Interpretive Letter to Name Not Public
November 27, 2012
Re: Request for Interpretative Guidance under NASD IM-2420-2 (Continuing Commissions Policy)
In your letter dated June 22, 2012, on behalf of Broker-Dealer Firm ("[Broker-Dealer Firm]"), you ask that the staff of the Financial Industry Regulatory Authority, Inc. ("FINRA") provide interpretative guidance regarding the application of NASD IM-2420-2 to payments by [Broker-Dealer Firm] of commission overrides, as described in your letter, to a terminated registered representative of [Broker-Dealer Firm].
Based on your letter and our subsequent phone conversation, I understand the facts to be as follows. On May XX, 2010, registered representative A ("Representative A") joined [Broker-Dealer Firm] along with registered representative B ("Representative B") and several other registered representatives of former broker-dealer firm X ("Firm X"; the other registered representatives of Firm X are hereinafter referred to as the "Firm X Group"). There were two agreements that accompanied their independent contractor arrangements with [Broker-Dealer Firm]: a Representative Agreement and an Individual Representative Commission Agreement. There was also a separate letter that discussed an arrangement to pay commission overrides to Representative A and Representative B from the production of the Firm X Group that was joining [Broker-Dealer Firm] at approximately the same time as these two individuals (the "Principals Letter"). You attached a copy of the Principals Letter to your letter. In your letter, you note that "[a]lthough it would be difficult to define [the Principals Letter] as a 'contract' in the terms of regulatory guidance, it is the intention of [Broker-Dealer Firm] to honor the arrangements if permitted by our regulators." In your letter, you further provide that the Principals Letter was prepared to "outline our common understanding of the basic terms of the goals of our current relationship and the future relationship between [Broker-Dealer Firm] and the current principals [of Firm X]."
The Principals Letter provides that if for any reason the principals do not act as an office of supervisory jurisdiction ("OSJ") for the Firm X Group, or the OSJ of the Firm X Group through the principals is terminated at any time before five years from the date of transfer of the Firm X Group, the principals will be entitled to an annual payment of an amount equal to five percent of the annual gross revenues of the Firm X Group as representatives at [Broker-Dealer Firm] for each year or portion of a year between the initial transfer date and five years thereafter for the time the principals are not the Firm X Group OSJ. You state in your letter that the transfer date was May XX, 2010.
In your letter, you state that Representative B was terminated from [Broker-Dealer Firm] on November XX, 2010, by the individual's request. Representative B had an adverse judgment in an arbitration case that resulted in a suspension by FINRA on December XX, 2010, and "the voluntary resignation appears to have been in anticipation of the suspension." You state that we should assume [Broker-Dealer Firm] will make no payments to Representative B at any future time. Representative A was terminated from [Broker-Dealer Firm] on October XX, 2011, for failing to disclose a securities-related outside business activity to the firm. You state that [Broker-Dealer Firm] believes that the matter is under review by FINRA Enforcement, but that Representative A is not currently suspended. During our phone conversation, you stated that you are not aware of Representative A's current activities or whether the individual is currently associated with another firm or entity engaged in the securities or financial services industry.
Unless otherwise permitted by the federal securities laws or FINRA rules, a person who receives commissions or other transaction-related compensation in connection with securities transactions generally has to be an appropriately registered broker-dealer or registered associated person of a broker-dealer.
NASD IM-2420-2 provides that the payment of continuing commissions in connection with the sale of securities is not improper so long as the person receiving the commissions remains a registered representative of a member. In addition, IM-2420-2 provides, in pertinent part, that members are permitted to pay continuing commissions to registered representatives after they cease to be employed by a member, if, among other things, a bona fide contract between the member and the registered representative calling for the payments was entered into in good faith while the person was a registered representative of the employing member. The arrangement may not permit a retired representative to solicit new business or open new accounts.
Based on the facts and representations set forth in your letter, the staff is of the view that the payments of commission overrides by [Broker-Dealer Firm] to Representative A as described in your letter and subsequent phone conversation would not be in compliance with NASD IM-2420-2. In reaching this conclusion, the staff notes, among other things, that the Principals Letter, even assuming it is a contract for purposes of NASD IM-2420-2, would permit the payment of compensation to Representative A based on new accounts and new customers of the Firm X Group, which is not permitted under NASD IM-2420-2.
Your letter also references the no-action letter issued by the staff of the SEC's Division of Trading and Markets to the Securities Industry and Financial Markets Association, dated November 20, 2008, regarding the circumstances by which a retiring representative may be compensated after the termination of employment for business done by and through his or her employer before the termination of employment without being required to register under Section 15(a) of the Securities Exchange Act of 1934 ("Exchange Act").1 You indicate that "the [Principals Letter] does not conform to the SEC guidance for term of employment, ethics, complaints, and regulatory action provisions." FINRA staff agrees that the arrangement described in your letter does not appear to satisfy the conditions in the SIFMA No-Action Letter; however, you should consult with SEC staff regarding the application of the SIFMA No-Action Letter and Exchange Act Section 15(a) to the arrangement described in your letter.
We trust 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 FINRA Board of Governors. This letter responds only to the issues you have raised based on the facts as you have described them and NASD IM-2420-2, and does not address any other rule or interpretation of FINRA, or all the possible regulatory and legal issues involved. In addition, you should be aware that any changes in the facts as you have described them or any amendments to IM-2420-2 will require further consideration and may cause us to reach a different conclusion.
Kosha K. Dalal
Associate Vice President and Associate General Counsel
1 See Securities Industry and Financial Markets Association, SEC No-Action letter, pub.avail. Nov. 20, 2008 ("SIFMA No-Action Letter").