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Recruitment of New Rep Disclosure – New FINRA Rule 2273 for Customer Notice Requirement (Includes a brief addendum regarding the Recruitment Compensation Disclosure Requirement under the new DOL Fiduciary Rule)

 

Background

On March 23, 2016, the SEC approved new FINRA Rule 2273, which establishes an obligation for a member firm to deliver to certain retail customers an educational communication in connection with newly recruited reps soliciting or encouraging their former customers to transfer their accounts to the new firm. FINRA hasn’t announced an effective date yet, but we are expecting it sometime between now and late September of this year.

While not an earthshaking new rule, it will require some planning and thought as firms will be required update their policies, procedures, and supervisory systems to ensure delivery of a FINRA-produced educational communication (Notice) to former customers of transferring reps who are encouraged or solicited by their reps to transfer their accounts to the new firm. Former customers are defined as any retail customer that had a securities or investment advisory account assigned to a rep at the rep’s former firm. Institutional accounts are excluded, except when such accounts are held by a natural person.  Additionally, Rule 2273 would not apply if the rep transferred to a non-member firm (e.g., an investment adviser or a bank) or associated with a member firm solely as an investment adviser representative.

Since the Notice is a FINRA-produced communication, firms have no flexibility (or responsibility) for the content of the Notice to be provided to such potential new customers. FINRA tells us that the as-yet-to-be-produced Notice is meant to highlight the potential implications of transferring assets to the recruiting firm, as well as to suggest specific questions the customer may want ask in order to make an informed decision whether to transfer his or her account or remain with the current firm.  Specifically, the Notice is intended to highlight these four areas:

1) The role that possible conflicts of interest may have between the rep and the customer moving to the new firm in light of any financial incentives (i.e., recruitment bonuses or enhanced payout rates) the rep received for changing firms.

 2) The costs to customers for assets not directly transferrable to the new firm or that may be incurred to liquidate and move those assets; whether the customer will otherwise incur inactivity fees to leave the assets with the current firm;

 3) Other potential costs related to transferring assets to the new firm, including potential taxes, as well as differences in the pricing structure and fees imposed between the customer’s current firm and the new firm;

4) Differences in products and services between the customer’s current firm and the new firm.

Delivery Notice Triggers and Methods of Delivery

The rule requires the delivery of the Notice at or shortly after the time of first contact. This means that if the first contact is in writing via email or snail mail, the Notice must accompany the written communication.  However, if the first contact is via email or another electronic means, the new firm must at least provide a hyperlink directly to the Notice with a brief message as to why it’s included.  If the first contact is orally by phone or in person, either the new firm or the rep must send it no later than three business days after the initial contact or with any other communication sent by the new firm to the rep’s former customer in connection with a potential transfer of assets, whichever is sooner.  Additionally, when contact is made orally, the rep or the firm has to inform the former customer that he or she will be receiving the Notice and that the Notice contains important considerations for determining whether to transfer assets to the rep’s new firm.

In situations where a former client initiates contact with the new firm without a first contact by the rep or the new firm, Notice must still be provided, though in those circumstances, it can be provided with the account transfer approval documentation.

Time Limit and Exception

The Notice delivery requirement continues for three months following the date that the rep begins employment or otherwise associates with the new firm. The only exception to not delivering the Notice is when the rep initiates contact to move the account and the former client indicates no interest in moving. However, if the former client has a change of heart, then the Notice must be delivered if it’s within the three-month time limit.

Supervision

As with any other public communications, the delivery of the Notice will require amending written supervisory procedures to ensure that the Notice and the delivery requirements come within the purview of the firm’s supervisory system. While FINRA has not specified supervisory procedures to be implemented, they do expect that members can implement a system reasonably designed to achieve compliance with the delivery requirements through training, spot checks, certifications, logs, or other measures.

***DOL’s New Requirement to Disclose Recruitment Bonuses Paid to Brokers***

The prior proposal for FINRA Rule 2273 required a recruiting member firm to disclose to previous customers the ranges of recruitment compensation that their rep received or would have received in connection with changing firms and the basis for the compensation (i.e., asset-based or production-based). FINRA withdrew that component in the final rule.  However, for broker-dealers who wish to continue to provide commission-based services to ERISA Plans and IRA accounts, the Department of Labor’s new Fiduciary Rule has a provision under its Best Interest Contract exemption (BIC) that will require such firms to disclose and post on their websites recruitment bonuses paid to reps along with the rep’s compensation grid.  Additionally, the compensation grid disclosure will be required for all reps doing ERISA and IRA business, not just the recruited reps.

While not yet in effect, the new DOL rule is complex and has unresolved questions such as when does the payment of a recruitment bonus require compliance with the BIC exemption and how does one comply with regard to past transactions? We’ll post more about this in the future. In the interim, if you have any questions or need help with designing your supervisory system to comply with the new FINRA rule, don’t hesitate to contact me at 616-752-2526 or ddawe@wnj.com.