On June 17, 2009, as part of the ongoing process to develop a consolidated FINRA rulebook, FINRA proposed new FINRA Rule 2341 (the “Proposed Rule”) regarding the distribution and sale of investment company securities.1 The Proposed Rule is largely based on current NASD Rule 2830 (“Rule 2830”), but includes four key changes. It would

  • require firms to make new disclosures to investors regarding the receipt of cash compensation;
  • make minor changes to the record keeping requirements for non-cash compensation;
  • eliminate a condition regarding discounted sales of investment company securities to dealers; and
  • codify past FINRA staff interpretations regarding purchases and sales of exchange-traded funds (ETFs).

These changes are discussed in greater detail below.

Comments on the Proposed Rule must be received by FINRA on or before August 3, 2009.

Proposed Changes to the Cash Compensation Provisions

Rule 2830 governs the payment and acceptance of cash and non-cash compensation in connection with the sale of investment company securities, and generally requires the disclosure of such payments. The Proposed Rule modifies the existing disclosures for cash compensation as follows:

  • It requires that standard “sales charges and service fees,” rather than all cash compensation, be described in the prospectus.
  • It eliminates the term “special cash compensation” and instead requires prospectus disclosure if a member firm receives greater (or special) sales charges or service fees than are ordinarily paid in connection with sales of fund shares, while other types of cash compensation, such as revenue-sharing payments, would not require prospectus disclosure.
  • It requires a member firm that receives cash payments in addition to the standard sales charges and service fees paid in connection with the sale of fund shares to
    • disclose that information about a fund’s fees and expenses may be found in the fund’s prospectus;
    • disclose, if applicable, (i) that the firm receives cash payments in addition to the standard sales charges and service fees disclosed in the prospectus, (ii) the nature of such payments received in the last 12 months and (iii) a list of fund offerors making such payments listed in descending order of payments received; and
    • provide a reference to a Web page or toll-free number containing updated information, which must be updated at least every six months (or, if the firm elects not to maintain a Web page or toll-free number, disclose updated information to customers every six months).
  • It adds supplementary material that clarifies provisions regarding the disclosure of cash compensation and supersedes all prior guidance with respect to these provisions. The supplementary material provides that  
    • “cash compensation” includes revenue sharing paid in connection with the sale and distribution of investment company securities (and therefore member firms would be required to disclose revenue sharing arrangements pursuant to the Proposed Rule);
    • “cash compensation” also includes these payments, whether they are based upon the amount of investment company assets that a member’s customers hold, the amount of investment company securities that the member has sold or any other amount, if the payment is related to the sale and distribution of the investment company’s securities;
    • a “special sales charge” or “service fee arrangement” includes any arrangement under which a member firm receives greater sales charges or service fees than other member firms selling the same investment company securities (e.g., if a member receives the full gross sales charge imposed on the sale of investment company securities while other members selling the same securities receive only a portion of the gross sales charge, or if a member receives a cash payout in addition to the regular commission paid on the sale of investment company securities and other members do not receive this additional cash payout); and
    • the “special sales charge” or “service fee arrangement” disclosure requirement applies even if a fund’s offeror would have made the same arrangement available to other members had they requested it.

As with Rule 2830, the Proposed Rule requires the names of the firms that have entered into arrangements to receive special sales charges or service fees (and the details of these arrangements) to be disclosed in the prospectus or SAI.

Proposed Changes to the Non-Cash Compensation Provisions

Subject to certain exceptions, Rule 2830 generally prohibits member firms and their associated persons from accepting or paying non-cash compensation. Rule 2830 also generally requires member firms to keep records of all compensation received by the member firm or its associated persons to include the nature of and—“if known”—the value of any non-cash compensation received.

The Proposed Rule modifies this requirement by deleting the phrase “if known” regarding the value of non-cash compensation. Firms would be permitted to estimate in good faith the actual value of non-cash compensation received for which a receipt (or similar documentation) assigning a value is not available.

Proposed Changes Regarding Conditions for Discounts to Dealers

Rule 2830 currently prohibits investment company underwriters from selling the fund’s securities to a retail broker-dealer at a price other than the public offering price unless, among other conditions, the sale is in conformance with NASD Rule 2420 (Dealing with Non-Members). Due to the fact that virtually all broker-dealers currently doing business with the public are FINRA members, the Proposed Rule eliminates the requirement that such sales be in conformance with Rule 2420.

Proposed Changes Regarding Sales of ETFs

The Proposed Rule includes a provision to codify earlier FINRA staff interpretive letters that permit the trading of ETF shares at prices other than the current net asset value consistent with applicable SEC rules or exemptive orders.