The Financial Industry Regulatory Authority (FINRA) filed its broker recruitment-disclosure rule (Rule 2273) with the Securities and Exchange Commission (SEC )on December 16, 2015. Rule 2273 requires brokers to deliver a FINRA-created “educational communication” to former customers when the broker is contacting the customer to try to bring the former customer to the broker’s new firm. Rule 2273 is a revised version of the rule which FINRA originally filed on March 10, 2014 (Rule 2243) and withdrew in June 2014. The past version required brokers to disclose to former customers detailed information about the broker’s compensation, including any bonuses for recruiting the former customer.
What Does the Rule Do?
Rule 2273 would require brokers to send a FINRA-created “educational communication” to former customers when attempting to recruit former customers to transfer their accounts to the broker’s new firm or when a former customer transfers his or her account to the broker’s new firm without the broker contacting the customer.
What Problem is FINRA Trying to Solve with this Rule?
When a broker leaves his or her firm, the broker often contacts former customers and encourages them to bring their accounts to the broker’s new firm. FINRA is concerned that the broker’s former customers may be only considering their relationship with the broker, at the exclusion of other important factors, when making their decision to transfer their accounts. FINRA believes that brokers are not motivated to disclose any less-than-sunny effects of a customer transferring his or her account when recruiting the customer to come to the new firm. To remedy this, Rule 2273 would require the broker to deliver a FINRA-created “educational communication” to the former customer. The educational communication highlights key factors the customer should consider when deciding whether to transfer their assets.
What Information Does the Required Disclosure Contain?
The education communication encourages investors to consider the following factors:
(1) Whether the broker has any financial incentives for recruiting the former customer that present a conflict-of-interest;
(2) The cost involved in transferring assets that are not directly transferable;
(3) Potential costs in transferring accounts, including price differences between the client’s current firm and the new firm; and
(4) The differences in services provided by the client’s current firm and the new firm.
FINRA hopes that the educational communication will encourage former customers to ask the broker more probing questions.
What Must a Broker Do to Comply With the Rule?
For a period of three months after a broker moves to a new firm, Rule 2273 requires the broker to deliver the educational communication to former customers when:
(1) The broker individually contacts the former customer to recruit him or her to transfer assets to the new firm; or
(2) The former customer, without being individually contacted by the broker, transfers his or her assets to an account at the broker’s new firm.
If the individualized contact is in writing, the broker must include the educational communication.
If the individualized contact is oral, the broker must orally explain to the customer that he will be providing an educational communication by mail or electronically. The broker must then provide the educational communication within three business days of the conversation.
If the former customer contacts the broker first, the broker must still deliver the educational communication with the customer’s account transfer documents.
Exemptions to Rule 2273
The rule exempts brokers from delivering the educational communication when a customer’s account is moved en masse with other customer accounts as a result of a merger or acquisition. The rule also exempts a broker from the delivery requirement if the only change is the broker of record (meaning there as been no transfer of the customer’s assets).
Concerns with the Rule
The Financial Cost of Compliance
Rule 2273 presents brokers and firms with yet another communication requirement. Like other SEC regulations, Rule 2273 requires brokers and firms to swallow the cost of sending the educational communication to customers. Fortunately, the educational communication can be send electronically.
Firms will need to establish procedures to ensure that they stay in compliance with Rule 2273, which requires time and resources. Firms will need to track whether and when former customers have been contacted and whether the delivery of the educational communication is needed. The cost of ensuring that the firm is in compliance will depend on the size and organization of the firm.
Discerning when the Obligation to Deliver is Triggered
The first scenario where the broker’s obligation to deliver the educational communication is triggered is when the broker individually contacts the former customer about transferring assets. There is industry concern that this requirement will be difficult to comply with because brokers who use representatives would need to rely on the representatives to report contacts with former customers. There is also industry concern that there may be scenarios where a customer transfers their assets without or prior to individualized contact by the broker – making it unclear whether or not the broker has an obligation to send the educational communication.
Rule 2273’s Interaction with Regulation S-P
There is industry concern that the educational communication will prompt customers to ask representatives questions that the representative will be unable to answer because Regulation S-P or other privacy agreements limit the representative’s ability to access the customer’s information. FINRA has stated that in such a situation, FINRA expects the representative to explain the situation to the customer. FINRA’s position is that Rule 2273 should have no effect on compliance with Regulation S-P or other privacy agreements.
Rule 2273 is an improvement on its initial form as proposed as Rule 2243 in March 2014, which required significant detailed disclosures by brokers of their financial interests in the recruitment of customers. Rule 2273 provides a succinct and simple educational piece to investors. However, the very succinct and simple nature of the educational communication raises the question of its necessity. FINRA does not give a lot of credit to the intelligence of investors or to the merits of the broker-investor relationship.
The factors noted in the educational communication are laughably basic. What investor does not consider and compare costs of the new firm when thinking of transferring his or her account? What investor does not realize there may be differences in services from firm to firm? What investor believes that a broker is entirely without financial incentives when trying to recruit his or her account to the new firm?
In a quality broker-investor relationship, the investor should expect the broker to act in the investor’s best interest and should be comfortable with asking the broker questions about the change in firms. Moreover, the broker is incentivized to make the customer aware of any negative effects of transferring because of the value the broker places in retaining the customer’s business.
FINRA should ask itself, is this statement-of-the-obvious that is the educational communication really worth the months of time, the cost of promulgation, and the use of the SEC’s and FINRA’s resources? FINRA should be a regulatory body, not an overprotective smothering parent to investors.
The opportunity for the public to comment on Rule 2273 closed on January 20, 2016. The SEC has an initial deadline of until March 8, 2016 to approve or disapprove the rule. The SEC may use its discretion to extend its deadline to approve or disapprove to April 27, 2016. If the SEC approves the rule, it will become effective within 180 days of the approval.
Sarah Holm, a law clerk at the Minneapolis office of Foley & Mansfield, is a student at Mitchell Hamline School of Law and is a managing editor of the Mitchell Hamline Law Review. She can be reached via E-mail at firstname.lastname@example.org.