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89-3 Proposed Rule to Restrict Payment of Referral Fees by NASD Members; Last Date for Comments: February 3, 1989

SUGGESTED ROUTING*

Senior Management
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*These are suggested departments only. Others may be appropriate for your firm.

REQUEST FOR COMMENTS

EXECUTIVE SUMMARY

The NASD invites comments on a proposed rule that would restrict the payment of "finders" or referral fees by NASD members to unregistered third parties for the referral of retail business. Fees paid in con-fWcttXr with a member's underwriting or merger and acquisition business would be excluded from the purview of the Rule, which also would permit an occasional fixed-amount referral-fee payment under certain circumstances. The text of the proposed rule follows this notice.

BACKGROUND

The NASD consistently has taken the position that it is improper for a member or a person associated with a member to make payments of "finders" or referral fees to third parties who introduce or refer prospective brokerage customers to the firm. This position is based on the definition of "representative" set forth in Part III (l)(b) of Schedule C to the NASD By-Laws, which states:

Persons associated with a member ... who are engaged in the investment banking or securities business for the member including the functions of supervision, solicitation or conduct of business in securities ... are designated as representatives. (Emphasis added.)

The NASD has maintained that persons who introduce or refer prospective customers and receive compensation for such activities are engaged in the securities business for the member in the form of solicitation. Solicitation is the first step in the consummation of a securities transaction and must be regarded as part of the conduct of business in securities. Although the NASD, on an informal basis, has permitted "one-time" fees not tied to the completion of a transaction or the opening of an account, it has, as noted above, consistently taken the position that the activities of locating, introducing, or referring potential retail customers come within the definition of representative and that those persons performing such activities are acting on behalf of the member.

The NASD has noted an increasing number of inquiries regarding the propriety of paying referral fees. To clarify the NASD's position and make it available to all members, the Qualifications Committee recommended, and the Board of Governors approved, the publication for comment of the proposed rule.

ANALYSIS OF PROPOSED AMENDMENT

The proposed Rule of Fair Practice regarding referral fees generally would prohibit payment of compensation to individuals or business entities for the referral of potential customers for brokerage services. Such compensation would be permitted in connection with the underwriting or merger-and-acquisition business of a member. In addition, members would be permitted to pay fixed fees for referrals on an occasional basis, provided that the fee is minimal and that neither the entitlement to nor the amount of the fees are linked to the opening of an account, the execution of transactions, the volume of business, or in any other way tied to the outcome of the referral. The payment of referral fees by associated persons would be prohibited under any circumstance.

The NASD believes that it is important to be able to regulate the flow of securities-related compensation from its members to unregistered persons. The Board of Governors believes that a Rule of Fair Practice, as described above, would significantly reduce the risks attendant on the solicitation of securities transactions by unregistered persons, while providing for the payment of referral fees under certain circumstances, such as the purchase of a mailing list, that do not pose such risks.

The NASD encourages all members and interested parties to comment on the proposed Rule of Fair Practice. Comments should be directed to

Mr. Lynn Nellius, Secretary
National Association of Securities Dealers, Inc.
1735 K Street, NW
Washington, DC 20006-1506

Comments must be received no later than February 3, 1989. Comments received by this date will be considered by the Qualifications Committee and the Board of Governors. The proposed Rule of Fair Practice must be approved by the membership and filed with, and approved by, the SEC before becoming effective.

Questions concerning this notice can be directed to Dennis C. Hensley, NASD Vice President and Deputy General Counsel, at (202) 728-8245, or Frank J. McAuliffe, NASD Vice President, Qualifications, at (301) 590-6694.

PROPOSED AMENDMENT TO NASD RULES OF FAIR PRACTICE

(a) No member or person associated with a member shall, directly or indirectly, give or permit to be given to any individual or business enterprise (other than persons registered with the member and other members) compensation of any kind in connection with the referral of prospective customers to the member.
(b) Paragraph (a) shall not apply to:
(1) the payment of compensation for the referral of business by a member where the compensation is solely in connection with the underwriting or merger and acquisition business of the member;
(2) the payment by a member of a fixed fee for the purchase of a listing of prospective customers; and
(3) the payment by a member of a small fixed fee for a referral where the payment is occasional, not part of a pattern or practice of such payments to the recipient, not determined by the outcome of the referral, and where the recipient does not regularly engage in activity that might reasonably be expected to result in continued referrals.

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