Interpretive Letter to Kathleen A. Wieland, William Blair & Company
Via Facsimile (312) 551-4646 & First Class Mail
September 27, 2000
Kathleen A. Wieland
Principal and Director of Compliance
William Blair & Company
222 West Adams Street
Chicago, Illinois 60606
Dear Ms. Wieland:
I am responding to your letter to NASD Regulation, Inc. (NASDR) received on January 24, 2000, in which you request interpretive advice on supervisory issues raised by William Blair & Company's (William Blair) plan to pay certain fees to a marketing entity that is not an NASD member (Non-Member) if the Non-Member refers clients to William Blair's investment advisory business. The supervisory issues are present because the Non-Member's president and sole shareholder is an associated person (AP) of an unnamed second broker-dealer (BD) (Second BD). You asked specifically if the AP of the Second BD would be considered an AP of William Blair for purposes of supervision and control under NASD Rules.
William Blair is registered as a BD under the Securities Exchange Act of 1934 (Exchange Act) and an investment adviser (IA) under the Investment Advisers Act of 1940 (IA Act), and is an NASD member. William Blair expects to enter into an arrangement with the Non-Member, under which the Non-Member will solicit persons to become clients of William Blair. Under the arrangement, William Blair has limited the service to be marketed to that of funds management in "separately managed accounts"; the Non-Member will have no authority to offer securities or other products offered by William Blair, including mutual funds, hedge funds or other pooled investment vehicles. William Blair proposes to pay the Non-Member: (1) a specified percentage of the management fees that the clients that are referred to William Blair by the Non-Member pay to William Blair; and (2) a monthly retainer, which is a fixed fee. William Blair specifically represents that the arrangement will be in compliance with Rule 206(4)-3 under the IA Act, which permits a registered IA to pay a fee to a third party solicitor as long as the conditions of Rule 206(4)-3 are met. William Blair specifically represents that the Non-Member will not be compensated for any securities transactions and the Non-Member will be authorized to solicit only investment advisory business on William Blair's behalf.
Although the Non-Member is not registered as a BD or an IA, the president and sole shareholder of the Non-Member is an AP of the Second BD. According to William Blair, the AP "is not now regularly involved in securities transactions for the member and has retained his license principally to ensure compliance with the securities laws and NASD rules to the extent that those are applicable to services that he otherwise provides."
Payments To a Non-Member Under Rule 2420. William Blair may pay the Non-Member either a specified fee based upon a percentage of the accounts managed by William Blair as a result of the referral from the marketing entity or a monthly retainer or both, and not violate Rule 2420 if the fees paid to the Non-Member meet the following conditions: all the requirements of IA Act Rule 206(4)-3 must be strictly followed and the fees must be paid from fees that William Blair's clients pay William Blair for programs and services performed by William Blair in its capacity as a registered IA.1 Since fees must be paid from fees that William Blair collects in its capacity as an IA, William Blair's obligation to pay a fixed monthly retainer must be contingent upon William Blair's receipt of a corresponding stream of income that is attributable to programs and services performed as an IA. As also provided in the Edwards Letter, NASD will scrutinize the arrangement to assure that payments otherwise prohibited are not being made. In particular, the NASD may review an agreement or an arrangement in order to determine that referral or finders fees or payments are not being calculated, directly or indirectly, based upon orders entered or transactions executed.
Supervision. Rule 3010 requires a member to establish and maintain a system to supervise the activities of each registered representative and AP in a manner that is reasonably designed to achieve compliance with applicable securities laws and regulations, and the Rules of the NASD.2
It is unclear from your letter if the Second BD will be informed of the activities that the AP, through the Non-Member he or she controls, intends to engage in, and for which the Second BD may have supervisory responsibility under Rule 3010. NASD Rules require that the AP notify the Second BD, depending on the type of activity in which the AP is engaged. Rule 3030 requires the AP to notify the Second BD in writing before the AP engages in a business activity that is outside the scope of his relationship with the employer. Once such notification is given, the Second BD may determine affirmatively if the AP will be engaging in any activity for which supervision is required and if Rule 3040 applies to the activity. If supervision is required, under Rule 3010, the Second BD must have in place, or develop, an appropriate supervisory system to supervise all activity and must use the system to meet its supervisory obligations. However, the AP will not be considered an AP of William Blair for purposes of supervision and control solely as a result of receiving payments in compliance with IA Act Rule 206(4)-3 through the Non-Member as described above.
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 NASD Regulation. This letter responds to the issues you have raised and certain related issues based on the facts as you have described them in your letter, and does not necessarily address all other rules or interpretations of the NASD or all the possible regulatory and legal issues involved.
Please do not hesitate to contact me at (202) 728-8985 should you have any further questions about these issues.
Very truly yours,
Assistant General Counsel
Carlotta A. Romano, District Director and Vice President
1 See Letter to David M. Rappaport, INVESTACORP, Inc., from Stephanie Dumont, Office of General Counsel, NASD Regulation, Inc., dated August 11, 2000; see also letter to Brian C. Underwood, A.G. Edwards " Sons, from Sharon Zackula, Office of General Counsel, NASD Regulation, Inc., dated September 16, 1998 (Edwards Letter).
2 In order to create and maintain an effective, comprehensive supervisory system, a member, among other things, must determine the number and location of its personnel, the qualifications of each registered person, the customer base, and the product lines being sold to customers. See Notice to Members 99-45. See also Notice to Members 98-38 regarding supervisory obligations of a member with respect to personnel operating in "unregistered" offices.