FINRA has issued a regulatory notice on new consolidated FINRA Rules 2040 (Payments to Unregistered Persons) and 0190 (Effective Date of Revocation, Cancellation, Expulsion, Suspension or Resignation), and on amendments to FINRA Rule 8311 (Effect of a Suspension, Revocation, Cancellation, or Bar). The new rules replace provisions of the NASD and NYSE rules and include new provisions governing the payment of commissions to registered persons, which are applicable to all broker-dealers that are FINRA members. The regulatory notice follows the SEC's approval of a FINRA rule change on December 30, 2014. The new rules and amendments take effect on August 24, 2015.
FINRA Rule 2040
FINRA Rule 2040 governs the payment of transaction-based compensation by broker-dealers that are FINRA members to unregistered persons. It expressly aligns with Exchange Act Section 15(a) (Section 15(a)) and its related guidance to determine whether registration as a broker-dealer is required for persons to receive transaction-related compensation and engage in related activities.
FINRA Rule 2040(a) prohibits broker-dealers or associated persons from, directly or indirectly, paying any compensation, fees, concessions, discounts, commissions or other allowances to either:
Any person that is not registered as a broker-dealer under Section 15(a) but that, by reason of receipt of the payments and the activities related to those payments, is required to be so registered under applicable federal securities laws and Exchange Act rules and regulations.
Any appropriately registered associated person, unless the payment complies with all applicable federal securities laws, FINRA rules and Exchange Act rules and regulations.
Rule 2040(a) also:
Directs persons to look to SEC rules to determine whether the activities in question require registration as a broker-dealer under Section 15(a).
Prohibits payments to appropriately registered associated persons unless the payments comply with applicable federal securities laws, FINRA rules, and Exchange Act rules and regulations.
Rule 2040.01 provides guidance to broker-dealers that are uncertain about whether an unregistered person may be required to be registered under Section 15(a). Broker-dealers can derive support for their determination by, among other things:
Reasonably relying on previously published releases, no-action letters or interpretations from the SEC staff that apply to their facts and circumstances.
Seeking a no-action letter from the SEC staff.
Obtaining a legal opinion from independent, reputable US licensed counsel knowledgeable in the area.
Rule 2040.01 is not intended to be an exhaustive list by which firms can make a reasonable determination of compliance with Section 15(a). Among other things, firms may rely on the advice of in-house counsel or foreign counsel under prong 1 above, which permits firms to make a determination by reasonably relying on previously published releases, no-action letters or interpretations.
A broker-dealer's determination must be:
Reasonable under the circumstances, which may include relying on the advice of in-house counsel or foreign counsel.
Reviewed periodically if payments to the unregistered person are ongoing in nature. FINRA believes that an annual review would be reasonable when there are no activities by the recipient of the payments that raise red flags.
The notice also states that broker-dealers are required to maintain books and records that reflect the broker-dealer's determination.
Rule 2040(b) replaces NASD IM-2420-2 (Continuing Commission Policy) and codifies existing FINRA and SEC staff guidance on the payment by broker-dealers of continuing commissions to retiring registered representatives. Under Rule 2040(b), a broker-dealer can pay continuing commissions to its retiring registered representatives, after they cease to be associated with the firm, that are derived from accounts held for continuing customers of the retiring registered representative regardless of whether customer funds or securities are added to the accounts during the period of retirement, provided that both:
There is a bona fide contract between the broker-dealer and the retiring registered representative providing for the payments that:
was entered into in good faith while the person was a registered representative of the firm; and
among other things, prohibits the retiring registered representative from soliciting new business, opening new accounts or servicing the accounts generating the continuing commission payments.
The arrangement complies with applicable federal securities laws, Exchange Act rules and regulations.
"Retiring registered representative" means an individual who retires from a broker-dealer (including as a result of a total disability) and leaves the securities industry. In the case of death of the retiring registered representative, the retiring registered representative's beneficiary designated in the written contract, or the retiring registered representative's estate if no beneficiary is designated, may be the beneficiary of the respective member's agreement with the deceased representative.
Rule 2040(c) replaces NASD Rule 1060(b) and NYSE Interpretation 345(a)(i)/03, and provides that a broker-dealer and persons associated with a broker-dealer may pay transaction-related compensation to non-registered foreign finders where a finder's sole involvement is the initial referral to the broker-dealer of non-US customers, and the broker-dealer complies with all of the conditions set out in the rule (foreign finders exemption):
The broker-dealer has assured itself that:
the finder who will receive the compensation is not required to register in the US as a broker-dealer;
the finder who will receive the compensation is not subject to a disqualification as defined in Article III, Section 4 of FINRA's By-Laws; and
the compensation arrangement does not violate applicable foreign law.
The finder is a foreign national (not a US citizen) or foreign entity domiciled abroad.
The customers are foreign nationals (not US citizens) or foreign entities domiciled abroad transacting business in either foreign or US securities.
Customers receive a descriptive document, similar to that required by Rule 206(4)-3(b) of theInvestment Advisers Act of 1940, that discloses the compensation being paid to finders.
Customers provide written acknowledgment to the broker-dealer of the existence of the compensation arrangement and the acknowledgment is retained and made available for inspection by FINRA.
Records reflecting payments to finders are maintained on the broker-dealer's books, and actual agreements between the broker-dealer and the finder are available for inspection by FINRA.
The confirmation of each transaction indicates that a referral or finders fee is being paid under an agreement.
If all the conditions are satisfied, broker-dealers can pay ongoing transaction-related compensation to non-registered foreign finders based on the business of non-US customers that finders refer to broker-dealers, and all accounts referred by the foreign finders would be carried on the books of the broker-dealer. Any activities beyond the initial referral of non-US customers and payment of transaction-based compensation for these activities would not be within the permissible scope of the foreign finders exemption.
Based solely on its activities in compliance with Rule 2040(c), a foreign finder would not be considered an associated person of the broker-dealer. However, unless otherwise permitted by the federal securities laws or FINRA rules, a person who receives commissions or other transaction-based compensation in connection with securities transactions generally has to be a registered broker-dealer or an appropriately registered associated person of a broker-dealer who is supervised by a broker-dealer. Broker-dealers that engage foreign finders would be required to have reasonable procedures that appropriately address the limited scope of activities permissible under these arrangements.
Under FINRA Rule 8311:
If a person is subject to a sanction or other disqualification, a broker-dealer may not allow that person to be associated with it in any capacity (including a clerical or ministerial capacity) that is inconsistent with the sanction imposed or disqualified status.
A broker-dealer may not pay or credit to any person subject to a sanction or disqualification, during the period of the sanction or disqualification or any period thereafter, any salary, commission, profit or other remuneration that the person might accrue, not just earn, during the period of the sanction or disqualification.
However, a broker-dealer may make payments or credits to a person subject to a sanction that are consistent with the scope of activities permitted under the sanction, where the sanction only limits an associated person from conducting specified activities (such as a suspension from acting in a principal capacity) or to a disqualified person that has been approved (or is otherwise permitted under FINRA rules and the federal securities laws) to associate with a broker-dealer.
Rule 8311 clarifies that:
Other disqualifications, not just suspensions, revocations, cancellations or bars, are subject to the rule (and the rule is not limited to orders issued by FINRA or the SEC).
A broker-dealer may not allow a person subject to a sanction or disqualification to "be" associated with the firm in any capacity that is inconsistent with the sanction imposed or disqualified status, including a clerical or ministerial capacity, not simply "remain" associated.
A broker-dealer may not pay any remuneration to a person subject to a sanction or disqualification, not just payments that result directly or indirectly from any securities transaction.
The rule applies to any salary, commission, profit or remuneration that the associated person might "accrue," not just "earn" during the period of a sanction or disqualification, not just suspension.
However, Rule 8311(b) expressly permits a broker-dealer to pay to any person subject to a sanction or disqualification any remuneration under an insurance or medical plan, indemnity agreement relating to legal fees, or as required by an arbitration award or court judgment.
Rule 8311.01 allows a broker-dealer to pay or credit to a person subject to a sanction or disqualification, salary, commission, profit or other remuneration that the firm can evidence accrued to the person prior to the effective date of the sanction or disqualification, unless the remuneration relates to or results from the activity that gave rise to the sanction or disqualification. A broker-dealer must be able to demonstrate that the remuneration accrued prior to the effective date of the sanction or disqualification in order to pay or credit the remuneration to the individual.
FINRA Rule 0190 is based largely on NASD IM-2420-1(a) and provides that, for purposes of FINRA Rule 2040, a broker-dealer will be considered 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. In the case of suspension, a broker-dealer will be automatically reinstated to membership in FINRA at the termination of the suspension period