By Erwin J. Shustak, Esq.  of Shustak Reynolds & Partners, P.C. posted on Tuesday, March 29, 2016.

Erwin J. Shustak

Managing Partner

Location: San Diego, California
New York, New York
Phone: (619) 696-9500 (Ext. 109)
(800) 496-5900 (Ext. 109)
Email: [email protected]

The Securities and Exchange Commission approved last week a new rule proposed by FINRA, the Financial Industry Regulatory Authority, which requires brokers departing one broker dealer for another, to send “educational information” to clients about their move to another firm and the financial compensation and incentives they will receive from the new firm for making the move.  The rule, however, is materially watered down from the original 2013 FINRA proposal which was met with vociferous objections from the investment community over mandatory disclosure of enhanced compensation for transitioning brokers.

In its notice approving new FINRA rule 2273, the SEC states that FINRA developed the rule out of concern that former customers “may not be aware of other important factors to consider in making a decision whether to transfer assets to the recruiting firm, including direct costs that may be incurred.”

To provide former customers with a more complete picture of the potential implications of a decision to transfer assets to the transitioning broker’s new firm, the rule requires the new firm to deliver an “educational communication” to all of the broker’s clients who will be solicited to change firms, that highlights key considerations in transferring assets to the recruiting firm, and the direct and indirect effects of such a transfer on those assets.

The rule states that an “educational communication” would have to be delivered when the member firm, directly or through a representative, individually contacts a former customer of that representative to transfer assets; or a former customer of the representative, absent individual contact, transfers assets to an account assigned, or to be assigned, to the representative at the member.  A “former customer” is defined as any customer that had a securities account assigned to a registered person at the rep’s previous firm.

The “educational communication” must highlight four potential implications of a customer transferring assets to the recruiting firm, including:

(i)                  Whether financial incentives received by the representative may create a conflict of interest;

(ii)                That some assets may not be directly transferrable to the recruiting firm and as a result the customer may incur costs to   liquidate and move those assets or account maintenance fees to leave them with his or her current firm;

(iii)              The potential costs related to transferring assets to the recruiting firm, including differences in the pricing structure and fees imposed by the customer’s current firm and the recruiting firm; and

(iv)              differences in products and services between the customer’s current firm and the recruiting firm.

This new rule is much less far reaching on the subject of mandatory disclosure of enhanced compensation than earlier FINRA proposals which were met with strong objections from the investment community.  The earlier FINRA proposals would have required the new firm to disclose all compensation, including up-front signing bonuses, enhanced compensation and forgivable notes, offered to the transitioning broker.  FINRA’s first proposal, announced in FINRA Notice 13-02, would have required a member that provides, or has agreed to provide, a representative with enhanced compensation in connection with the transfer from one broker-dealer to another to disclose the details, including specific amounts, of such enhanced compensation to any former customer at the previous firm that is contacted to transfer their account to the new firm.  In the Notice 13-02 Proposal, the term “enhanced compensation” was defined as compensation paid in connection with the transfer of securities employment (or association) to the recruiting firm other than the compensation normally paid by the recruiting firm to its established registered persons.  Enhanced compensation included but was not limited to signing bonuses, upfront or back-end bonuses, loans, accelerated payouts, transition assistance, and similar arrangements, paid in connection with the transition from one firm to another.

After receiving strong objections to the 2013 proposal, FINRA modified its proposed rule to require disclosure of enhanced compensation only if it was in the range of $100,000 or more, including aggregate up-front payments and aggregate potential future payments.  That amended proposal also was met with strong objections from the investment community.

In the final, revised rule change, approved by the SEC, FINRA has removed the requirement to disclose to former customers the magnitude of recruitment compensation paid to a transferring representative due to the privacy and operational concerns expressed by commenters to the prior rule proposal.  Furthermore, removing the requirement to disclose ranges of compensation also obviates members’ need to calculate recruitment compensation to be paid to a transferring representative so as to determine whether the threshold of $100,000 or more in compensation has been met separately as to aggregate upfront payments and aggregate potential future payments and affirmative cost and portability statements.

In the proposed rule change, FINRA removed the requirement to disclose to former customers the magnitude of recruitment compensation paid to a transferring representative due to the privacy and operational concerns expressed by commenters to the 2014 revised rule proposal.  Furthermore, removing the requirement to disclose ranges of compensation also obviates members’ need to calculate recruitment compensation to be paid to a transferring representative so as to determine whether the threshold of $100,000 or more in compensation has been reached.

Under the final rule, just approved and now effective, the recruiting firm only is required to disclose to the broker’s former clients who are solicited to transfer their accounts, “whether financial incentives received by the representative may create a conflict of interest.”  Exactly what that means, and what must be disclosed, however, are left vague and it will be up to the new firms to make decisions of when, and how much must be disclosed about the recruitment financial incentives.  More to come as FINRA weighs in as the new rule is implemented and interpreted.

The full text of the SEC announcement can be found at: http://www.finra.org/sites/default/files/rule_filing_file/SR-FINRA-2015-057.pdf.

Shustak Reynolds & Partners, P.C.  focuses its practice on the securities industry and matters affecting broker-dealers, registered representatives and the financial services sector.    For more information, contact Erwin J. Shustak, managing partner, at [email protected], or call 800.496.5900 for a free consultation.

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