Legal & Compliance
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CORRECTION TO NOTICE TO MEMBERS 88-55
Notice to Members 88-55 announced the approval by the Securities and Exchange Commission of amendments to Article III, Section 19(f) of the NASD Rules of Fair Practice permitting performance-based fees under some circumstances. One of the requirements for charging such a fee is that the customer either has a net worth of not less than $1 million at the time the account is opened or the minimum amount to be invested in the account is not less than $500,000.
The text of the change to Section 19 that accompanied Notice to Members 88-55 erroneously stated that the minimum net worth was $100,000 rather than $1 million. A corrected copy of the amendments to Section 19(f) accompanies this notice.
PROPOSED AMENDMENTS TO ARTICLE III, SECTION 19(f) OF THE NASD RULES OF FAIR PRACTICE
(Note: New language underlined; deleted language in brackets; correction in boldface.)
Customers' Securities or Funds
Sharing in accounts; extent permissible
(A) Except as provided in Subsection (f)(2) no member or person associated with a member shall share directly or indirectly in the profits or losses in any account of a customer carried by the member or any other member [unless]; provided, however, that a member or person associated with a member may share in the profits or losses in such an account if (i) such member or person associated with a member obtains prior written authorization from the member carrying the account; and (ii) the member or person associated with a member shares in the profits or losses in the account only in direct proportion to the financial contributions made to such account by either the member or person associated with a member.
(B) Exempt from the direct proportionate share limitation of subsection (f)(l)(A)(ii) are accounts of the immediate family of such member or person associated with a member. For purposes of this section, the term "immediate family" shall include parents, mother-in-law or father-in-law, husband or wife, children or any relative to whose support the member or person associated with a member otherwise contributes directly or indirectly.
(2) Notwithstanding the prohibition of subsection (f)(l), a member or person associated with a member may receive compensation based on a share in profits or gains in an account if all of the following conditions are satisfied:1
(A) The member or person associated with a member seeking such compensation obtains prior written authorization from the member carrying the account;
(B) The customer has at the time the ac count is opened either a net worth which the mem ber or person associated with a member reasonably believes to be not less than $1,000,000, or the mini mum amount invested in the account is not less than $500,000;
(C) The member or person associated with a member reasonably believes the customer is able to understand the proposed method of compensation and its risks prior to entering into the arrangement;
(D) The compensation arrangement is set forth in a written agreement executed by the customer and the member;
(E) The member or person associated with a member reasonably believes, immediately prior to entering into the arrangement, that the agreement represents an arm's-length arrangement between the parties;
(F) The compensation formula takes into account both gains and losses realized or accrued in the account over a period of at least one year; and
(G) The member has disclosed to the customer all material information relating to the arrangement including the method of compensation and potential conflicts of interest which may result from the compensation formula.
1 It is the position of the Division of Investment Management of the Securities and Exchange Commission that compensation received by a member or person associated with a member under this rule would constitute "special compensation" for purposes of the exception to the definition of "investment adviser" in Section 202(a)(ll)(C) of the Investment Advisers Act of 1940 (Advisers Act). Any member or person associated with a member, required to be registered under the Advisers Act, or state law, who receives compensation based on a share of profits or capital appreciation of a customer's account must comply with Section 205(1) and Rule 205-3 under the Advisers Act, or applicable state law, with respect to such compensation. (SEC Release 34-24355,52 Fed. Reg.