On March 23, 2016, the Securities and Exchange Commission (“SEC”) approved the adoption of FINRA Rule 2273, a rule first proposed by the Financial Industry Regulatory Authority (“FINRA”) on December 16, 2015. Rule 2273 provides that member firms who hire or associate with a registered representative must provide an “educational communication” to the representative’s former and current customers. The education communication is designed to provide customers with guidance regarding their decision whether to remain customers of that representative. Rule 2273 went into effect on November 11, 2016.
FINRA’s stated purpose for proposing Rule 2273 was to provide “customers with a more complete picture of the potential implications of a decision to transfer assets.” The belief was that otherwise, customers would simply rely on their “experience and confidence” with the representative. FINRA found that such experiences alone do not always guarantee that staying with the representative will be in the customers’ best interests. Thus, FINRA proposed the educational communication, which contains a number of questions that FINRA believes customers should ask themselves before deciding to remain with the representative.
First, the educational communication recommends that customers discuss the representative’s motivation for changing firms. It is known that firms sometimes offer registered representatives monetary incentives when they join, such as “bonuses based on customer assets the broker brings in,” “incentives for selling in-house products or a higher share of commissions,” and “financial incentives to retain brokers or customers.” FINRA believes that such incentives can cause a representative to prioritize his or her own interests over those of the customer, thus creating a conflict of interest. Thus, the educational communication recommends that customers consider whether a representative’s decision to change firms, which could stem from financial incentives, is in alignment with the customer’s investment goals.
Second, the educational communication asks that customers consider whether they can transfer all of their holdings to the new firm and what the consequences will be if they cannot. This recommendation is made because there are some products, like certain mutual funds, that are not transferable to the representative’s new firm. Thus, if the customer decides to follow the representative to the new firm, he or she will likely need to either liquidate the non-transferable holdings or simply keep them at the representative’s old firm. Both of these strategies could generate additional costs to the customer.
Third, the educational communication states that customers should consider potential account costs. Closing one account and opening a new one has the potential to generate termination fees, transfer fees, and/or account opening fees. There is also the possibility that the new firm will have a different pricing structure for maintaining an account or conducting transactions.
Fourth, the educational communication provides that customers should ask the registered representative about the products at the new firm so customers can compare them with the products they receive at the current firm. The educational communication informs customers that there is a possibility that the new firm may offer different investments from the ones they have previously purchased or are considering purchasing. Thus, customers must compare products at each firm to see whether they will be satisfied with the products that the new firm offers in lieu of the ones they would have purchased with the old one.
Finally, the educational communication provides that customers should ask the registered representatives about the nature of the services that the new firm will offer. It asks customers to ascertain their individual needs and determine, based on the registered representative’s answers, which firm’s services best meet those needs.
FINRA has also posted some Frequently Asked Questions (“FAQs”) on its website designed to provide FINRA members with additional guidance on how to follow Rule 2273 when required. For example, FINRA members are forbidden from changing the format or substance of the educational communication and from removing the FINRA logo. This is designed to ensure that the educational communication remains standardized for every FINRA member. FINRA members, though, are permitted to distribute the educational communication in electronic format, such as through a hyperlink or PDF attachment in an email. However, Rule 2273(b)(1)(A) provides that “if the first individualized contact with a former customer by the registered representative or member firm is in writing, the educational communication must accompany the written communication.”
The FAQs also contain a number of guidelines regarding what constitutes “individualized contact” with a former customer, which would require the representative to send the educational commission to the former customer. A “former customer” is defined as a customer “who held a securities account assigned to a registered representative at the registered representative’s previous firm.”
Whether a communication is an individualized contact is largely a matter of substance. The FAQs provide that these communications may include: “(1) informing the former customer that the registered representative is now associated with the recruiting firm; (2) suggesting that the former customer consider transferring his or her assets or account to the recruiting firm; (3) informing the former customer that the recruiting firm may offer better or different products or services; or (4) discussing with the former customer the fee or pricing structure of the recruiting firm.” FINRA further provides that an individualized contact does not occur if a former customer transfers “assets to the recruiting firm (1) on his or her own initiative; (2) in response to a general advertisement; (3) in response to a general posting on a social media website; or (4) after learning of the registered representative’s transfer from another former customer.”
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