Member ceasing to offer retail brokerage accounts with investment advisory and prime brokerage services may use negative response letters to accomplish the bulk transfer of its retail brokerage accounts to a newly formed broker-dealer.
June 2, 2006
Michael R. Trocchio, Esq.
Bingham McCutchen LLP
1120 20th St., N.W.
Washington, D.C. 20036
Re: Use of Negative Response Letters
Dear Mr. Trocchio:
I am responding to your letters dated March 20, 2006, April 21, 2006, and June 1, 2006, as supplemented by conversations with the staff, in which you seek interpretive guidance regarding the use of negative response letters by a broker-dealer to transfer its retail customer accounts to a newly formed broker-dealer, where the transferring broker-dealer is ceasing to participate in a joint venture with an investment adviser affiliated with the new broker-dealer and ceasing to offer retail brokerage accounts with investment advisory and prime brokerage services.
Based on your letters and oral representations, I understand the facts to be as follows: In 2001, State Street Corporation ("State Street") purchased a 75% interest in Bel Air Investment Advisors, LLC (the "Adviser"), a federally registered investment adviser since 1997.1 State Street also purchased 100% of the Adviser's affiliate broker-dealer, Bel Air Securities LLC (the "Original Bel Air BD"), which handled and introduced the brokerage accounts for the Adviser's customers. Since 2001, the Adviser has been operated as a joint venture between State Street and the original owners and management of the Adviser who still maintain a minority interest in the Adviser. The brokerage operations of the Original Bel Air BD, including the registered persons and customer accounts, were transferred to State Street Global Markets LLC ("SSGM"), a subsidiary of State Street, where they have been operated as a separate division within SSGM (the "Bel Air Division"). The Original Bel Air BD subsequently ceased operations and filed a Form BDW. The sole office of the Original Bel Air BD, located in California, became a branch office and an office of supervisory jurisdiction of SSGM, and that office is today the only branch office of the Bel Air Division.
Your letters and oral representations also indicate that prior to the joint venture, the Original Bel Air BD customer accounts were cleared and carried by Bear Stearns & Co., Inc. ("Bear Stearns"), which also functioned as the prime broker for the vast majority of those customer accounts.2 Since the transfer to SSGM, those customer accounts have continued to be cleared through, and receive prime brokerage services from, Bear Stearns even though all other SSGM brokerage accounts are carried and cleared by National Financial Services, LLC ("NFS").3
Joint Investment Advisory Venture
Pursuant to the joint investment advisory venture, the Adviser provides advisory and asset management services to high net worth individuals whose brokerage accounts are now handled by SSGM's Bel Air Division. Currently, the Bel Air Division has approximately 1400 brokerage accounts, substantially all of which are discretionary accounts using Bear Stearns as prime broker. Other than the retail brokerage services provided through the Bel Air Division, SSGM is primarily an institutional broker-dealer, only offering limited retail brokerage services to State Street employees and their family members, UGMA accounts and self-directed 401(k) brokerage accounts.
The Bel Air Division does not share common customers with the remainder of SSGM, nor do they share office space. All of the brokerage customers of the Bel Air Division are clients of the Adviser. Only Bel Air Division registered persons service customers of the Bel Air Division. As noted above, the Bel Air Division operates solely out of its one office in California and does not service institutional accounts or otherwise handle SSGM brokerage accounts.
Cessation of Joint Investment Advisory Venture
According to your letters, State Street, SSGM, and the minority owners and management of the Adviser have decided to terminate their joint investment advisory venture. State Street is selling its entire 78% interest in the Adviser back to the Adviser's management team who are currently minority owners. In connection with this transaction, SSGM proposes to transfer Bel Air Division's brokerage accounts from SSGM to a newly formed broker-dealer ("New Bel Air BD"), with the same name, Bel Air Securities LLC, as the Original Bel Air BD. The existing Bel Air Division's office and personnel will also be transferred from SSGM to the New Bel Air BD. Besides having the same name as the Original Bel Air BD, the New Bel Air BD will conduct the same business as the Original Bel Air BD and the Bel Air Division (i.e., providing discretionary brokerage account services to high net worth individuals advised by the Adviser with Bear Stearns functioning as the clearing firm and prime broker). Following the transfer, SSGM will no longer be in the business of offering retail brokerage accounts with investment advisory and prime brokerage services. Additionally, your letters note that SSGM will also cease using Bear Stearns as a clearing broker, as SSGM only used Bear Stearns for transactions by the Bel Air Division.
Request For Interpretation
You seek interpretive guidance regarding the use of negative response letters to accomplish the bulk transfer of the Bel Air Division accounts at SSGM to a new broker-dealer, referred to in this letter as New Bel Air BD.
In September 2002, NASD issued Notice to Members 02-57 ("NtM 02-57" or "Notice") concerning the use of negative response letters for the bulk transfer of customer accounts. In the Notice, the staff expressed its general view that a customer should affirmatively consent to the transfer of its account to another firm. The staff acknowledged, however, that there are situations, as outlined in the Notice, where a negative response letter may be appropriate to provide for the efficient transfer of those accounts. One of the situations identified in the Notice is an introducing firm no longer in business.
The staff believes that the transfer of the Bel Air Division and termination of SSGM's retail brokerage business that supports advised accounts and prime brokerage arrangements in accordance with the representations in your letter is analogous to a member that is going out of business for purposes of NtM 02-57. Because SSGM does not intend to offer retail brokerage services that support advised accounts and prime brokerage arrangements after this function is transferred to the new Bel Air BD, the staff believes it is appropriate to use negative response letters to transfer accounts from the Bel Air Division to New Bel Air BD, provided the disclosures recommended in NtM 02-57 are made.
I hope that this letter is responsive to your request. 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 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 NASD, or all the possible regulatory and legal issues involved.
1 State Street bought an additional 3% of the Adviser after the original purchase of 75%, bringing its ownership level to 78%, where it currently stands.
2 According to the information you have provided, the advisory clients and Bear Stearns enter into an agreement entitled "Customer Agreement for Introduced Clearance Accounts (the "Customer Agreement"), which governs Bear Stearns' clearance and carrying arrangements for the advisory clients' accounts. For those advisory clients that also receive prime brokerage services from Bear Stearns, the customer agreement is supplemented by additional provisions (the "Prime Brokerage Supplement"), which govern Bear Stearns' provision of prime brokerage services.
3 The information you have provided indicates that although SSGM handles and introduces the brokerage accounts for the Adviser's customers, SSGM does not act as an executing broker for any prime brokerage transactions of the advisory clients of the Adviser. Additionally, with respect to trades directed by the Adviser to executing brokers on behalf of the advisory clients pursuant to the prime brokerage arrangement with Bear Stearns, SSGM does not act as a broker in connection with such trades and does not receive any compensation (in the form of commissions, fees, or otherwise) in connection with those trades. SSGM only earns commissions from advisory clients when it acts in an agency capacity with respect to transactions that are outside of the prime brokerage arrangement.