NASD Office of General Counsel, Regulatory Policy and Oversight

NASD staff is issuing this memorandum to provide additional guidance on Notice to Members (NtM) 04-72 (October 2004), which generally prohibits the use of negative response letters1  to change the “broker-dealer of record” (hereinafter, BD of record) on a mutual fund or variable insurance product account held directly at the issuer.2   As further discussed below, it is consistent with the staff’s general views regarding the transfer of customer accounts, as articulated in NtM 02-57 (September 2002), to allow a member firm that is currently the BD of record to use negative response letters to change the BD of record to another broker-dealer. 

Background

In September 2002, NASD issued NtM 02-57, which discussed NASD Rule 11870 (Customer Account Transfer Contracts) and the use of negative response letters for the bulk transfer of customer accounts.  In NtM 02-57, NASD staff expressed its general view that a customer should affirmatively consent to the transfer of his or her account to another firm.  The staff, however, identified five specific situations in which it believed negative response letters could be appropriate to transfer customers’ accounts.  These situations involve:

  • A member experiencing financial or operational difficulties;
  • An introducing firm no longer in business;
  • Changes in a networking arrangement with a financial institution;
  • An acquisition or merger of a member firm; and
  • A change in a clearing firm by an introducing firm.

As the staff explained in NtM 02-57, given the potential risks to investors and costs to firms that could result in these situations if firms were required to solicit individual transfer instructions from each customer, the use of negative response letters to facilitate the bulk transfer of accounts in these circumstances would be appropriate. The bulk transfer of accounts in these situations would also help minimize interruptions to customers’ access to their accounts and the trading markets.

However, the staff specifically indicated in NtM 02-57 that the guidance in the Notice did not apply to transfers of special product accounts such as mutual fund or variable annuity accounts, nor did it apply to the transfer of specific securities.3  This statement reflected the staff’s belief that such situations did not merit an exception from the general principle that firms should obtain affirmative consent from a customer prior to transferring such accounts (including changing the BD of record) or specific securities.

Following the publication of NtM 02-57, NASD staff continued to receive a number of inquiries regarding whether members could use negative response letters to change the BD of record in mutual fund or variable insurance product accounts held directly at the issuer. Accordingly, NASD staff issued NtM 04-72 in October 2004, to reaffirm that the guidance provided in NtM 02-57 regarding the use of negative response letters did not apply to changes of BD of record for directly held mutual fund and variable insurance product accounts. As the staff explained in NtM 04-72, the use of negative response letters to change the BD of record on such accounts was not appropriate because such a change did not affect the owner’s access to his or her account. Nor did a change in the BD of record materially alter any of the account features, such as account holders, assets, investment objectives, etc. Rather, the change predominantly affected who would receive any fees and commissions the mutual fund or variable insurance product issuer may pay.

Discussion

Since the issuance of NtM 04-72, NASD staff has received a number of requests for interpretive guidance from the membership, specifically regarding whether any exceptions exist to the general prohibition on the use of negative response letters to change the BD of record. NASD staff has already provided supplemental guidance on this question in an October 20, 2004 interpretive letter, which recognizes the appropriateness of the use of negative response letters to change the BD of record in directly held mutual fund and variable insurance product accounts in situations involving the acquisition or merger of a member firm where the acquiring or surviving entity is the legal successor-in-interest to the member firm.4  However, based on the membership’s questions, NASD staff has determined that additional guidance regarding when negative response letters may be used to change the BD of record is necessary.

As an initial matter, NASD staff believes that the use of negative response letters to make changes to a customer’s account, including changing the BD of record, should be used only when a compelling reason exists that overrides potential risks to investors.  In any other situation, customers should have the opportunity to affirmatively consent to such changes.  With respect to the transfer of accounts of a registered representative moving to a new firm, NASD staff has never found that a sufficiently compelling reason exists that would override the requirement to obtain affirmative consent and allow the departing representative to send negative response letters to customers serviced by the representative to effect the transfer of those customers to the representative’s new firm.5

However, NASD staff believes that in situations where the registered representative assigned to a customer’s directly held mutual fund or variable insurance product account is no longer available to provide services to the account and the member firm currently named as the BD of record for the account no longer intends to provide the services performed by the registered representative, the member firm may use negative response letters to change the BD of record to another broker-dealer.  According to industry members, customers with direct application mutual fund and variable insurance product accounts often rely upon their registered representatives to provide services to these accounts.  If a customer’s registered representative is no longer available to service the customer’s directly held accounts and the member firm does not intend to continue to service such accounts, then the interruption in service effectively causes the account to become “abandoned” with respect to the provision of customer services.  NASD staff believes that the potential “abandonment” of such an account presents a compelling concern that would make it appropriate for the firm currently named as BD of record to use negative response letters to change the BD of record on the account. 

Situations where an account would be effectively abandoned due to the unavailability of a registered representative to service a customer’s directly held account might include the following circumstances:

  • A broker-dealer going out of business – when a broker-dealer is going out of business, the broker-dealer may use negative response letters to change the BD of record on customers’ directly held mutual fund and variable insurance product accounts to another broker-dealer willing to service the accounts to avoid the accounts from being effectively “abandoned”;
     
  • A registered representative exiting a firm, where that firm will not be providing the services the registered representative was performing for the directly held account – in a situation where a registered representative leaves a firm and the firm currently named as BD of record will not be providing services to the directly held account in the registered representative’s absence, it is appropriate for the broker-dealer to use negative response letters to change the BD of record on the account to a firm that is willing to provide services to the account; and
     
  • Changes in a networking arrangement with a financial institution – upon the conclusion or termination of a networking arrangement with a financial institution, a member may use negative response letters to change the BD of record on direct application customer accounts established pursuant to the networking arrangement to a new firm with which the financial institution has formed a networking arrangement in those circumstances where not changing the BD of record would result in the “abandonment” of those customer accounts.
     

These examples are not intended as an exclusive or exhaustive list of circumstances under which a member may use negative response letters to change the BD of record on directly held mutual fund and variable insurance product accounts that will become effectively abandoned because the member currently named as the BD of record does not intend to service those accounts on a going forward basis.

The staff expects a member seeking to change the BD of record using negative response letters pursuant to this guidance to provide account holders, consistent with just and equitable principles of trade under Rule 2110, with adequate time and information to decide whether to object to the transfer. Accordingly, the staff advises members to provide each customer with the information and disclosures outlined in NtM 02-57.6  Members are also reminded that the firms must be in full compliance with SEC Regulation S-P.7

Please note that the opinions expressed in this memorandum are staff opinions only and have not been reviewed or endorsed by the NASD Board of Governors. If you have any questions regarding this memorandum, please contact Patricia Albrecht, Assistant General Counsel, Office of General Counsel, NASD Regulatory Policy and Oversight, at (202) 728-8026.


1 A negative response letter generally informs the recipient of the letter of an impending action and requires the recipient to respond or act within a specified time frame if the recipient objects to the action. If the recipient does not respond, he or she is deemed to have consented to the action.

2 The BD of record refers to the broker-dealer identified on a customer’s account application for accounts held directly at a mutual fund or variable insurance product issuer. Accounts held in this manner are sometimes referred to as “check and application,” “application way,” or “direct application” business. The BD of record generally receives fees or commissions resulting from the customer’s transactions in the account.

3 See NtM 02-57 (September 2002) n.1 (“This Notice to Members does not apply to transfers of special product accounts such as mutual fund or variable annuity accounts, nor does it apply to the transfer of specific securities. Further, certain account transfers may require NASD approval under Rule 1017.”).

4 See Letter to Barry Harris, Chief Counsel, Banc of America Investment Services, Inc., from Patricia Albrecht, Assistant General Counsel, NASD Regulatory Policy and Oversight, dated October 20, 2004.

5 See NtM 02-57 (September 2004); see also letter to Justine Rusin, Principal, Merit Capital Associates, Inc., from Office of General Counsel, NASD Regulation, Inc. (predecessor to NASD Regulatory Policy and Oversight), dated October 16, 2000.


6 NtM 02-57 advises member firms using negative response letters to provide each customer with the following information in the negative response letter:

(1) a brief description of the circumstances necessitating the transfer;
(2) a statement that the customer has the right to object to the transfer;
(3) information on how a customer can effectuate a transfer to another firm;
(4) a sufficient time period for the customer to respond to the letter (at least 30 days from the receipt of the letter unless exigent circumstances exist that warrant a shorter time period);
(5) disclosure of any cost that will be imposed on the customer as a result of the transfer, including costs to the customer if the customer initiates a transfer of the account after the account is moved pursuant to the negative response letter; and
(6) a statement regarding the firm’s compliance with Securities and Exchange Commission (SEC) Regulation S-P (Privacy of Consumer Financial Information) in connection with the transfer.

7 See Exchange Act Rel. No. 42974 (June 22, 2000), 65 F.R. 40334 (June 29, 2000).]