[Federal Register Volume 79, Number 60 (Friday, March 28, 2014)]
[Notices]
[Pages 17592-17610]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2014-06895]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-71786; File No. SR-FINRA-2014-010]
Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Notice of Filing of Proposed Rule Change To Adopt
FINRA Rule 2243 (Disclosure and Reporting Obligations Related to
Recruitment Practices)
March 24, 2014.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on March 10, 2014, Financial Industry Regulatory Authority, Inc.
(``FINRA'') filed with the Securities and Exchange Commission (``SEC''
or ``Commission'') the proposed rule change as described in Items I,
II, and III below, which Items have been prepared by FINRA. The
Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
FINRA is proposing to adopt FINRA Rule 2243, which would establish
disclosure and reporting obligations related to member recruitment
practices.
The text of the proposed rule change is available on FINRA's Web
site at http://www.finra.org, at the principal office of FINRA and at
the Commission's Public Reference Room.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, FINRA included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. FINRA has prepared summaries, set forth in sections A,
B, and C below, of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and the
Statutory Basis for, the Proposed Rule Change
1. Purpose
Background
FINRA members dedicate substantial resources each year to recruit
registered persons (``representatives'') to their firms. Implicit in
these recruitment efforts is an expectation that many of the
representative's former customers will transfer assets to the member
recruiting the representative (``recruiting firm'') based on the
relationship that the representative has developed with those
customers. To induce representatives to leave their current firm,
recruiting firms often offer inducements to the representatives in the
form of recruitment compensation packages. Recruitment compensation
packages provide a significant layer of
[[Page 17593]]
compensation in addition to the commission payout grid or other
compensation that a representative receives based on production at a
new firm. Recruitment compensation typically takes the form of some
combination of upfront payments, such as cash bonuses or forgivable
loans, and potential future payments, such as performance-based bonuses
or special commission schedules that are not provided to similarly
situated representatives.
FINRA understands that representatives who contact former customers
to join them at their new firm often emphasize the benefits the former
customers would experience by transferring their assets to the firm,
such as superior products, platforms and service. However, while the
recruiting firm and the representative understand the financial
incentives at stake in a transfer, the representative's former
customers who are contacted or notified about moving assets to the
recruiting firm generally are not informed that their representative is
receiving a recruitment compensation package to transfer firms, or the
potential magnitude of such packages. Furthermore, the former customers
often may not be aware of the potential financial impacts to their
assets that may result if they decide to transfer assets to a new firm,
including, among other things, costs incurred to close an account with
their current firm, transfer assets or open an account at the
recruiting firm, and tax consequences if some assets are not portable
and must be liquidated before transfer.
The proposed rule change aims to provide former customers of a
representative with a more complete picture of the factors involved in
a decision to transfer assets to a recruiting firm. FINRA believes that
former customers would benefit from information regarding recruitment
compensation packages and such other considerations as costs, fees and
portability issues that may impact their assets before they make a
decision to transfer assets to a recruiting firm. A representative's
most recent 12-month gross production and revenue, often referred to as
his or her ``trailing 12,'' is typically the prominent factor in how
firms calculate recruitment compensation packages. Other factors may
include the firm from which the representative is transferring, the
representative's book of business, the percentage of a representative's
book of business that he or she expects will transfer to the new firm,
the representative's years of service, debts to his or her previous
firm, and the business model of the firm offering the package. FINRA
understands that for representatives transferring to a large wirehouse
firm, a standard recruitment compensation package may include an
upfront payment, usually in the form of a forgivable loan, with a 7 to
10 year term that equals from 150 to 200 percent of the
representative's trailing 12. These packages also typically include
potential future payments that the representative earns if specified
production targets are met at the recruiting firm.
FINRA understands that smaller firms generally do not offer
significant recruitment compensation packages to representatives. For
representatives that move to a firm with an independent broker-dealer
model, recruitment compensation also may not include significant
upfront payments. Firms that operate under an independent model
typically offer compensation packages that include transition
assistance and higher commission payout grid compensation in lieu of
upfront payments. Transition assistance packages are intended to offset
costs incurred by a representative to transfer firms, such as moving
expenses, leasing space, buying office supplies and furniture, and
hiring staff. These arrangements also are often based on the
representative's trailing 12 and can result in significant recruitment
compensation packages depending on the recruited representative's
production and client base.
FINRA recognizes the business rationales for offering financial
incentives and transition assistance to recruit experienced
representatives and seeks neither to encourage nor discourage the
practice with the proposed rule change. However, FINRA believes that
former customers currently are not receiving important information from
recruiting firms and representatives when they are induced to move
assets to the recruiting firm. There are a number of factors a former
customer should consider when making a decision to transfer assets to a
new firm. These factors include, among other things, a representative's
motives to move firms, whether those motives align with the interests
and objectives of the former customer, and any costs, fees, or product
portability issues that will arise as a result of an asset transfer to
the recruiting firm. The proposed rule change is intended to provide
former customers information pertinent to these considerations, so they
have a more complete picture of the factors relevant to a decision to
transfer assets to a new firm and can engage in further conversations
with the recruiting firm or their representative in areas of personal
concern. FINRA believes that former customers would benefit from
knowing, among other things, the magnitude of the financial incentives
that may have led their representative to change firms, how the former
customer's assets, or trading activity, factored into the calculation
of such incentives, and whether moving their assets to the recruiting
firm will impact their holdings or impose new costs. The proposed rule
change is intended to focus a former customer's attention on the
decision to transfer assets to a new firm, and the direct and indirect
impacts of such a transfer on those assets, so they are in a position
to make an informed decision whether to follow their representative.
In addition, the proposed rule change would require members to
report to FINRA information related to significant increases in total
compensation over the representative's prior year compensation that
would be paid to the representative during the first year at the
recruiting firm so that FINRA can assess the impact of these
arrangements on a member's and representative's obligations to
customers and detect potential sales practices abuses. FINRA believes
that incorporating such data into its risk-based examination program
will help to identify and mitigate potential harm to customers
associated with member recruitment practices.
Disclosure and Reporting Obligations Related to Recruitment Practices
The proposed rule change would provide targeted and meaningful
information to customers at what FINRA believes to be a relatively low
cost to firms and without implying any bad faith on the part of
representatives who receive recruitment compensation to move firms. The
proposed rule change includes a disclosure obligation to ``former
customers''\3\ who the recruiting firm attempts to induce to follow a
transferring representative and a reporting obligation to FINRA. First,
it would require disclosure to former customers of a representative of
the financial incentives the representative will receive in conjunction
with the transfer to the recruiting firm and the basis for those
incentives. Second, the proposed rule change would require disclosure
to former customers of any costs, fees or product portability issues,
including taxes if some assets must be liquidated prior to transfer,
that will result if the former customer decides to transfer assets to
the recruiting firm. The
[[Page 17594]]
proposed disclosures are intended to encourage customers to make
further inquiry to reach an informed decision by providing a framework
with some specific information to consider the impact to their
accounts. Finally, the proposed rule change would require a recruiting
firm to report to FINRA, at the beginning of a representative's
employment or association with the firm, significant increases in total
compensation over the representative's prior year compensation that
would be paid to the representative during the first year at the
recruiting firm. The details of proposed FINRA Rule 2243 (Disclosure
and Reporting Obligations Related to Recruitment Practices) are set
forth in detail below.
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\3\ See definition of ``former customer'' discussed infra at
page 81.
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Disclosure Requirement
The proposed rule change would require a member that hires or
associates with a representative and directly or through that
representative attempts to induce a former customer of that
representative to transfer assets to an account assigned, or to be
assigned, to the representative at the member to disclose to the former
customer if the representative has received or will receive $100,000 or
more of either (1) aggregate ``upfront payments'' or (2) aggregate
``potential future payments'' in connection with transferring to the
member.\4\ The proposed rule change would require members to disclose
recruitment compensation by separately indicating aggregate upfront
payments and aggregate potential future payments in the following
ranges: $100,000 to $500,000; $500,001 to $1,000,000; $100,000,001 to
$2,000,000; $2,000,001 to $5,000,000; and above $5,000,000.\5\ Thus,
the proposed rule change effectively establishes two separate de
minimis exceptions for payments of less than $100,000: One applied to
aggregate upfront payments and one applied to aggregate potential
future payments. Members also would be required to disclose the basis
for determining any upfront payments and potential future payments
(e.g., asset-based or production-based) the representative has received
or will receive in connection with transferring to the member.\6\
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\4\ See proposed FINRA Rule 2243(a)(1). See also FINRA Rule
0140(a), which states that persons associated with a member shall
have the same duties and obligations as a member under FINRA rules.
\5\ See proposed FINRA Rule 2243.01 (Disclosure of Ranges of
Compensation).
\6\ See proposed FINRA Rule 2243(a)(2).
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The proposed rule change would define a ``former customer'' as any
customer that had a securities account assigned to a representative at
the representative's previous firm. The term ``former customer'' would
not include a customer account that meets the definition of an
``institutional account'' pursuant to FINRA Rule 4512(c); provided,
however, accounts held by a natural person would not qualify for the
``institutional account'' exception.\7\ For the purpose of the proposed
rule, ``upfront payments'' would mean payments that are either received
by the representative upon commencement of employment or association or
specified amounts guaranteed to be paid to the representative at a
future date, including, e.g., payments in the form of cash, deferred
cash bonuses, forgivable loans, loan-bonus arrangements, transition
assistance, or in the form of equity awards (e.g., restricted stock,
restricted stock units, stock options, etc.) or other ownership
interest.\8\ The term ``potential future payments'' would include,
e.g., payments (including the forms of payments described in the
definition of the term ``upfront payments'') offered as a financial
incentive to recruit the representative to a member that are contingent
upon satisfying performance-based criteria, or a special commission
schedule for representatives paid on a commissioned basis beyond what
is ordinarily provided to similarly situated representatives, or are an
allowance for additional travel and expense reimbursement beyond what
is ordinarily provided to similarly situated representatives.\9\ FINRA
understands that members sometimes partner with another financial
services entity, such as an investment adviser or insurance company, to
recruit a representative. In those circumstances, both upfront payments
and potential future payments would include payments by the third party
as part of the recruitment arrangement.
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\7\ See proposed FINRA Rule 2243.05(a). FINRA Rule 4512(c)
defines ``institutional account'' to mean the account of (1) a bank,
savings and loan association, insurance company, or registered
investment company; (2) an investment adviser registered either with
the SEC under Section 203 of the Investment Advisers Act of 1940 or
with a state securities commission (or any agency or office
performing like functions); or (3) any other entity (whether a
natural person, corporation, partnership, trust, or otherwise) with
total assets of at least $50 million.
\8\ See proposed FINRA Rule 2243.05(b).
\9\ See proposed FINRA Rule 2243.05(c). FINRA notes that neither
category of recruitment compensation would include higher commission
schedule payouts received by a transferring representative, such as
may occur where a representative transfers to an independent broker-
dealer, unless such payouts are beyond what is provided to similarly
situated representatives, and that amount, alone or in combination
with other payments, meets the $100,000 threshold for one of the
categories of recruitment compensation.
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In addition to the recruitment compensation disclosure, the
proposed rule change would require the member to disclose to a former
customer of the representative if transferring the former customer's
assets to the member: (1) Will result in costs to the former customer,
such as account termination or account transfer fees from the former
customer's current firm or account opening or maintenance fees at the
member, that will not be reimbursed to the former customer by the
member; \10\ and (2) if any of the former customer's assets are not
transferable to the member and that the former customer may incur
costs, including taxes, to liquidate and transfer those assets in their
current form to the member or inactivity fees to leave those assets
with the former customer's current firm.\11\
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\10\ See proposed FINRA Rule 2243(a)(3).
\11\ See proposed FINRA Rule 2243(a)(4).
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The proposed rule change would allow a member to rely on the
reasonable representations of the representative, supplemented by the
actual knowledge of the member, in determining whether the proposed
disclosures must be made to a former customer.\12\ In the event that a
member, after considering the representations of the newly hired
representative, cannot make a determination whether any of the former
customer's assets are not transferable to the member, the member must
advise former customers in the disclosure: (1) To ask their current
firms whether any of their assets will not transfer to the member and
what costs, if any, the customers will incur to liquidate and transfer
such assets or keep them in an account with their current firm and (2)
that nontransferable securities account assets will be identified to
the former customer in writing prior to, or at the time of, validation
of the account transfer instruction pursuant to FINRA Rule 11870
(Customer Account Transfer Contracts).\13\
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\12\ See proposed FINRA Rule 2243.03 (Representations of a
Registered Person).
\13\ See supra note 12.
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FINRA believes that the proposed rule change would provide key
information to investors that they seldom receive today--that
compensation may have been a motivating factor for a representative's
transfer of firms, that the basis of any recruitment compensation may
have or could impact the representative's treatment of the customer or
the recommendation to move assets to the recruiting firm, that there
may be costs associated with
[[Page 17595]]
transferring assets, and that there may be direct and indirect costs
associated with liquidating or leaving behind nontransferable assets--
relevant to a decision to follow the representative to the recruiting
firm.
FINRA believes starting the disclosure of ranges of compensation at
$100,000 for each category of recruitment compensation creates a
reasonable de minimis exception from the proposed disclosure
requirement at a level where the recruitment compensation or transition
assistance are lesser motivating factors for a representative to move.
FINRA will consider with interest comments on the appropriateness of
the proposed de minimis exception amount of $100,000 for aggregate
upfront payments and aggregate potential future payments; whether the
disclosure of ranges of recruitment compensation should begin at a
different amount; and whether the threshold should apply separately to
upfront payments and potential future payments.
More generally, FINRA believes disclosure of ranges of compensation
received strikes a balance that will provide former customers detailed
information about the nature and magnitude of the financial incentives
involved in their representative's move to factor into their decision
whether to transfer assets to the new firm, while reducing privacy
concerns about specific disclosure of a representative's compensation.
FINRA believes the specified level of detail regarding the
representative's recruitment compensation and the treatment of former
customer's assets is necessary to make the disclosures valuable to
former customers. The disclosures are intended to prompt a dialogue
between the former customer and the representative or recruiting firm
by providing a framework to consider the impact of a decision to
transfer assets to a new firm. FINRA believes that the proposed
disclosures would encourage customers to make further inquiries to the
representative and the recruiting firm to reach an informed decision
about whether to transfer assets. In addition, FINRA believes that
requiring the basis for recruitment compensation to be disclosed would
allow a former customer to review his or her account activity during
the relevant time to see if any unusual activity occurred to boost the
representative's revenue base in anticipation of a move and to more
closely monitor activity at the new firm, should the customer decide to
move assets there.
Delivery of Disclosures
The proposed rule change would require a member to deliver the
proposed disclosures at the time of first individualized contact with a
former customer by the representative or the member that attempts to
induce the former customer to transfer assets to the member.\14\ If
such contact is in writing, the written disclosures must accompany the
written communication; if such contact is oral, the member must give
the disclosures orally at the time of contact followed by written
disclosures sent within 10 business days from such oral contact or with
the account transfer approval documentation, whichever is earlier. If
the representative or the member attempts to induce a former customer
to transfer assets to an account assigned, or to be assigned, to the
representative at the member, but no individualized contact with the
former customer by the representative or member occurs before the
former customer seeks to transfer assets, the disclosures must be
delivered to the former customer with the account transfer approval
documentation.\15\ The disclosure requirement would apply for a period
of one year following the date the representative begins employment or
associates with the member.\16\
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\14\ See proposed FINRA Rule 2243(b)(1).
\15\ See proposed FINRA Rule 2243(b)(2).
\16\ See proposed FINRA Rule 2243(b)(3).
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FINRA believes that any action taken by a recruiting firm directly
or through a representative that attempts to induce former customers of
the representative to transfer assets to the recruiting firm should
trigger the disclosures. As such, under the proposed rule change,
actions by the recruiting firm or the representative that do not
involve individualized contact, such as a tombstone advertisement, a
general announcement, or a billboard, would be considered attempts to
induce former customers to move their assets. In these circumstances,
if a former customer subsequently decides to transfer assets to the
recruiting firm without individualized contact, the proposed rule
change would require the recruiting firm to provide the proposed
disclosures to former customers with the account transfer approval
documentation.
Format of Disclosures
The proposed rule change would require a member to deliver the
proposed disclosures in paper or electronic form in a format prescribed
by FINRA, or an alternative format with substantially similar
content.\17\ The proposed rule change would require that written
disclosures must be clear and prominent.\18\ To facilitate uniform
disclosure under the proposed rule change and to assist members in
making the proposed disclosures to former customers of a
representative, FINRA has developed a disclosure template form that
members may use to make the required disclosures.\19\ Members may,
however, create their own disclosure form, as long as it contains
substantially similar content to the FINRA-developed template.
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\17\ See proposed FINRA Rule 2243.02 (Format of Disclosures).
\18\ See supra note 17.
\19\ See Exhibit 3, attached to FINRA's filing with the
Commission.
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On the disclosure form, a member would be required to indicate the
applicable range of compensation in each category of recruitment
compensation (i.e., aggregate upfront payments and aggregate potential
future payments), for compensation in amounts of $100,000 or more that
the representative has received or will receive in connection with
transferring to the member. Thus, a representative who receives $75,000
in aggregate upfront payments and $75,000 in potential future payments
would not trigger the compensation disclosure under the proposed rule
because the $100,000 threshold applies separately to each category of
recruitment compensation. Members also would be required to indicate
the basis for those payments, e.g., assets brought in or future
production. In addition, members would be required to indicate if
transferring assets to the representative's new firm will result in
costs to the former customer that will not be reimbursed by the member,
if any of the former customer's assets are not transferable to the
member and that the former customer may incur costs, including taxes,
to liquidate and transfer those assets in their current form to the
member or inactivity fees to leave those assets with the former
customer's current firm.
The FINRA-developed disclosure template would include a free text
section in which the member or representative may include additional,
contextual information regarding the disclosures, as long as such
information is not false or misleading. A member could provide the same
context in a disclosure form of its own design, as long as it does not
obscure or overwhelm the required disclosures and is not false or
misleading. FINRA believes that allowing members and representatives an
opportunity to provide context regarding the disclosures will alleviate
concerns that
[[Page 17596]]
the disclosures will be confusing or imply bad faith on the part of the
representative. FINRA believes that providing a uniform disclosure form
will allow members to make the required disclosures at a relatively low
cost and without significant administrative burdens.
Reporting Requirement
The proposed rule change would require a member to report to FINRA
at the beginning of the employment or association of a representative
that has former customers (as defined by proposed Rule 2243.05) if the
member reasonably expects the total compensation paid to the
representative by the member during the representative's first year of
employment or association with the member to result in an increase over
the representative's prior year compensation by the greater of 25% or
$100,000.\20\ In determining total compensation, the member must
include any aggregate upfront payments, aggregate potential future
payments, increased payout percentages or other compensation the member
reasonably expects to pay the representative during the first year of
employment or association with the member. A member's report to FINRA
must include the amount and form of such total compensation and other
related information, in the time and manner that FINRA may prescribe.
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\20\ See proposed FINRA Rule 2243(c) (Reporting Requirement).
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The compensation information reported to FINRA pursuant to the
proposed rule would not be made available to the public. FINRA intends
to use the reported compensation information as a data point in its
risk-based examination program. As such, FINRA believes it is important
to capture the compensation information in a structured way. FINRA
believes this data will help FINRA examiners better assess the adequacy
of firm systems to monitor conflicts of interest and systems to detect
and prevent underlying business conduct abuses potentially attributable
to recruitment compensation incentives, and target exams where concerns
appear. This data also will help FINRA to identify whether the
conflicts of interest attendant to particular levels or structures of
increased compensation when a representative transfers firms result in
customer harm that is not adequately addressed by current FINRA
rules.\21\ Further, FINRA believes such data would inform any future
rulemaking to require firms to manage conflicts arising from specific
compensation arrangements. In addition, FINRA believes the proposed
reporting requirement itself could mitigate potential sales practice
violations, as it might encourage firms to give greater supervisory
attention to the more lucrative compensation packages that will be
reported to FINRA.
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\21\ Recruitment compensation packages offered to
representatives have been the subject of regulatory concern for many
years. Former SEC Chairman Schapiro identified potential conflicts
raised by recruitment practices in 2009 in an open letter to broker-
dealer CEOs. The letter noted that: ``[s]ome types of enhanced
compensation practices may lead registered representatives to
believe that they must sell securities at a sufficiently high level
to justify special arrangements that they have been given. Those
pressures may in turn create incentives to engage in conduct that
may violate obligations to investors. For example, if a registered
representative is aware that he or she will receive enhanced
compensation for hitting increased commission targets, the
registered representative could be motivated to churn customer
accounts, recommend unsuitable investment products or otherwise
engage in activity that generates commission revenue but is not in
investors' interest.'' See Open Letter to Broker-Dealer CEOs from
SEC Chairman Mary L. Schapiro, dated August 31, 2009.
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Calculating Compensation
The proposed rule change would provide that in calculating
compensation for the purpose of the proposed disclosure requirement and
the proposed reporting requirement to FINRA, a member: (1) Must assume
that all performance-based conditions on the representative's
compensation are met; (2) may make reasonable assumptions about the
anticipated gross revenue to which an increased payout percentage will
be applied; and (3) may net out any increased costs incurred directly
by the representative in connection with transferring to the
member.\22\ Members must include as part of such calculations all
compensation the representative has received or will receive that is
based on gross commissions and assets under care from brokerage
business and, if applicable, fee income and assets under management
from investment advisory services. For example, a dual-hatted
representative that receives from the recruiting firm an upfront
payment of $1.5 million based on gross commissions from brokerage
business and an upfront payment of $1 million based on fees and assets
under management from investment adviser business would be required to
indicate on the customer disclosure form that he or she has received
recruitment compensation in the range of $2,000,001 to $5,000,000 in
aggregated upfront payments, and include $2.5 million in upfront
payments as part of calculating total compensation for the purposes of
the reporting requirement to FINRA.
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\22\ See proposed FINRA Rule 2243.04 (Calculating Compensation).
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FINRA will announce the effective date of the proposed rule change
in a Regulatory Notice to be published no later than 60 days following
Commission approval. The effective date will be no later than 180 days
following publication of the Regulatory Notice announcing Commission
approval.
2. Statutory Basis
FINRA believes that the proposed rule change is consistent with the
provisions of Section 15A(b)(6) of the Act,\23\ which requires, among
other things, that FINRA rules must be designed to prevent fraudulent
and manipulative acts and practices, to promote just and equitable
principles of trade, and, in general, to protect investors and the
public interest. FINRA believes that the proposed rule change will
promote investor protection by providing information on the costs and
conflicts associated with a former customer's important decision
whether to transfer assets to a representative's new firm. FINRA
further believes that the proposed rule change would allow a former
customer to make a more informed decision, taking into account the
financial incentives that may motivate a representative to move firms
and induce a customer to follow, as well as the costs to be borne by
the customer in connection with transferring assets and the possibility
that some assets cannot transfer. In addition, the proposed requirement
to report to FINRA significant increases in total compensation in a
representative's first year at a recruiting firm will enhance investor
protection by allowing FINRA to monitor such practices and use the data
collected to detect potential sales practice abuses.
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\23\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition
FINRA does not believe that the proposed rule change will result in
any burden on competition that is not necessary or appropriate in
furtherance of the purposes of the Act. By relying on disclosure and
reporting, the proposed rule seeks to focus a former customer's
attention on the decision to transfer assets to a new firm, and the
direct and indirect impacts of such a transfer on those assets, so they
are in a position to make an informed decision whether to follow their
representative.
The proposed rule would require a recruiting firm to determine the
dollar
[[Page 17597]]
value of a representative's recruitment compensation, and if meeting a
threshold, provide disclosure to former customers the recruiting firm
or representative attempt to induce to transfer assets during the
representative's first year of employment or association. In addition,
the proposed rule would require the recruiting firm to report
information about a representative's total compensation to FINRA if it
meets the proposed threshold. Firms also would be responsible for
developing compliance policies, training and tracking for the proposed
rule. Some commenters have noted that the proposed rule also may have
an impact on the market for representatives.
FINRA does not believe that the proposed rule change will impose
undue operational costs on members to comply with the disclosure and
reporting obligations because the information needed to make the
calculations resides with either the recruiting firm or the
representative. The recruiting firm knows how much upfront compensation
they will be paying the representative, as well as the additional
potential future income the representative may earn if he or she
satisfies conditions. Furthermore, the proposed rule change permits the
recruiting firm to make reasonable assumptions about the gross revenue
to which any increased payout percentage may apply. In addition, FINRA
understands that the recruiting firm or the representative typically
has ongoing contact with former customers, thereby facilitating the
opportunity for the disclosures to be made. With respect to the
disclosure of costs, FINRA believes that the representative will know
of costs a former customer will incur at the current firm to transfer
assets or leave them inactive and that the recruiting firm knows the
costs it imposes to transfer assets and open and maintain an account
there. Also, the proposed rule change allows the recruiting firm to
rely on the reasonable representations of the representative for much
of the information, and with respect to portability, give more
generalized disclosure where the information cannot be ascertained from
the representative or other actual knowledge.
In developing the proposed rule change, FINRA considered several
alternatives to the proposed rule change, which are set forth below, to
ensure that it is narrowly tailored to achieve its purposes described
previously without imposing unnecessary costs and burdens on members or
resulting in any burden on competition that is not necessary or
appropriate in furtherance of the purposes of the Act. The proposed
rule change addresses many of the concerns noted by commenters in
response to an earlier version of the proposal.\24\
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\24\ See Item C., which contains a detailed discussion of the
earlier version of the proposal that was published in Regulatory
Notice 13-02 (January 2013).
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First, the earlier version of the proposed rule change would have
required a member that provides, or has agreed to provide, to a
representative enhanced compensation in connection with the transfer of
securities employment of the representative from another financial
services firm to disclose the details, including specific amounts, of
such enhanced compensation \25\ to any former customer of the
representative at the previous firm that is contacted regarding the
transfer of the securities employment (or association) of the
representative to the recruiting firm, or who seeks to transfer assets,
to a broker-dealer account assigned to the representative with the
recruiting firm. The earlier proposal did not include any disclosure of
costs or portability ramifications associated with transferring assets
to the new firm. As discussed in detail in Item C., a majority of the
comments received on the earlier version of the proposal opposed
specific disclosure of enhanced compensation, stating that it was
burdensome, an invasion of privacy and failed to address a particular
harm to customers. Some commenters instead favored general disclosure
that a representative is receiving unspecified compensation as part of
a transfer.
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\25\ In the initial 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 transfer of securities
employment (or association) to the recruiting firm.
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FINRA considered, as an alternative to the proposed rule change, a
proposal that would have included a general recruitment compensation
disclosure (i.e., no specific dollar amounts) and general disclosure
that the former customer may incur costs or encounter portability
issues in connection with any asset transfer. However, FINRA believes
that the proposed rule change is preferable to alternatives with
general disclosure requirements because the general disclosure approach
does not give former customers any sense of the scope or magnitude of a
representative's recruitment compensation package or whether the cost
and portability disclosures will actually impact their personal
holdings. FINRA developed the revised approach in the proposed rule
change to strike a balance between specific disclosure and general
disclosure by requiring disclosure of ranges of compensation of
$100,000 or more as applied separately to aggregate upfront payments
and aggregate potential future payments and affirmative cost and
portability statements.
The proposed disclosure of ranges of recruitment compensation
provides customers with meaningful information, i.e., that compensation
may have been a motivating factor in their representative's decision to
change firms, to consider in conjunction with a representative's other
stated reasons for changing firms, without requiring members to
disclose specific information about the payments that may compromise
the privacy of the representative. As noted in Item A., representatives
often emphasize the superior products, platforms and services of the
recruiting firm without disclosing the lucrative financial incentives
they have received or will receive in connection with the transfer. In
addition, to assist members with compliance with the proposed rule
change and to mitigate costs and administrative burdens, FINRA
developed a disclosure form that members may use to make the required
disclosures. The proposed rule change adds flexibility by allowing
recruiting firms to deliver the disclosures in an alternative format
with substantially similar content so firms can leverage existing
compliance efforts or procedures.
Second, as noted above, the proposed rule change exempts
compensation that does not meet a $100,000 threshold as applied
separately to aggregate upfront payments and aggregate potential future
payments for purposes of disclosure to former customers and
compensation that does not meet a threshold of the greater of 25% or
$100,000 over the representative's prior year's compensation for
purposes of reporting total compensation to FINRA, and allows members
to net out direct costs paid by the representative in a transfer to a
new firm when making such calculations. The initial proposal included a
$50,000 exception, which many commenters opposed because, among other
things, they felt it was arbitrary, too low to cover expenses incurred
by representatives to transfer firms and did not allow firms to net out
direct costs incurred by the representative in calculating recruitment
compensation. Based on the
[[Page 17598]]
comments and discussions with firms, FINRA believes that raising the
proposed de minimis exception for recruitment compensation to $100,000
for each of aggregate upfront payments and aggregate potential future
payments will substantially mitigate costs for firms without
compromising investor protection. Based on input from firms that offer
recruitment compensation, FINRA believes the proposed de minimis
exception will except from the disclosure obligation those firms whose
payments are only intended as transition assistance to help cover
relocation and overhead costs, such as new business cards and
letterhead, and that amounts below this threshold significantly
diminish the motivating impact for the representative to move firms and
therefore would not be as meaningful to customers. FINRA also
understands that recruitment compensation that exceeds the $100,000
threshold for aggregate upfront payments and aggregate potential future
payments is typically offered only by the largest firms and therefore
the disclosure obligation should not impact most small firms or
independent broker-dealers, where the relative costs of compliance
would be more burdensome.
FINRA understands the proposed de minimis exception for disclosure
of compensation under $100,000 in each category of recruitment
compensation may impose some burden on small member firms to establish
administrative processes to track compensation and to ensure that
records are available to evidence compliance. FINRA does not believe
that the administrative costs to track recruitment compensation
outweighs the investor protection benefits of increased transparency to
inform former customers about recruitment compensation that may have
motivated their representative to move firms before they decide to
transfer account assets to their representative's new firm. In
addition, FINRA notes that the proposed rule change incorporates a
provision that permits members to net out costs directly incurred by a
representative in connection with a transfer to the recruiting firm.
Members would measure compensation amounts for purposes of determining
the $100,000 threshold in each category of recruitment compensation
after direct costs to the representative in connection with the
transfer have been netted out. Therefore, FINRA believes it is more
likely that the de minimis exception will apply when a representative
moves from a wirehouse firm to a firm with an independent broker-dealer
model or when a representative otherwise incurs direct costs associated
with a transition.
Third, the proposed rule change limits the proposed disclosures to
situations where a member, directly or through a representative,
attempts to induce that representative's former customers to transfer
assets to the member. Recruiting firms would not have to make the
disclosures to former customers if the recruiting firm or
representative does not undertake any efforts to induce former
customers to transfer assets to the member, either through
individualized contact, such as an email or phone call, or non-
individualized contact, such as a tombstone advertisement, a billboard
or a notification on the firm's Web site.
Fourth, FINRA notes that the proposed rule change includes a one-
year disclosure period so that members do not have to track for or
provide disclosures to customers after the representative has been with
the firm for a year. FINRA considered an alternative that would have
required disclosure for as long as the representative continued to
receive recruitment compensation, which in some cases, could be 10
years. FINRA understands that most former customers who transfer assets
to the representative's new firm do so soon after the representative
changes firms so the one-year period should provide a reasonable end
date for the proposed disclosure requirement.
Fifth, FINRA considered whether the proposed rule should apply to
any new customers of the representative at the new firm, or whether
disclosure to just former customers would accomplish the goals of the
proposed rule change. FINRA determined that it would limit the proposed
rule to former customers of the representative because the recruitment
compensation the representative has received or will receive in a
transfer is likely based on activity in the accounts of such former
customers and the expectation that they will transfer assets to follow
the representative to the recruiting firm. In addition, representatives
should have a sense of how moving assets to the recruiting firm will
impact former customers' accounts because they are aware of the costs
associated with account termination, transfer and opening and product
limitations at their previous firm and at the recruiting firm.
Representatives are less likely to have similar information for new
customers opening an account with the recruiting firm. A customer
opening a new account also does not have an established relationship
with the representative and, in many cases, has already determined to
place assets with a new firm without any inducement from the
representative.
Sixth, FINRA considered whether the proposed rule should require
disclosure to current customers when their representative receives a
retention bonus. As explained in more detail in Item C., the proposed
rule change does not include that requirement because the proposal is
more narrowly focused on providing a former customer important
information when deciding whether to follow his or her representative
to a new firm, and incentives offered to a representative while at a
firm do not implicate the same considerations for customers, such as
transfer costs and portability issues. FINRA notes that to the extent a
retention bonus is part of a recruitment compensation package,
disclosure would be required as a potential future payment if the
magnitude of the bonus exceeds the $100,000 threshold. FINRA further
notes that the reporting requirement in the proposed rule change is
intended, in part, to provide insight as to whether compensation
packages are resulting in increased risk to customers of inappropriate
sales practice activities. That information will help inform whether
additional regulation around retention bonuses or other compensation
incentives is necessary.
Finally, in considering the proposed requirement that members
report to FINRA significant increases in a recruited representative's
total compensation over the prior year, FINRA notes that it consulted
with its advisory committees to determine the proposed threshold of the
greater of $100,000 or 25%, which is intended to exclude compensation
arrangements that do not pose the same level of potential conflicts of
interest. FINRA believes compensation increases of amounts below the
threshold are less valuable for its examination program, particularly
when compared to the burden of compliance on smaller firms that are
more likely to offer recruitment packages in those ranges. FINRA will
consider with interest comment on whether the proposed threshold is
appropriate and, if commenters favor an alternative, the reasons why
such alternative is preferable.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
FINRA published an earlier version of the proposal for comment in
Regulatory Notice 13-02 (January 2013) (the ``Notice Proposal''). A
copy of the
[[Page 17599]]
Notice Proposal is attached as Exhibit 2a. The comment period expired
on March 5, 2013. FINRA received 567 comment letters in response to the
proposal, of which 65 were unique letters. A list of the comment
letters received in response to the Notice Proposal is attached as
Exhibit 2b.\26\ Copies of the comment letters received in response to
that proposal are attached as Exhibit 2c.\27\ Of the 65 unique comment
letters received, 21 were generally in favor of the proposed rule
change, 43 were generally opposed, and one letter did not address the
merits of the proposal.
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\26\ All references to the commenters under this Item are to the
commenters as listed in Exhibit 2b.
\27\ Exhibits 2a, 2b, and 2c are attached to FINRA's filing with
the Commission.
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The Notice Proposal required a member that provides, or has agreed
to provide, to a representative ``enhanced compensation'' in connection
with the transfer of securities employment of the representative from
another financial services firm to disclose the details of such
enhanced compensation to any former customer of the representative at
the previous firm who: (1) Is individually contacted by the member or
representative, either orally or in writing, regarding the transfer of
employment (or association) of the representative to the member; or (2)
seeks to transfer an account from the previous firm to an account
assigned to the representative with the member. The proposal defined
enhanced compensation to include signing bonuses, upfront or back-end
bonuses, loans, accelerated payouts, transition assistance, and similar
arrangements. The proposal would have required disclosure for one year
following the date the representative associates with the recruiting
firm. The proposal included an exception for enhanced compensation of
less than $50,000 and customers that meet the definition of an
institutional account pursuant to FINRA Rule 4512(c), except any
natural person or a natural person advised by a registered investment
adviser.
Comments in support of the proposal were split between those that
favored specific disclosure and those that advocated general disclosure
of recruitment compensation. In general, comments opposed to the
proposal asserted that it did not address an identifiable harm to
customers, was pejorative toward representatives, invaded their
privacy, and failed to include other cost impacts to customers when
transferring their accounts. The comments and FINRA's responses are set
forth in detail below.
Support for the Notice Proposal
In general, commenters that supported the proposal stated that
disclosing specific recruitment compensation to customers would provide
investors with information relevant to investment decisions, promote
greater transparency, increase investor confidence and trust, and
increase customer awareness of potential conflicts of interest relating
to recruitment compensation packages.\28\ One commenter noted that the
proposal put the interest of customers first, supported a high standard
of business ethics, and provided disclosure appropriate for customers
to make informed decisions without prohibiting legitimate business
practices.\29\ Another commenter noted that informing customers of
potential conflicts of interest regarding recruitment compensation is
especially important if the representative's compensation is determined
by the assets a customer moves to the representative's new firm.\30\
One commenter also noted that most representatives do not tell
customers that they are receiving recruitment compensation for moving
customer assets to the new firm and inflate production to benefit
trailing 12 calculations.\31\ Another commenter stated that registered
investment advisers are required to disclose all conflicts of interest,
including those that may arise when the adviser changes firms.\32\ Two
commenters noted that transparency is a key component of a customer's
ability to make an informed decision about transferring his or her
assets.\33\
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\28\ APA, Arrigo, Capstone-FA, Cornell, Edward Jones, HDVest,
JGHeller, Merrill, Miami, Morgan Wilshire, MSWM, NASAA, Oppenheimer,
PIABA, Ruchin, Scott Smith, Summit-E, UBS, Wedbush, WFA.
\29\ UBS.
\30\ Capstone-FA.
\31\ APA.
\32\ Cornell.
\33\ Morgan Wilshire, Wedbush.
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Specific vs. General Enhanced Compensation Disclosure
Several commenters wrote in support of uniform, industry-wide
disclosure of recruitment compensation to customers, including the form
of the recruitment compensation arrangement and specific dollar
amounts.\34\ One commenter suggested that FINRA should work with the
industry to create a model approach that clearly articulates
appropriate disclosure for enhanced compensation arrangements and
supported concise, direct and plain English disclosures of information
that is sufficient to inform an investor of the potential material
conflicts of interest that may arise in connection with recruiting
related bonus payments.\35\ Another commenter noted that specific
disclosure would make it significantly easier for former customers to
assess the merits of the change to reach an informed decision about
whether to transfer an account to the new firm.\36\
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\34\ Edward Jones, Merrill, MSWM, NASAA, Summit-E, UBS, WFA.
\35\ SIFMA.
\36\ Oppenheimer.
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The Notice Proposal requested comment on an alternative approach
that would require a general upfront disclosure by the recruiting firm
or representative that the representative is receiving, or will
receive, material enhanced compensation in connection with the transfer
of securities employment (or association) to the recruiting firm and
that additional specific information regarding the details of such
compensation would be available at a specified location on the firm's
Web site or upon request.
A few commenters asserted that a general disclosure would dilute
the goal of proactive, timely disclosure because customers would carry
the burden to seek out the more detailed disclosures from the member or
representative.\37\ One commenter opposed the alternative approach
because the more detailed web-based disclosure would be accessible not
only by customers, but also the public.\38\ Numerous commenters
suggested that the proposal should require general disclosure of
recruitment compensation, instead of specific disclosure, with an
opportunity for customers to request more information from the
representative or member regarding the details of such
compensation.\39\ Some commenters also stated that a general disclosure
would prompt a dialogue between the representative and retail customers
that would be more valuable than raw numbers without context.\40\
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\37\ Edward Jones, Summit-E, UBS.
\38\ Summit-E.
\39\ Advisor Group, Ameriprise, BDA, Bischoff, Cetera, Janney,
LaBastille, Lax, Lincoln, Miami, NAIFA, Plexus, Stifel, Summit-B,
Sutherland, Wedbush.
\40\ Ameriprise, Cetera, Wedbush.
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Several commenters stated that a brief, plain English, generic
disclosure with the delivery of Automated Customer Account Transfer
Service (``ACATS'') forms or at account opening would be more
meaningful to customers than specific disclosure of compensation, and
also would avoid
[[Page 17600]]
privacy and anti-competitive issues.\41\ Several other commenters noted
that specific disclosure might mislead or confuse customers and would,
therefore, not be helpful or serve the purposes of investor
protection.\42\ One commenter stated that customers might view
recruitment compensation as a bribe or excessive.\43\ One commenter
suggested that firms should provide customers with a single page, plain
English form to inform the client that their representative is
receiving recruitment compensation exceeding $50,000 and, although the
representative is under no suspicions of acting unethically, FINRA has
identified enhanced compensation as an area prone to conflicts, and any
concerns regarding the management of investment accounts and objectives
should be raised with the representative.\44\ Two commenters noted that
disclosure of specific recruitment compensation may be viewed as a
measure of the new firm's endorsement of the representative.\45\
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\41\ Ameriprise, Cetera, Janney, Lax, Stifel, Sutherland,
Wedbush.
\42\ Advisor Group, BDA, Bischoff, Burns, Miami, NAIFA, Plexus,
Sutherland.
\43\ Smith Moore.
\44\ Cornell.
\45\ Burns, Elzweig.
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As discussed in Item B., FINRA does not agree that general
disclosure of recruitment compensation would provide sufficient
information for a former customer to weigh in a decision whether to
transfer assets to his or her representative's new firm. FINRA
continues to believe that some level of specificity regarding the
magnitude of recruitment compensation paid by a member to a
representative is necessary for the disclosure to be meaningful to
former customers. FINRA believes that customers need some quantifiable
measure to evaluate the impact recruitment compensation may have had on
the representative's decision to move firms and his or her attempt to
induce former customers to transfer assets to that new firm. FINRA
further believes that the disclosure of ranges of compensation will
provide a former customer enough sense of the magnitude of the payments
to foster further inquiry with the representative if the customer finds
the compensation relevant to his or her decision to transfer assets to
the new firm.\46\
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\46\ See also FINRA's responses to comments regarding privacy
and anti-competitive concerns on pages 110 through 116.
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Opposition to the Notice Proposal
In general, commenters opposed to the proposal stated that it does
not address an identifiable harm or conflict of interest, is
unnecessary and redundant, and does not provide additional protections
to retail investors beyond existing rules (e.g., FINRA's suitability
rule already addresses churning and unsuitable recommendations and
FINRA's supervision rules address firms' supervisory systems).\47\
Three commenters noted that the benefits of the proposal are unclear
because, among other things, a representative's compensation has no
direct impact on a customer's account and recruitment compensation does
not present a conflict of interest that is distinguishable from other
compensation arrangements not covered by the proposal.\48\
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\47\ Abel, Advisor Group, Ameriprise, APA, BDA, Bischoff, Burns,
Capstone-AG, Cetera, Commonwealth, Cutter, Edde, Elzweig, FORM, FSI,
Gompert, Janney, LaBastille, Lincoln, LPL, NPB, SIPA, Smith Moore,
Spartan, Stifel, Sutherland, Summit-B, Summit-E, Taylor, Taylor
English, Whitehall, Wilson, Wood.
\48\ Smith Moore, Sutherland, Taylor English.
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Five commenters stated that the proposal is not helpful to
customers and will not assist them in making a decision to transfer
assets to a new firm.\49\ Three commenters stated that the proposal is
not well designed to mitigate conflicts or help customers because it
does not prohibit any action; it merely provides an incomplete
disclosure of one of many potential conflicts.\50\ A few commenters
stated that if the true intent of the proposal is to reduce conflicts
of interest by curtailing recruitment compensation packages, then it
would be more efficient for FINRA to address such arrangements, rather
than requiring disclosure to customers with the hope that the second
order impact will be for firms to change their practices.\51\
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\49\ Advisor Group, Bischoff, Commonwealth, Spartan, Wedbush.
\50\ Burns, Taylor English, Showalter.
\51\ Cutter, Taylor English, Whitehall.
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Numerous commenters questioned the purpose of the proposal given
the lack of evidence that recruitment compensation harms clients in any
way.\52\ Several commenters noted that FINRA cited no enforcement
actions, cases, customer complaints or other empirical evidence that
enhanced compensation creates a conflict of interest between customers
and representatives and requested that FINRA consider modifying the
proposal to more accurately address any perceived harm.\53\ One
commenter stated that more rigorous analysis is needed to determine if
an actual conflict exists.\54\
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\52\ Advisor Group, Burns, Cutter, Edde, Herskovits, Smith
Moore, Summit-B, Sutherland, Taylor English, Wedbush and Whitehall.
\53\ Burns, Commonwealth, Janney, Stifel, Sutherland.
\54\ Janney.
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Several commenters were concerned that the proposal assumes that
representatives act in bad faith and implies that customers should not
trust representatives if they have received recruitment compensation,
even if it merely helps offset the cost of moving firms.\55\ One
commenter noted that the backlash from customers will outweigh any
benefits of the proposal.\56\ Another commenter noted that the proposal
does not explain how the significant consequences to the representative
of specific compensation disclosure are outweighed by the benefit to
retail customers and suggested focus group testing to determine whether
a general disclosure would be as effective as specific disclosure.\57\
One commenter stated that the proposal will cause jealousy and bad will
among clients, create a more litigious environment, and will force
representatives to take on larger and fewer clients.\58\ Another
commenter stated that the disclosure will put pressure on
representatives to perform above prevailing market conditions to
justify payouts.\59\ One commenter stated that the proposal will
further sensationalize the transition of a representative to another
firm.\60\ Another commenter stated that it, instead, could harm a
representative's interests with no practical purpose.\61\ However, one
commenter stated that specific disclosure of recruitment compensation
that is moderate and reasonable will not negatively affect
representatives because he or she can explain the benefits of the move
and the costs and lost revenues involved in the transition.\62\
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\55\ Abel, Ameriprise, Burns, Capstone-AG, Commonwealth, Cutter,
FORM, FSI, Lincoln, LPL, Whitehall.
\56\ Bischoff.
\57\ FSI.
\58\ Wilson.
\59\ Taylor.
\60\ Smith Moore.
\61\ Lax.
\62\ Korth.
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Some commenters raised concerns that the proposed disclosure will
be confusing to customers because they cannot understand the complexity
of compensation packages and, therefore, the proposal will not be
valuable to them or serve the purposes of investor protection.\63\ One
commenter noted that customers are not in a position to judge the
merits of recruitment compensation to understand their value to the
future
[[Page 17601]]
of a firm or branch, and are more likely to view them all
negatively.\64\ Other commenters requested clarification of what is
meant by disclosure of ``details'' of enhanced compensation and
``similar arrangements.''\65\
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\63\ Advisor Group, BDA, Miami, Plexus, Sutherland.
\64\ Bischoff.
\65\ Sutherland, Lax, NAIFA, Cutter, Summit-E.
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A number of commenters also noted that recruitment compensation may
actually benefit investors because it may cover ACATS transfer fees,
moving expenses, or new advertising materials, and allow the
representative to move to a new firm with better service.\66\ One
commenter noted that the proposal does not consider that
representatives who receive significant recruitment compensation
packages are those that are in high demand and the firms that recruit
them will have quality platforms and services that will benefit
clients.\67\
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\66\ FORM, Lincoln, LPL, Capstone-AG.
\67\ Elzweig.
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FINRA believes the proposed rule change addresses many of the
commenters' concerns by better focusing the proposal on the impact to
customers when they are considering transferring assets to a
representative's new firm, rather than specific amounts of recruitment
compensation paid to a representative. As stated in Item A., FINRA
recognizes the business rationales for offering financial incentives
and transition assistance to recruit experienced representatives and
seeks neither to encourage nor discourage the practice with the
proposed rule change. The proposed rule change also does not intend to
cast representatives in a negative light for receiving recruitment
compensation when they accept a new position.
The proposed rule change would require disclosure of ranges of
compensation, instead of specific amounts of compensation, and expands
the disclosures to include information about the costs, fees, and
portability issues that will directly impact a customer's assets. The
proposed rule change is intended to provide former customers with this
information, so they have a more complete picture of the factors
relevant to a decision to transfer assets to a new firm and can engage
in further conversations with the recruiting firm or their
representative in areas of personal concern. Moreover, the proposed
rule change will focus a former customer's attention on the decision to
transfer assets to a new firm, and the direct and indirect impacts of
such a transfer on those assets, so they are in a position to make an
informed decision whether to follow their representative.
FINRA does not believe that former customers will be confused by a
clear, plain English disclosure regarding a representative's
recruitment compensation. However, FINRA notes that the proposed rule
change amends the Notice Proposal to require disclosure of ranges of
compensation, the basis for such compensation, and other important
considerations that a former customer should consider when they are
deciding whether to transfer assets to a new firm. The proposed rule
change would require members to use the FINRA-developed disclosure
template, or their own form with substantially similar content, and
would include a free text section to include contextual information
regarding the disclosures. In addition, members would be required to
include descriptions regarding ``upfront payments'' and ``potential
future payments'' to assist customers in understanding the types of
payments that their representative has received or will receive from
the recruiting firm.
As noted in Item A., FINRA believes the proposed rule change
provides targeted and meaningful information to customers at a
relatively limited cost to firms and without implying any bad faith on
the part of the registered representative. The disclosures are intended
to encourage customers to make further inquiry to reach an informed
decision by providing a framework with some specific information to
consider the impact to their accounts. In addition, FINRA believes that
former customers should be given enough information to understand how
their assets factor into the calculation of their representative's
recruitment compensation package, and how much money is at stake in
these transfers.
Privacy Concerns
Numerous commenters opposed specific disclosure of recruitment
compensation because it would interfere with a representative's right
to privacy.\68\ Some commenters stated that the proposal threatens the
financial privacy of representatives in a manner that is unfair,
needlessly intrusive, and may jeopardize client relationships.\69\
Others noted that it will expose personal and confidential information
without any tangible benefit to the customer and should not be required
absent a compelling public policy reason to do so.\70\ One commenter
minimized the operational and privacy concerns stating that they do not
outweigh clients' best interests, and disclosures may enhance client
relationships based on transparency and trust.\71\
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\68\ Ameriprise, Burns, Cetera, Gompert, Janney, Lax, Stifel,
Sutherland, Wedbush, Whitehall, Wilson.
\69\ FSI, Herskovits, LaBastille, Lax, Stifel.
\70\ Ameriprise, BDA, Stifel.
\71\ MSWM.
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A number of commenters stated that the proposal exposes
representatives to safety risks, including, e.g., identity theft, data
security incidents,\72\ financial fraud, kidnapping, black mail and
extortion.\73\ One commenter expressed concerns that disclosure of
recruitment compensation will make a representative's compensation a
factor when customers are considering the settlement of outstanding
complaints and negotiating settlement offers.\74\ Two commenters
further stated that firms will be unable to protect widespread
dissemination of a representative's compensation information once it is
disclosed.\75\ One commenter suggested including with the proposed
disclosure a customer confidentiality provision with an exception for
the customer to share the information with an attorney or financial
professional for consulting purposes.\76\ One commenter noted that the
information gained by the disclosure will eventually be obtained and
aggressively used by the previous firm to try to persuade clients not
to follow their representatives to the new firm.\77\ Two commenters
warned that the proposed disclosure would expose trade secrets and
destroy proprietary business formulas that have been developed by
firms.\78\ Another commenter stated that it threatens the confidential
nature and success of firms' recruiting programs and impacts a core and
currently proprietary tool that broker-dealers use to manage their
business (i.e., compensation of personnel) without a measurable
increase in customer protection or evidence that the disclosure will
impact the perceived conflicts.\79\ Three commenters stated that the
proposal could violate applicable state and federal privacy
regulations, including the Gramm-Leach-Bliley Act and Regulation S-P,
which are designed to protect the dissemination of non-public customer
personal information.\80\ One commenter
[[Page 17602]]
encouraged FINRA to consider the operational challenges presented by
the proposal, such as non-compete agreements and the prohibitions in
Regulation S-P.\81\
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\72\ Cetera, Janney.
\73\ FSI, Janney, SIPA.
\74\ SIPA.
\75\ Ameriprise, Janney.
\76\ Miami.
\77\ Burns.
\78\ Janney, Miami.
\79\ Sutherland.
\80\ FSI, Janney, Taylor English.
\81\ Sutherland.
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FINRA believes that many of the privacy concerns noted by
commenters are reduced by the proposed rule change that would provide
for simplified and less specific disclosure of recruitment compensation
in ranges. FINRA believes that the proposed disclosure of ranges of
compensation and affirmative cost and portability disclosures,
collectively, strike an appropriate balance to alleviate privacy and
anti-competitive concerns, while providing customers with important
information upon which to base a decision to transfer assets to a new
firm. FINRA does not agree with the commenters that stated that there
is no benefit or significant policy reason to provide recruitment
compensation disclosure to former customers of a transferring
representative. FINRA believes that receiving lucrative financial
incentives that are often based on the amount of assets that will
transfer with a representative to a new firm or the representative's
trailing 12 creates a conflict of interest when a member, directly or
through that representative, attempts to induce the owners of such
assets to transfer them to the new firm. The representative's interest
in receiving recruitment compensation may not align with the customer's
best interest as to where to maintain his or her assets. FINRA believes
that the investor protection benefits of providing this important
information to former customers to inform their decision whether to
transfer assets to their representative's new firm outweigh any
remaining privacy issues that may arise under the proposed rule change.
In addition, FINRA does not agree that the proposal to require
disclosure of ranges of recruitment compensation to former customers
would encourage violations of federal or state privacy regulations
because it does not require the disclosure of any information related
to non-public customer personal information. With respect to
commenters' concerns regarding non-compete agreements and the
prohibitions in Regulation S-P, FINRA notes that the proposed rule
change should not impact any contractual agreement between a
representative and his or her former firm or new firm and does not
require members to disclose information in a manner inconsistent with
Regulation S-P.\82\ The proposed rule change assumes that recruiting
firms and representatives will act in accordance with the contractual
obligations established in employment contracts, state law, and, if
applicable, the Protocol for Broker Recruiting.\83\
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\82\ See 17 CFR 248.15(a)(7)(i).
\83\ The Protocol for Broker Recruiting (the ``Protocol'') was
created in 2004 and permits departing representatives to take
certain limited customer information with them to a new firm, and
solicit those customers at the new firm, without the fear of legal
action by their former employer. The Protocol provides that
representatives of firms that have signed the Protocol can take
client names, addresses, phone numbers, email addresses and account
title information when they change firms, provided they leave a copy
of this information, including account numbers, with their branch
manager when they resign.
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Anti-Competitive Consequences of the Notice Proposal
The Notice Proposal solicited comment on whether the proposal will
affect business practices and competition among firms with respect to
recruiting and compensation practices. Many commenters stated that a
general disclosure is preferable to specific disclosure of recruitment
compensation because specific disclosure may have anti-competitive
consequences.\84\ Two of these commenters noted that the proposal is an
indirect restraint on trade and suppresses fair competition
inconsistent with the requirements of a registered securities
association under the Exchange Act.\85\ Numerous commenters stated that
the proposal may constructively operate as a restrictive covenant not
to compete if representatives are essentially restrained from
transitioning to a new firm because of disclosures that are applicable
only to their industry, which may result in a representative remaining
with a less competitive or unethical firm.\86\ Two commenters noted
that the proposal will dampen innovation and harm customers.\87\ One
commenter cautioned that the proposal could cripple the opportunities
for representatives to merge and consolidate their practices and to be
compensated for their expenses.\88\ Another commenter disagreed and
stated that competition for talented representatives will not be
affected by the proposal.\89\
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\84\ Ameriprise, Cetera, Janney, Lax, Stifel, Sutherland,
Wedbush.
\85\ Cetera, Janney.
\86\ Burns, Burke, Elzweig, Janney, Smith Moore, Steiner,
Stifel, Taylor, Wilson.
\87\ Burns, Elzweig.
\88\ Capstone-AG.
\89\ UBS.
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Three commenters noted that the proposal deepens the regulatory gap
between broker-dealers and registered investment advisers and posited
that it could have the result of driving representatives into the
registered investment adviser business.\90\ One commenter suggested
that FINRA work with the Commission and the states to adopt similar
disclosure requirements for registered investment advisers so that
representatives who switch to an adviser firm will also be subject to
the proposed disclosure requirements.\91\
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\90\ Ameriprise, FSI, Janney.
\91\ WFA.
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FINRA believes that representatives should have the freedom to
transfer firms for any business reason. The proposed rule change is not
designed to obstruct representatives from moving to a situation that
better suits their needs and the needs of their customers. FINRA does
not believe that the proposed rule change will prevent representatives
from transferring firms by simply requiring the disclosure of key
information that a former customer should consider before making a
decision to move his or her assets to a new firm. Further, the proposed
disclosure of recruitment compensation ranges is less intrusive than
the more specific requirements of the Notice Proposal and should cure
many of the concerns that the proposed rule change would be anti-
competitive. Based on consultation with FINRA's advisory committees and
discussions with member firms, FINRA does not anticipate that industry-
wide uniform disclosure of recruitment compensation of $100,000 or more
for each category of recruitment compensation will have the effect of
stalling representatives' movement between firms. With respect to
commenters' concerns regarding the disparate treatment of registered
investment advisers under the proposed rule, FINRA notes that
registered investment advisers are subject to the oversight of the SEC
pursuant to the Investment Advisers Act of 1940 and a disclosure regime
established by the Form ADV (Uniform Application for Investment Adviser
Registration).\92\
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\92\ See Form ADV, Section 2B, Item 5 (Additional Compensation):
``If someone who is not a client provides an economic benefit to the
supervised person for providing advisory services, generally
describe the arrangement. For purposes of this Item, economic
benefits include sales awards and other prizes, but do not include
the supervised person's regular salary. Any bonus that is based, at
least in part, on the number or amount of sales, client referrals,
or new accounts should be considered an economic benefit, but other
regular bonuses should not.''
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Disclosure Is Misleading to Customers Without Context
Two commenters questioned the value of the proposed disclosure
without any context to explain the justification and basis for the
[[Page 17603]]
recruitment compensation arrangement.\93\ Two other commenters stated
that customers may think that the amount is a measure of the new firm's
endorsement of the representative.\94\ Commenters also noted that
customers will not be able to fully understand a recruitment package
without having a full picture of all the factors involved, including,
among other things, the risks and costs of a transition,\95\ personal
reasons for a move,\96\ lost revenues suffered during the transition
and first months at a new firm, and without relative frames of
reference regarding the representative's compensation, such as the size
of the representative's book of business or average annual
revenues.\97\ Other commenters stated that customers are not
experienced enough to know the right questions to ask or the proper due
diligence to perform without context, including, among other things,
that the arrangement may involve minimum customer asset transfer
amounts or minimum revenue amounts attached to asset transfers for
payments to fully vest.\98\ One commenter asked whether the disclosure
may be accompanied by a statement explaining the other factors
considered when making the move to the new firm, such as the
availability of research and market analysis.\99\ Three commenters
noted that there are many reasons why a representative will move firms
so the financial incentives received should not call into question the
motivation behind such a move or serve as an indication that the move
was for any other reason than in the best interest of clients.\100\
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\93\ MarketCounsel, Taylor English.
\94\ Burns, Elzweig.
\95\ Cutter, Smith Moore.
\96\ Noble.
\97\ Bischoff, Burns, Wedbush.
\98\ Capstone-FA, Plexus.
\99\ LaBastille.
\100\ Janney, NAIFA, Summit-B.
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FINRA believes it appropriate to allow a member to provide context
to inform a former customer's decision-making process and enhance his
or her understanding of recruitment compensation arrangements, and
other considerations such as costs, fees and portability issues that
may impact the customer. Therefore, FINRA plans to include on the
FINRA-developed disclosure template a free text section in which a
member or representative may choose to include contextual information
to explain the reasoning and basis for the recruitment compensation
package and information regarding costs, fees and portability issues
that may impact the former customer. FINRA believes that any
information that may clarify the disclosures is appropriate so long as
it is not misleading.
Notice Proposal Is Too Broad
Four commenters suggested that the proposal should exclude
transition assistance designed solely to help offset the costs incurred
by representatives to switch firms.\101\ One commenter requested that
transition assistance associated with loss of insurance renewals due to
vesting restrictions be excluded from the proposed disclosure
requirement.\102\ Two commenters questioned the need for a disclosure
requirement for asset-based recruitment compensation.\103\ One
commenter recommended that FINRA incorporate an exception in the
proposed rule for firms that do not include commission targets as part
of enhanced compensation arrangements.\104\ Some commenters also noted
that the proposal should be narrowed to include only compensation that
presents a material conflict of interest \105\ or FINRA should prohibit
practices deemed to have greater conflicts of interest, e.g., bonuses
tied to commission or revenue goals and enhanced payout
arrangements.\106\ One commenter stated that enhanced compensation
means something different to a wirehouse representative than transition
assistance for a representative in an independent broker-dealer model
who employs a staff, has mortgage payments on leased commercial space,
and may take three or more months to get the business up and
running.\107\
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\101\ Commonwealth, NAIFA, Summit-B, Summit-E.
\102\ Summit-E.
\103\ Burns, Sutherland.
\104\ Summit-E.
\105\ Commonwealth, FORM, Herskovits, Lincoln, LPL, Sutherland.
\106\ Wedbush.
\107\ Ameriprise.
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FINRA believes the proposed rule change to require disclosure of
recruitment compensation ranges beginning at $100,000 as applied
separately to aggregate upfront payments and aggregate potential future
payments would establish a threshold that would exclude many payments
intended only to cover transition assistance, such as relocation and
various overhead costs (e.g., office equipment, new business cards and
letterhead). FINRA believes amounts above that threshold, particularly
those based on a representative's trailing 12, are properly included in
the disclosure requirement, as they are significant enough to bear on
the representative's motivation to move firms and may prompt questions
by former customers based on a review of their account activity. FINRA
also notes that the proposed rule change would permit members to net
out any increased costs incurred directly by the registered person in
connection with transferring to the member in calculating whether a
threshold is met.
With respect to commenters' suggestion that asset-based recruitment
compensation be excluded from the proposed rule change, FINRA does not
agree. FINRA believes that asset-based recruitment packages present the
same level of conflicts of interest when a member or a representative
attempts to induce a former customer to transfer assets to the member
because the representative's interest in asset gathering at the new
firm may not align with the customer's best interest as to where to
maintain those assets. As noted in Item A., most recruitment
compensation packages are based, in part, on a representative's asset
levels at his or her previous firm and members take these numbers into
consideration when calculating recruitment compensation packages with
an understanding that many of the representative's former customers
will follow their representative to a new firm.
De Minimis Exception
The Notice Proposal included an exception to the disclosure
requirement for recruitment compensation of less than $50,000. The
proposal requested comment on whether FINRA should establish an amount
different from the proposed $50,000 for a de minimis exception. One
commenter supported the $50,000 de minimis proposal, asserting that it
was reasonable, would significantly reduce the burden for firms that
pay only true transition assistance, and would allow firms to cover a
representative's out of pocket expenses in many cases without
triggering disclosure.\108\ Several commenters stated that $50,000 is
an arbitrary and nominal threshold.\109\ Some commenters stated that
the proposed de minimis was too low a threshold amount to cover the
substantial costs incurred by representatives who transition
firms.\110\ Two of these commenters suggested that the de minimis
exception should be raised to
[[Page 17604]]
$100,000 or higher.\111\ Other commenters thought the $50,000
disclosure was too high and suggested a $25,000 de minimis
exception.\112\ Others suggested an alternative to the $50,000 de
minimis amount that would require disclosure of any recruitment
compensation that exceeds a certain percentage of the previous 12-month
calendar year commissions.\113\ One commenter asked if FINRA considered
account transfer and registration costs when establishing the de
minimis exception.\114\ A few commenters warned that firms may
restructure arrangements and use the de minimis exception as a means to
avoid disclosure.\115\ Two commenters ask how the de minimis exception
would be calculated in cases of unspecified dollar amounts at the time
of transfer, such as covering transfer costs and deferred
incentives.\116\
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\108\ HDVest.
\109\ Commonwealth, Cutter, FSI, Lax, Smith Moore, Summit-B,
Summit-E.
\110\ Commonwealth, Lax, NAIFA, Wedbush.
\111\ NAIFA, Wedbush.
\112\ PIABA, UBS.
\113\ Commonwealth, Korth, Summit-B, Summit-E.
\114\ Taylor English.
\115\ Lax, Miami, Showalter.
\116\ NAIFA, Taylor English.
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In response to the comments, FINRA revised the proposal to include
an effective de minimis exception for any recruitment compensation in
an amount less than $100,000, as applied separately to aggregate
upfront payments and aggregate potential future payments. In addition,
the proposed rule change permits members to net out from the
calculation of recruitment compensation (and total compensation for
purposes of reporting to FINRA) any increased costs incurred directly
by the representative in connection with transferring to the member.
FINRA believes that the combination of raising the de minimis amount
and allowing firms to net out costs directly incurred by a
representative in a transfer addresses many of the commenters'
concerns.
With respect to the comments regarding how the de minimis exception
would be calculated in cases of unspecified dollar amounts at the time
of transfer, such as covering transfer costs and deferred incentives,
FINRA notes that the proposed rule change includes supplementary
material that clarifies that the member must assume that all
performance-based conditions on the compensation are met and may make
reasonable assumptions about the anticipated gross revenue to which an
increased payout percentage will be applied.
Notice Proposal Should Be Expanded
Numerous commenters questioned why FINRA singled out recruitment
compensation when it is just one piece of a total compensation package
offered by a recruiting firm.\117\ Such commenters noted that isolating
recruitment compensation for inspection by customers is misleading
because it does not present a conflict of interest significantly
greater than other incentives offered in the ordinary course of
business or in the form of retention bonuses and other compensation.
One commenter recommended that firms report to FINRA their recruitment
compensation, retention compensation and other incentives, and FINRA
can determine whether a compensation package is justified.\118\ One
commenter noted that the proposal seemed unnecessarily limited by
excluding such benefits as new territories, new titles, and new high
net worth customers.\119\ Another commenter suggested that FINRA
require disclosure of additional gross compensation paid to the
representative when it is more than 15 percentage points higher than a
representative received at his or her previous firm.\120\
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\117\ BDA, Bischoff, Burke, Burns, Capstone-AG, FORM, FSI,
MarketCounsel, Miami, Lincoln, NAIFA, NASAA, Smith Moore, Steiner,
Taylor English, WFA.
\118\ Smith Moore.
\119\ Plexus.
\120\ Korth.
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One commenter suggested that FINRA consider the fair dealing
obligations of the representative's former firm when communicating with
a representative's clients about staying with the firm because they may
offer financial incentives to retain the accounts.\121\ One commenter
noted that many current employee contracts are full of deterrent and
non-compete provisions that can also be seen as conflicts of
interest.\122\ In addition, one commenter noted that branch managers
may be paid a bonus six to nine months after a representatives departs
a firm based on the amount of assets that did not follow the
representative to his or her new firm.\123\ Another commenter stated
that firms should be required to disclose when they terminate
representative payouts thus incentivizing the representative to look
for new opportunities.\124\
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\121\ WFA.
\122\ Spartan.
\123\ Burns.
\124\ Showalter.
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FINRA understands the commenters' concerns that the proposal does
not require disclosure of retention bonuses and other incentive
compensation to customers. With the proposed rule change, FINRA is
primarily concerned with providing customers impactful information to
consider when deciding whether to transfer assets to a representative's
new firm. Therefore, in response to these comments, FINRA has focused
more narrowly on the costs and conflicts associated with that decision
by a customer. FINRA notes that incentives offered while the
representative is situated at a firm do not implicate the same
considerations, such as transfer costs and portability issues.
However, FINRA is interested in how compensation packages may be
influencing representatives and their sales practice activities, so it
is proposing a requirement that members report to FINRA at the
beginning of the employment or association of a representative that has
former customers if the member reasonably expects the total
compensation paid to the representative by the member during the
representative's first year of employment or association with the
member to result in an increase over the representative's prior year
compensation by the greater of 25% or $100,000. In determining total
compensation, the member must include any aggregate upfront payments,
aggregate potential future payments, increased payout percentages or
other compensation the member reasonably expects to pay the
representative during the first year of employment or association with
the member. FINRA will review the proposed rule within an appropriate
period after its approval and implementation to determine whether it is
achieving its intended purpose and whether it is having unintended
effects. As part of that review, FINRA will determine whether to
eliminate the reporting requirement if the information is not useful,
or expand it to other material increases in compensation, such as
retention bonuses, that may result in increased risk to customers.
One commenter stated that the proposal should more clearly spell
out for customers the practical and personal impacts of the potential
conflicts to permit an informed decision about whether to transfer
assets to the representative's new firm.\125\ Another commenter
suggested that investors should have answers to questions such as
whether: (1) Products and services can be transferred to the new firm;
(2) the investor will have to pay fees to the old or new firm to make a
transition; or (3) the recruitment compensation package involves sales
targets or other
[[Page 17605]]
incentives that may impact their accounts.\126\ The proposed rule
change addresses these comments by requiring disclosure to former
customers if transferring the former customer's assets to the member
will result in costs to the former customer, such as account
termination or account transfer fees from the former customer's current
firm or account opening or maintenance fees at the member, that will
not be reimbursed by the member, and if any of the former customer's
assets are not transferable to the member and that the former customer
may incur costs, including taxes, to liquidate and transfer those
assets to the member or inactivity fees to leave those assets with the
former customer's current firm. In addition, the proposed rule would
require disclosure of the basis of any aggregate upfront payments and
aggregate potential future payments received, or to be received, of at
least $100,000 by the representative. FINRA believes such disclosure
will prompt a dialogue between former customers and their
representatives about the impacts the structure and magnitude of a
recruitment package may have had on their accounts at the previous
firm, and may have on an account at the recruiting firm if the customer
decides to transfer assets.
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\125\ SIFMA.
\126\ Edward Jones.
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Disclosure at First Contact With a Former Customer
The Notice Proposal required disclosure of the details of the
enhanced compensation to be made orally or in writing at the time of
first individualized contact by the member or representative with the
former customer after the representative has terminated his or her
association with the previous firm. If the disclosure was made orally,
the recruiting firm also would have been required to provide the
disclosure in writing to the former customer with the account transfer
approval documentation. When individualized contact with that former
customer had not occurred and the customer sought to transfer an
account from the previous firm to a broker-dealer account assigned to
the representative with the recruiting firm, the recruiting firm also
would have been required to provide the disclosure in writing to the
former customer with the account transfer approval documentation. The
Notice Proposal asked for comment on whether the proposed rule should
require written disclosure at first individualized contact in all
instances, rather than allowing oral disclosure.
Many commenters opposed the proposal to require oral disclosure of
recruitment compensation at the time of first individualized contact by
the member or the representative, contending that such a requirement is
unworkable and would present significant tracking and supervisory
challenges for recruiting firms.\127\ One commenter supported oral
disclosure at first contact in lieu of written disclosure, stating that
written disclosure at first contact is not practical from a business
standpoint, jeopardizes the representative's move to the new firm,
delays the transfer, and is a segmented approach.\128\ Two commenters
requested clarification that the requirement is limited to the initial
contact that relates to the former client's transfer of an account and
not an announcement of the representative's new employment.\129\
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\127\ Advisor Group, Cetera, Cutter, Merrill, Miami, PIABA,
Showalter, Summit-B, Taylor English, WFA.
\128\ Summit-E.
\129\ Ameriprise, Gehring.
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The proposed rule change retains the requirement to provide oral
disclosures to a former customer when a member or representative makes
individualized oral contact to attempt to induce the former customer to
transfer assets to the member. FINRA believes that the administrative
and tracking challenges of oral disclosure asserted by commenters do
not outweigh the value in providing disclosures at the time of first
individualized contact because it is the point at which a customer
begins the decision-making process on whether to follow a
representative to a new firm. FINRA does not believe that setting up
policies and procedures to supervise a registered person's
communications with former customers presents an unreasonable burden to
members. Members already are obligated to supervise representatives'
communications with customers and have flexibility to design their
supervisory systems. FINRA notes that the commenters did not provide
specific data to support their contention that oral disclosure at first
individualized contact would be unworkable for recruiting firms.
Under the proposed rule, FINRA would consider a phone call to a
former customer announcing a representative's new position with the
member to qualify as first individualized contact and an attempt to
induce the former customer to transfer assets to the member even when
the conversation is limited to an announcement. Therefore, the proposed
disclosures must be provided orally during the phone call and must be
followed by written disclosures sent within 10 business days from such
oral contact or with the account transfer approval documentation,
whichever is earlier.
One commenter supported written disclosure at first individualized
contact, noting that disclosure may be overlooked by a customer if
written disclosure is not required until the account transfer
documentation.\130\ Several commenters objected to the proposal to
require written disclosure at first individualized contact, stating
that it is impractical and interferes with the representative's ability
to timely contact customers.\131\ These commenters suggested instead
that written disclosure be required at or prior to account opening
because it gives customers an opportunity to comprehensively review the
disclosure.
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\130\ PIABA.
\131\ Commonwealth, Lax, Merrill, Summit-B, Summit-E, Taylor
English, UBS, WFA.
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The proposed rule change retains the requirement to provide written
disclosures at the time of first individualized contact with a former
customer if such contact is in writing. FINRA believes disclosure at
first individualized contact is more effective than disclosure at or
prior to account opening because customers typically have already made
the decision to transfer assets by that point in the process. FINRA
does not believe that it is particularly burdensome to require members
to include as part of a written communication to former customers a
disclosure form that includes key information for the customer to
consider in making a decision to transfer assets to a new firm. In
addition, FINRA believes that the information required by the proposed
disclosures should be accessible to the recruiting firm and the
representative at the time first contact is made by the recruiting form
or the representative. The proposed rule change provides that a
recruiting firm may rely on the reasonable representations of the
representative, supplemented by the actual knowledge of the recruiting
firm, in determining whether a disclosure must be made to a former
customer. If after considering the representations of the newly hired
representative, the firm cannot make a determination regarding the
portability of a former customer's products, the firm must advise
former customers in the disclosure to ask their current firm whether
any of their securities account assets will not transfer and what
costs, if any, the customers will incur to liquidate and transfer such
assets or
[[Page 17606]]
keep them in an account with their current firm. The firm must further
disclose that nontransferable securities account assets will be
identified to the former customer in writing prior to, or at the time
of, validation of the account transfer instructions.
The Notice Proposal also solicited comment on whether the proposal
should require a representative to disclose specific amounts of
recruitment compensation to any customer individually contacted by the
representative regarding such transfer while the representative is
still at the previous firm. Numerous commenters objected to such a
requirement while the representative is still at the previous
firm,\132\ suggesting that it would be unworkable from an operational
and supervisory standpoint,\133\ unnecessary to fulfill the goals of
the proposal,\134\ would interfere with the representative's ability to
give notice to the firm, and may violate existing statutory or
contractual obligations to the firm.\135\ Based on the comments, FINRA
did not incorporate such a requirement in the proposed rule change.
However, if FINRA finds that representatives are contacting former
customers before association or employment with the new firm as a way
to avoid making the disclosures required by the proposed rule, FINRA
will consider future rulemaking in this area.
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\132\ Advisor Group, Ameriprise, Cetera, Lax, Taylor English,
SIFMA, UBS, Wedbush, WFA.
\133\ Ameriprise, SIFMA.
\134\ Taylor English, WFA.
\135\ Lax.
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One-Year Disclosure Period
The Notice Proposal would have required the proposed disclosure to
former customers for one year following the date the representative
associates with the recruiting firm. The Notice Proposal requested
comment on whether the proposal should apply a different time period.
Commenters had mixed views on the issue. Three commenters supported the
proposed disclosure period of one year following the date the
representative associates with the recruiting firm.\136\ Four
commenters recommended that the disclosures should apply for the period
that the representative is receiving enhanced compensation.\137\ Two
commenters recommended a disclosure period of 90 days from the date the
representative associates with the new firm \138\ and one commenter
recommended 90 to 180 days from such date.\139\ One commenter suggested
a disclosure period of six months to one year from the date of hire
because most representatives contact their clients within the first six
months of employment.\140\ Another commenter stated that the one-year
time period is arbitrary and seems extensive based on typical transfer
time.\141\
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\136\ Summit-B, UBS, WFA.
\137\ Cornell, Miami, PIABA, Ruchin.
\138\ Commonwealth, Sutherland.
\139\ Summit-E.
\140\ Wedbush.
\141\ Cutter.
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The proposed rule change retains the proposed requirement for
disclosure to former customers for a period of one year following the
date the representative begins employment or associates with a member.
As noted in Item B., FINRA understands that most customers who transfer
assets to the recruiting firm do so soon after the representative
changes firms so the one-year period should be sufficient to ensure
that virtually all former customers that the recruiting firm or
representative attempt to induce to transfer assets to the recruiting
firm receive the disclosure. FINRA is not proposing a shorter time
period for the proposed disclosures because it also understands it may
take some former customers longer to make a determination to transfer
assets to the representative's new firm, particularly if such customer
is initially hesitant about transferring assets to the new firm. FINRA
believes the disclosure information is equally relevant for customers
that wait some time to consider transferring assets to the new firm and
that one year is a reasonable cutoff. FINRA believes the burden of
compliance should diminish over the year period, consistent with early
efforts to induce former customers to transfer their assets.
Who Should Receive Disclosure
The Notice Proposal would have required disclosure to any former
customer with an account assigned to the representative at the previous
firm who is individually contacted by the recruiting firm or
representative, either orally or in writing, regarding the transfer of
the securities employment (or association) of the representative to the
recruiting firm; or seeks to transfer an account from the previous firm
to a broker-dealer account assigned to the representative with the
recruiting firm. The Notice Proposal requested comment on whether the
proposal should apply to all customers recruited by the transferring
representative during the year after transfer. FINRA also asked for
comment on whether it should apply to any new broker-dealer account
assigned to the representative with the recruiting firm opened by a
former customer of the representative in addition to accounts
transferring from the previous firm.
Commenters were split on who should receive the proposed disclosure
of specific compensation. One set of commenters suggested that the
proposal should focus on the conflict that exists when a representative
asks a former customer to move to the recruiting firm, so only former
customers should receive the disclosure.\142\ Another set of commenters
stated that all clients, including new clients at the recruiting firm,
should receive the proposed disclosure.\143\ One commenter stated that
the proposal should be expanded beyond retail customers to include
institutional customers, because their asset levels make them
particularly susceptible to misconduct aimed at increasing a
representative's production.\144\
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\142\ Commonwealth, Cutter, NAIFA, Summit-B, Summit-E,
Sutherland, UBS.
\143\ Cornell, Miami, PIABA, Ruchin.
\144\ Miami.
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The proposed rule change would apply to customers that meet the
definition of a ``former customer'' under the proposed rule. This would
include any customer that had a securities account assigned to a
representative at the representative's previous firm and would not
include a customer account that meets the definition of an
institutional account pursuant to FINRA Rule 4512(c); provided,
however, accounts held by any natural person would not qualify for the
``institutional account'' exception. FINRA agrees with the commenters
that suggested that the proposed rule change should address the
conflict that exists when a representative attempts to induce a former
customer to move assets to the recruiting firm. FINRA believes that
former customers that a member or representative attempts to induce to
transfer assets to a new firm are most vulnerable in recruitment
situations because they have already developed a trusting relationship
with the representative and because their assets may be both the basis
for the representative's recruitment compensation (if the
representative's upfront payments and potential future payments are
asset-based or production-based) and subject to potential costs and
changes if the customer decides to move those assets to the recruiting
firm. FINRA did not extend the application of the proposed rule to non-
natural person institutional accounts because it believes that such
accounts are more sophisticated in their dealings with
[[Page 17607]]
representatives and that the proposed disclosure would not have as
significant an impact on their decision whether to transfer assets to a
new firm.
Customer Affirmation
The Notice Proposal also requested comment on whether the proposed
rule should include a requirement that a customer affirm receipt of the
disclosure regarding recruitment compensation at or before account
opening at the new firm. FINRA was interested, in particular, in the
potential for such a requirement to delay the account opening process
in a manner that could disadvantage customers. A majority of the
commenters that responded to this request opposed a customer
affirmation requirement because it would cause delays in the account
opening and transfer process, create an additional layer of tracking,
review and approval to members' operations, may disadvantage clients,
and would impose costs and an undue burden on members.\145\ Two
commenters supported a requirement for written customer affirmation and
suggested using a standard form in the new account paperwork that would
not be overly burdensome to members.\146\
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\145\ Cetera, Janney, NAIFA, Taylor English, Wedbush.
\146\ Cornell, Summit-E.
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The proposed rule change does not incorporate a written customer
affirmation requirement. FINRA believes that the requirements to
provide disclosure at the time of first individualized contact with a
former customer, to follow up in writing if such contact is oral, and
to deliver the disclosures with the account transfer approval
documentation when no individual contact is made, will ensure that
former customers receive and have an opportunity to review the proposed
disclosure before they decide to transfer assets to a new firm. At this
time, FINRA does not believe that a customer affirmation is necessary
to accomplish the goals of the proposed rule change, especially in
light of commenters' concerns that such a requirement may delay the
account opening and transfer process. FINRA will assess the
effectiveness of the disclosure requirement without a customer
affirmation requirement following implementation of the proposed rule.
If FINRA finds that the proposed disclosures alone are not attracting
the attention of customers to influence their decision-making process,
then it will reconsider a customer affirmation requirement.
Economic Impacts of the Notice Proposal
The Notice Proposal requested comments on the economic impact and
expected beneficial results of the proposed rule. Specifically, FINRA
asked for comment on what direct costs for the recruiting firm will
result from the rule, and what indirect costs will arise for the
recruiting firm or its transferring persons. Three commenters stated
that the proposal will generate significant administrative challenges
and implementation costs for firms and representatives, including
additional paperwork and forms, tracking mechanisms, training, and new
policies and procedures.\147\ Two commenters stated that there will be
initial implementation costs, but they are warranted to elevate
industry standards and provide better information to clients before
they transfer their accounts to a new firm.\148\ One commenter stated
that the disclosure can be included with new account documentation so
it will not delay the account transfer process or impose significant
costs on firms.\149\ One commenter suggested that FINRA should conduct
a cost-benefit analysis of the proposal that assesses the impact not
only on customers, but also the attendant impact on representatives,
firms, and restraints on trade.\150\ Two commenters asked whether the
proposal would include an obligation to disclose modifications to
recruitment compensation packages with an updated disclosure to former
customers who have already transferred assets to the recruiting
firm.\151\
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\147\ Advisor Group, Summit-E, Sutherland.
\148\ Edward Jones, UBS.
\149\ Cornell.
\150\ Janney.
\151\ Cetera, Taylor English.
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Despite a request for quantitative comments, the commenters that
stated that the proposal will generate significant administrative
challenges and implementation costs did not provide specific costs or
empirical data upon which to base their assertions. FINRA has given
careful consideration to the economic impacts of the proposed rule
change. It has considered the comments to the Notice Proposal, as well
as feedback from its advisory committees, other industry members and
the public. Based on the input received, FINRA does not believe that
the proposed rule change will result in unsupportable administrative
and implementation challenges for members. As with most rule changes,
the proposed rule change would likely require updates to members'
systems and procedures; however, FINRA believes the burden of such
updates are outweighed by the significant benefit to retail investors
in receiving key information relevant to a decision to transfer their
assets to a new firm and the benefit to FINRA's risk-based examination
process by receiving information related to significant increases in a
representative's compensation in the first year at a recruiting firm.
As discussed in Item B., FINRA has made several changes to the
Notice Proposal that will assist members and reduce the burdens of
compliance: Among other things, the proposed rule change includes a
$100,000 de minimis exception that applies separately to aggregate
upfront payments and aggregate potential future payments, allows
members to net out costs paid to a representative as reimbursement for
direct costs incurred by a representative in a move, includes a FINRA-
developed disclosure template, and allows disclosure of recruitment
compensation ranges instead of specific amounts to protect the privacy
of transferring representatives. In addition, members may rely on the
reasonable representations of a representative regarding the cost and
portability disclosures and, although such disclosures must be
affirmative as they relate to each former customer's assets, the
disclosures do not have to be specific as to the amount of costs or
products that will not transfer.
With respect to the commenters' question regarding disclosure of
modifications to a representative's recruitment compensation package,
FINRA is not aware that recruitment packages typically are modified
after a recruited representative has associated with the recruiting
firm. To the extent that practice occurs and is not designed to
circumvent the requirements of the proposed rule, the proposed rule
change would not require any such modifications to be disclosed to
customers that have already transferred their accounts. FINRA notes
that the proposed rule is focused on a former customer's decision to
transfer assets to the recruiting firm. A modification to the
recruitment package cannot affect the decisions of customers that have
already transferred assets (unless they have additional assets that
could still be transferred). However, FINRA cautions that any aspects
of the recruitment package that were agreed upon prior to the
representative associating with the recruiting firm--including any
modifications that would take effect at a later date--would be
considered either upfront or potential future payments for
[[Page 17608]]
the purposes of the disclosure obligation.
Small Firms Concerns
The Notice Proposal solicited comment on whether the impacts of the
proposal with respect to changes in business practices and recruiting
efforts differentially will affect small or specialized broker-dealers.
Six commenters stated that compliance with the proposal will be more
difficult for small firms with limited operational resources and
supervisory personnel and will make recruiting efforts more
challenging.\152\
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\152\ Cetera, Gompert, Janney, Plexus, Summit-E, Whitehall.
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In crafting the proposed rule change, FINRA considered its
potential impacts on small firms and specialized broker-dealers. The
proposed rule change provides for disclosure of recruitment
compensation in ranges only for amounts of $100,000 or more, as applied
to two separate categories of recruitment compensation. Based on input
from members, including independent broker-dealers and small firms,
FINRA believes that the $100,000 thresholds as applied separately to
aggregate upfront payments and aggregate potential future payments for
purposes of disclosure to former customers and the greater of 25% or
$100,000 over the representative's prior year's compensation for
purposes of reporting total compensation to FINRA will exclude most
small firms and specialized broker-dealers from the proposed rule
because such firms are not likely to offer recruitment compensation or
total compensation packages that meet the proposed thresholds,
particularly when, as permitted under the proposed rule, direct costs
incurred by the representative in connection with the transfer are
netted out from the calculation.\153\ FINRA believes that, to the
extent that a small firm or specialized broker-dealer does pay the
significant levels of recruitment compensation captured by the proposed
rule change, their customers should similarly be provided the
disclosure that will facilitate an informed decision as to whether to
transfer assets to the representative's new firm. FINRA also is
proposing disclosure to former customers via a FINRA-developed template
that would save all members, small and large, from the resources,
administration and costs related to developing a disclosure form that
would meet the requirements of the proposed rule.
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\153\ See proposed FINRA Rule 2243.04.
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Alternatives Suggested
One commenter recommended that FINRA adopt a rule that would
prohibit recruitment compensation over $100,000 to level the recruiting
playing field among all members and eliminate potential or perceived
conflicts of interest.\154\ Another commenter suggested that the
disclosure should be given by the firm the representative is leaving
and should be provided to all clients of the departing representative
at the time of his or her resignation.\155\ A few commenters believed
that placing the burden on firms to enhance their supervisory structure
and develop comprehensive policies and procedures related to conflicts
identification and disclosure would better serve the industry and
investors.\156\ One commenter suggested that FINRA allow members to
make their own business decisions and determine what is competitive and
profitable for them regarding recruitment practices.\157\ Another
commenter suggested amending the proposal to require the member to
disclose compensation paid by its non-member affiliates to a
transferring representative to avoid a loophole for dual-hatted
representatives.\158\ One commenter asked FINRA to evaluate whether the
proposed rule should apply to all client-facing professionals
(investment bankers, institutional sales representatives, financial
planners, sales traders) who receive recruitment compensation.\159\ Two
commenters stated that recruiting firms should be required to send
clients a FINRA-drafted pamphlet that flags issues related to
transitions, so clients can make their own determination as to what
information they consider important in evaluating whether they should
follow their representative to a new firm.\160\
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\154\ Wedbush.
\155\ Oppenheimer.
\156\ FSI, Janney, NASAA.
\157\ Midwestern.
\158\ Gehring.
\159\ Janney.
\160\ Burns, Miami.
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As detailed in Item B., FINRA has considered numerous alternatives
suggested by the commenters to the Notice Proposal but believes that
the proposed rule change strikes an appropriate balance to increase
transparency with respect to recruitment practices without creating
unnecessary costs or burdens on members and their representatives. As
to these commenters' suggestions, FINRA does not believe it appropriate
to regulate the amount of recruitment compensation paid to
representatives; rather, the proposed rule change seeks to provide
disclosure related to compensation incentives to the extent it may
impact a retail investor's decision whether to follow his or her
representative to a new firm. FINRA believes the recruiting firm that
is paying representatives recruitment compensation in amounts that meet
the proposed thresholds is in the best position to provide the required
disclosures. FINRA encouraged members in its Report on Conflicts of
Interest to enhance their supervision of representative's activity
around the time of compensation thresholds; \161\ however, the primary
focus of the proposed rule change is to provide retail investors with
important cost information and transparency of conflicts related to the
decision whether to transfer assets to a representative's new firm.
FINRA also notes that the proposed rule change would require disclosure
of recruitment compensation paid by non-member affiliates to the extent
those amounts, when combined with any recruitment compensation paid by
the recruiting member, exceed the $100,000 thresholds for each category
of recruitment compensation. The proposed rule change would apply to
recruitment compensation paid to any registered person; however, FINRA
notes that investment bankers and other types of registered persons not
involved in retail sales are unlikely to have retail customers whose
assets might be induced to transfer.
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\161\ Report on Conflicts of Interest, FINRA, October 2013,
available at, http://www.finra.org/web/groups/industry/@ip/@reg/@guide/documents/industry/p359971.pdf.
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Finally, FINRA believes the more specific disclosure that would be
required under the proposed rule change will appreciably benefit retail
customers more than a general pamphlet that sets out considerations
without providing the actual information related to those
considerations. FINRA will continue to evaluate alternatives based on
the comments received on the revised proposal.
Implementation and Requests To Delay Rulemaking
Some commenters expressed concerns regarding the implementation of
the proposal. Five commenters noted that due to the nature of some
enhanced compensation arrangements (e.g., deferred incentives or
modifications to a package) it will be difficult to calculate dollar
amounts at the time of transfer.\162\ Two commenters requested guidance
on how recruitment
[[Page 17609]]
compensation should be calculated and disclosed, by group or
individual, where bonuses are given to a group of brokers and
assistants who move to a new firm together.\163\ One commenter
requested that FINRA allow adequate time for implementation.\164\
Another commenter suggested limiting the application of the rule to
those hired after the rule goes into effect.\165\
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\162\ Ameriprise, NAIFA, Summit-B, Sutherland, Taylor English.
\163\ Cetera, LaBastille.
\164\ Advisor Group.
\165\ Gehring.
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One commenter suggested that it would be prudent for FINRA to
assemble a working group to collect qualitative information related to
the use of recruitment compensation in the industry to make a well-
informed decision about how best to proceed in order to achieve its
intended goals.\166\ One commenter noted that the proposal should
consider FINRA's proposal in Regulatory Notice 10-54 (Disclosure of
Services, Conflicts and Duties) and Section 919 of the Dodd-Frank
Act,\167\ which grants permissive authority to the SEC to engage in
rulemaking with respect to compensation practices, because a
comprehensive review of the required disclosure regime for broker-
dealers would result in a more thoughtful, consistent and effective set
of disclosures that would be most likely to benefit investors.\168\
Another commenter suggested that FINRA integrate the proposal with the
pre-engagement disclosures contemplated in Regulatory Notice 10-
54.\169\ Two commenters recommended that FINRA delay further regulatory
action until the conflicts initiative is completed.\170\ Finally, one
commenter noted that FINRA should do a global conflicts assessment not
limited to this isolated and singular conflict.\171\
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\166\ FSI.
\167\ Dodd-Frank Wall Street Reform and Consumer Protection Act,
Pub. L. No. 111-203, 124 Stat. 1376 (2010).
\168\ Sutherland.
\169\ FSI.
\170\ Advisor Group, FSI.
\171\ Janney.
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FINRA believes that members are in a position to calculate
recruitment compensation for purposes of the proposed disclosure
requirement at the time a representative or the member attempts to
induce a former customer of the representative to transfer assets to
the representatives' new firm. FINRA notes that the representative will
already be associated with or employed by the member, so all
compensation arrangements between the representative and the member
should be clear and agreed to by all parties. The proposed rule change
also provides guidance with respect to calculating recruitment
compensation and total compensation for the purpose of the proposed
disclosure and reporting requirements, respectively: members must
assume that all performance-based conditions on the representative's
compensation are met, may make reasonable assumptions about the
anticipated gross revenue to which an increased payout percentage will
be applied and may net out any increased costs incurred directly by the
registered person in connection with transferring to the member. With
respect to a transfer of a group, or team, of representatives and
staff, FINRA believes that members can make a reasonable determination
regarding the application of recruitment compensation to each
individual that transferred to the firm to make the required
disclosures. FINRA will consider further guidance regarding application
of the proposed rule change as issues arise.
FINRA understands the commenters' suggestions to delay rulemaking
and incorporate the proposed rule change into other ongoing efforts
related to conflicts of interest. However, FINRA believes that the
proposed rule change should move forward at this time, as it is
narrowly focused on a retail investor's important decision whether to
transfer assets to a new firm, rather than conflicts associated with
compensation practices more broadly. FINRA believes that former
customers should begin receiving the proposed disclosures as soon as
practicable so that they are fully informed before making a decision to
transfer assets to a representative's new firm. FINRA will consider how
the proposed rule change fits within the larger scheme of conflicts of
interest regulations as the timetables on such other proposals
progress. In addition, FINRA will establish a reasonable implementation
period for the proposed rule change to provide members with sufficient
time to update their internal systems and policies.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) By order approve or disapprove such proposed rule change, or
(B) institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml ); or
Send an email to [email protected]. Please include
File Number SR-FINRA-2014-010 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE., Washington, DC 20549-1090.
All submissions should refer to File Number SR-FINRA-2014-010. This
file number should be included on the subject line if email is used. To
help the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml
). Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for Web site viewing and printing in
the Commission's Public Reference Room, 100 F Street NE., Washington,
DC 20549, on official business days between the hours of 10:00 a.m. and
3:00 p.m. Copies of such filing also will be available for inspection
and copying at the principal office of FINRA. All comments received
will be posted without change; the Commission does not edit personal
identifying information from submissions. You should submit only
information that you wish to make available publicly. All submissions
should refer to File Number SR-FINRA-2014-010 and should be submitted
on or before April 18, 2014.
[[Page 17610]]
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\172\
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\172\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-06895 Filed 3-27-14; 8:45 am]
BILLING CODE 8011-01-P