FINRA filed a proposed rule change with the SEC to adopt FINRA Rule 2040 regarding the payment of transaction-based compensation by FINRA member broker-dealers to unregistered persons.
FINRA has also proposed amending FINRA Rule 8311 and adopting FINRA Rule 0190 regarding payments to, and the treatment of, persons subject FINRA sanctions and disqualifications.
FINRA’s proposals would streamline provisions of various NASD and NYSE rules and interpretations into the consolidated FINRA rulebook and delete certain NASD and NYSE rules that FINRA believes would be duplicative in light of the proposed amendments.
Broker-dealer registration under Section 15(a) of the Exchange Act
Section 15(a)(1) of the Securities Exchange Act of 1934 (the “Exchange Act”) generally requires a broker-dealer effecting transactions in securities to be registered with the SEC.
FINRA has not typically provided interpretive guidance on whether a person is acting as an unregistered broker-dealer, as the authority to interpret Section 15(a) of the Exchange Act falls with the SEC. Proposed Rule 2040 is meant to align with Section 15(a) of the Exchange Act and its related guidance.
Consistent with Section 15(a), proposed FINRA Rule 2040(a) would prohibit member firms and their associated persons from paying compensation or fees to
- any person that is not registered as a broker-dealer under Section 15(a) of the Exchange Act, but because of the receipt of such payment and the activities related thereto, is required to so register; or
- any appropriately registered associated person unless such payment complies with all applicable federal securities laws, FINRA rules and Exchange Act rules and regulations.
Under the proposal, persons would look to SEC rules and regulations, as well as published guidance by the SEC and its staff, to determine whether the activities in question require broker-dealer registration under Section 15(a).
Continuing commissions to retired registered representatives
FINRA Rule 2040(b) would codify existing FINRA staff guidance on the payment by FINRA members of continuing commissions to retired registered representatives.
The proposed rule would allow FINRA members to pay continuing commissions to retired registered representatives of the FINRA member, regardless of whether customer funds or securities were added to the accounts during the period of retirement, as long as such payments were derived from accounts held for continuing customers of the retired registered representative.
Under the rule proposal, among other conditions, there would have to be a bona fide contract entered into between the member and the retired registered representative while the representative was registered with the broker-dealer that provided for the payment, and prohibited the registered representative from soliciting new business, opening new accounts or otherwise servicing the accounts after his or her retirement.
Payments to foreign finders
FINRA Rule 2040(c) would allow FINRA members and persons associated with FINRA members to pay transaction-based compensation to non-registered foreign finders, subject to certain conditions.
The proposed provision includes minor technical revisions but generally comprises current NASD and NYSE rules and interpretations.
Under the proposal, a FINRA member would be permitted to pay a foreign finder transaction-based compensation based upon the business of customers the finder directs to the FINRA member, if among other things, the FINRA member has assured itself that the finder is not required to register in the United States as a broker-dealer, the finder is not a US citizen, the customers are not US citizens, and the customers receive a descriptive document that discloses what compensation is being paid to finders (similar to the disclosure document required in Rule 206-4(3) under the Investment Advisers Act of 1940).
Further, FINRA members that engage foreign finders would be required to have procedures in place that address the limited scope of activities permissible under such arrangements.
Payments to and treatment of sanctioned or disqualified persons
In addition, FINRA has proposed amendments to FINRA Rule 8311 which would clarify the scope of the rule on payments by FINRA members to persons subject to sanctions and other disqualifications.
Under the proposal, if a person was subject to a sanction or other disqualification, a FINRA member could not allow such person to be associated with the FINRA member in any way that was inconsistent with the sanction or disqualification imposed, including in a clerical or ministerial capacity.
Further, the FINRA member could not pay or credit any person subject to a sanction or disqualification, any salary or profit, that the person might have accrued during the period of the sanction or disqualification.
Under proposed supplementary material to the rule, the FINRA member could pay a person subject to a sanction or disqualification compensation that the FINRA member could evidence accrued to the person prior to the effective date of the sanction or disqualification as long as such payment did not relate to or result from the activity giving rise to the sanction or disqualification.
FINRA has also proposed to adopt FINRA Rule 0190 that would provide that a FINRA member would be treated as a non-member of FINRA from the effective date of any order or notice from FINRA or the SEC issuing a revocation, cancellation, expulsion or suspension of its membership. FINRA believes that this is consistent with current NASD interpretations and should be retained in the FINRA rulebook.
FINRA will announce the effective date of the proposed rule changes in a regulatory notice that will be published no later than 90 days following SEC approval.
The SEC has asked for all comments to these proposed changes by October 22, 2014.