Two years ago, FINRA first proposed to the SEC a rule that would require brokers to disclose to clients not only when they receive compensation (including signing bonuses and other payments) to switch from one broker-dealer to another, but, worse, the amount of that compensation. The industry was seriously not pleased with the rule.  FINRA, for a change, capitulated to the pressure, and withdrew its rule proposal a few months later, in June 2014.  But, FINRA was dogged, and rather than abandoning the notion, it continued to tinker with the rule.  In May 2015, FINRA circulated the revised rule – Conduct Rule 2272 – and, ultimately, submitted it to the SEC. A week or so ago, the SEC approved the revised rule. Here’s what you need to know to impress your friends who are tired of discussing the election or the tragic loss suffered by the Tar Heels in the Final Four or Jordan Spieth’s meltdown on the 12th hole (bearing in mind that the effective date of the new rule’s implementation has not yet been established).

The initial rule FINRA proposed had two key components when a rep received at least $100,000 as inducement to change from BD A to BD B: (1) the requirement to disclose the compensation (in dollar ranges) to former BD A retail customers who BD B recruited to follow the rep and transfer their accounts; and (2) an obligation to report the compensation to FINRA. The disclosure obligation also required that the rep disclose the basis for that compensation (e.g., asset-based or production-based), and if a former BD A customer would incur costs to transfer assets to BD B that would not be reimbursed by BD B. The initial proposal would have required disclosure for one year following the date the rep moved to BD B.

In the face of loud and widespread criticism from the industry, the revised proposal ditched a lot of the original requirements, including, most notably, the need to tell a customer how big a signing bonus a rep got to switch firms. Instead, it substituted the much more benign requirement merely to give customers an “educational communication” – drafted by FINRA – on the implications of moving from BD A to BD B. The communication would need to be provided at the time of, or shortly after, BD B reaches out to the client, vice versa, about transferring his or her assets.  Information to be communicated to the customer is intended to suggest to the customers issues they may want addressed about the requested transfer:

  • whether financial incentives received by the rep may create a conflict of interest;
  • whether there are assets that may not be directly transferrable to BD B, which, as a result, the customer may incur costs to liquidate and move those assets or inactivity fees to leave them with BD A;
  • potential costs related to transferring assets to BD B, including differences in the pricing structure and fees imposed between BD A and BD B; and
  • differences in products and services between BD A and BD B.

In addition, the duty to notify FINRA was eliminated, and the length of time BD B would need to provide this communication was cut in half, down to six months from the rep’s transfer.

This watered down version of the initial rule is what the SEC approved, with the following general comment:

The Commission believes that the proposed rule change would increase the information available to investors regarding the potential implications of transferring assets. The Commission further believes that the proposed educational communication may encourage former customers to make inquiries of their representatives, which could increase communication between customers and representatives about the potential implications of transferring assets.  The Commission believes that the increase in information and communication about the potential implications of transferring assets will benefit customers when deciding whether to transfer assets.

I can’t really argue with any these points. Sure, this “educational communication” may cause some customers to think about why their rep moved firms, and whether compensation was part of the reason.  And some of those customers may actually choose to engage in a dialogue about broker compensation, or fees and costs that the new BD may impose.  Not a bad thing, under any circumstance.

So, on balance, I am ok with this new rule, and, really, here’s why: I am in favor of any rule that largely puts the burden on the customer actually to take affirmative steps to protect him- or herself. There are tons of existing rules and regulations and statutes that are disclosure based, i.e., they require reps to make all sorts of disclosures to their firm, to FINRA, to their customers.  Indeed, the very heart of securities regulation in America is based on disclosure: if you fairly disclose the potential risks and rewards of an investment, and only sell it to people for whom it is suitable, you can, by and large, sell (or attempt to sell, anyway) any piece of crap you want.

The problem is that in reality, even when a rep (or a firm) makes all the required disclosures, the regulators regularly still find fault with the investment, or the manner in which it was sold.  You have read prospectuses and private placement memoranda: they contain pages and pages of risk disclosures.  I saw a four-page advertising slick for an investment the other day that had more verbiage in the fine print on the final page than in the other three pages combined.  Forms ADV, U-4 and BD disclose all sorts of potentially scary disciplinary history.  Customer account agreements have grown to monsters, with pages and pages of small print disclosures about risks, costs, etc.  Yet, because no customer bothers to read these things, despite their legal obligation to do so, BDs, IAs, and reps continue to pay the price.

If this rule truly shifts the burden to customers actually to read this disclosure, and then to follow up by asking questions that they may (or may not) have, as opposed simply to requiring that firms dump more, and more detailed, disclosures on them, I, for one, am a strong supporter.  It is about time that the regulators have acknowledged that customers have a duty to exercise their own due diligence when it comes to their accounts and their money.