schedule A of Form BD of a member. NASD Rule 1031(b) defines registered representative as “persons associated with a member, including assistant officers other than principals, who are engaged in the investment banking or securities business for the member including the functions of supervision, solicitation or conduct of business in securities or who are engaged in the training of persons associated with a member for any of these functions (emphasis added).”
The Walnut Street registered representatives clearly would be engaged in the securities business and, based on the information you have provided to the staff, under the control of CAI. In making its determination, the staff notes your representation that CAI will “maintain control over the payment of commission dollars to the registered representatives of Walnut Street” who are also employees of CAI, issue paychecks to these dual employees, determine benefit levels, help determine the securities products offered by Walnut Street registered representatives, and provide office space at CAI’s offices for the securities-related activities of Walnut Street registered representatives. In addition, you state that CAI will retain a portion of the securities commission revenues generated by the registered representatives of Walnut Street (who, according to your letter, are also employees of CAI for their non-securities business), while Walnut Street will receive only a flat fee from CAI for supervising, training, and providing administrative services to its registered representatives. Among other things, this arrangement suggests that CAI potentially could have a greater financial interest in the securities-related activities of the registered representatives than Walnut Street. Moreover, the individuals appear to be selling variable insurance products and mutual fund shares on behalf of CAI, which further evidences their need to be registered representatives of CAI. In this regard, the staff notes that dual registration of a registered representative with two member firms is not prohibited by NASD rules.2
NASD staff further recommends that you consult with the Division of Market Regulation at the Commission on this matter. The Division has previously noted that the receipt of compensation related to securities transactions is a key factor that may require a person to register as a broker/dealer. Generally, the Commission requires registration under Section 15(a) of the Securities Exchange Act of 1934 where a person receives securities commissions or transaction-based compensation in connection with securities-based activities that fall within the definition of “broker” or “dealer” generally.3 In this case, in the event the registered representatives were not dually registered with Walnut Street and CAI, they could be required to register as broker/dealers as they would not be registered persons of the firm from which they receive securities-based compensation.
I hope this letter responds 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 Governors of NASD. This letter responds only to the issues that you have raised based on the facts as you have described them, and does not address any other rule or interpretation of NASD, or all the possible regulatory and legal issues involved.
Kosha K. Dalal
Assistant General Counsel
Carlotta A. Romano, Sr. Vice President and District Director, District 8
1 See SR-NASD-97-35.
2 The staff, however, recommends that you consult with state securities regulators regarding this issue.
3 See the 1st Global, Inc. (May 7, 2001) no-action letter issued by the Commission and the letters cited therein.