Interpretive letter to Michael Markunas, B. Riley FBR, Inc. and B. Riley Wealth Management, Inc.
Registered representatives who are not qualified to engage in investment banking activities may, subject to specified conditions, receive transaction-based compensation for referring existing brokerage clients that express an interest in investment banking transactions.
Dear Mr. Markunas:
This is in response to your correspondence dated June 15, 2020, in which you request interpretive guidance on behalf of B. Riley FBR, Inc. (“BRFBR”) and B. Riley Wealth Management, Inc. (“BRWM”), both FINRA members, regarding whether registered representatives of the firms, who are not qualified to engage in the investment banking activities specified under FINRA Rule 1220(b)(5) (Investment Banking Representative),1 are eligible to receive transaction-based compensation for referring investment banking business to BRFBR’s investment banking group.
Based upon your correspondence, we understand the facts to be as follows. BRFBR and BRWM are affiliated broker-dealers. BRFBR is an investment bank, which provides financial advisory, corporate finance, research, securities lending and sales and trading services to corporate, institutional and high-net-worth individual clients. BRFBR has an investment banking group that handles the firm’s investment banking transactions. BRWM provides wealth management and brokerage services to individuals and families, corporations and non-profit organizations, including qualified retirement plans, trusts, foundations and endowments.
BRFBR proposes to compensate BRFBR and BRWM registered representatives who are not qualified to engage in the investment banking activities specified under FINRA Rule 1220(b)(5) (hereinafter, the “referring representatives”) for referrals of investment banking business. The referral arrangement will not be available to equity or debt “research analysts,” “research principals,” “supervisory analysts” or other registered representatives who are subject to limitations with respect to their activities relating to investment banking.2 In addition, individuals in BRFBR’s investment banking group, including any individuals who have oversight, supervisory or compliance responsibilities with respect to BRFBR’s investment banking business, will not be eligible for referral compensation pursuant to this arrangement.
Referring representatives will receive compensation for referring their existing brokerage clients that express an interest in an investment banking transaction to BRFBR’s investment banking group. The compensation amount will be based on a percentage of any resulting investment banking fee generated by the referral. The percentage of compensation paid to the referring representatives will be reasonable, commensurate with the time and effort required by the referral and appropriately tailored to reflect that the referring representatives’ activities are strictly limited to the initial referral.
You represent that BRFBR and BRWM will establish, maintain and enforce reasonably designed supervisory systems and controls, including written policies and procedures, consistent with FINRA Rules 3110 (Supervision) and 3120 (Supervisory Control System) with respect to the referral arrangement to:
- ensure that referring representatives will not be involved in any aspects of BRFBR’s investment banking business or investment banking transactions, other than the initial referral, or otherwise engage in the investment banking activities specified under FINRA Rule 1220(b)(5), including, but not limited to, the solicitation of investment banking business or participation in the structuring or marketing of investment banking transactions;
- determine the referral compensation and review the payments prior to their distribution to each of the referring representatives: (i) to ensure the compensation is reasonable, commensurate with the time and effort required by the referral and appropriately tailored to reflect the referring representatives’ limited role; and (ii) for compliance with applicable securities laws, rules and regulations; and
- prevent and detect non-compliance with applicable securities laws, rules and regulations.
You seek guidance on whether the referring representatives are eligible to receive referral compensation in the manner described above.
FINRA Rule 1210 (Registration Requirements) precludes a representative from acting as a representative in any area not covered by his or her registration category. FINRA Rule 1220(b)(5) requires that each representative as defined in FINRA Rule 1220(b)(1) (Definition of Representative) register with FINRA as an Investment Banking Representative if his or her activities in the investment banking or securities business of a member involve:
- advising on or facilitating debt or equity securities offerings through a private placement or a public offering, including but not limited to origination, underwriting, marketing, structuring, syndication, and pricing of such securities and managing the allocation and stabilization activities of such offerings, or
- advising on or facilitating mergers and acquisitions, tender offers, financial restructurings, asset sales, divestitures or other corporate reorganizations or business combination transactions, including but not limited to rendering a fairness, solvency or similar opinion.3
The staff would not consider the mere act of a registered representative referring his or her existing brokerage client that expresses an interest in an investment banking transaction to a member’s investment banking group and receiving compensation for that referral to be “advising on” or “facilitating” an investment banking activity under FINRA Rule 1220(b)(5). Where a registered representative who is not qualified to engage in the investment banking activities specified under FINRA Rule 1220(b)(5) receives referral compensation derived from the investment banking activities set forth in the rule, the member must supervise the activities of that registered representative and the compensation he or she receives to ensure that the representative does not conduct activities that go beyond the initial referral and does not engage in any of the activities specified in the rule. The member should be able to demonstrate that its supervisory systems and controls, including its written policies and procedures, are reasonably designed as such.
Based on the foregoing and your representations, the staff believes that the referring representatives may receive transaction-based compensation for referrals of investment banking business.4
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 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 will require further consideration and may cause us to reach a different conclusion.
Very truly yours,
/s/ Emily Goebel
cc: Afshin Atabaki
1. See FINRA Rule 1220(b)(5) (setting forth the activities that require registration as an Investment Banking Representative).
2. See FINRA Rules 2241(a)(8) and 2242(a)(1). We note that the definitions of “research analyst” and “debt research analyst” under FINRA rules are quite broad and could encompass registered representatives whose primary job function is something other than producing research. For example, Rule 2241(a)(8) defines an equity research analyst as “an associated person who is primarily responsible for, and any associated person who reports directly or indirectly to a research analyst in connection with, the preparation of the substance of a research report, whether or not any such person has the job title of ‘research analyst.’”
3. The rule provides an exception from Investment Banking Representative registration for appropriately qualified and registered associated persons who are advising on or facilitating the placement of direct participation program securities as defined in FINRA Rule 1220(b)(8) (Direct Participation Programs Representative) or who are effecting private securities offerings as specified in FINRA Rule 1220(b)(9) (Private Securities Offerings Representative).
4. Note that this response does not provide guidance as to the application or interpretation of state Blue Sky laws.