NTM 04-72 Significantly Affects Financial Institution Networking

NASD Notice to Members (NTM) 04-72, released in October, prohibits the use of "broker-dealer of record change letters" to move responsibility for direct mutual fund and variable annuity positions to a new broker-dealer. Thus, the NASD has greatly complicated the task of a financial institution involved in a networking relationship switching to a new broker-dealer. Additionally, the ability to recruit established registered representatives has become more difficult in direct proportion to the volume of the representative’s direct mutual fund or variable annuity business.

BACKGROUND
The background on this issue begins with NASD Uniform Practice Code Rule 11870 which describes the process by which a customer can transfer their brokerage account from one broker-dealer to another. The process relies primarily upon prior written instructions from the customer. In September of 2002 the NASD in Notice to Members 02-57 addressed the use of negative response letters for the transfer of customer brokerage accounts. While NTM 02-57 generally prohibited the use of negative response letters in the transfer of brokerage accounts, the NASD did recognize five limited circumstances in which broker-dealers may transfer customer accounts without prior written approval from the customer.

Notably and very fortunately for financial institution networking activity, NTM 02-57 states that upon the conclusion or termination of a networking arrangement with a financial institution a broker-dealer may seek to transfer all customer brokerage accounts established pursuant to the networking arrangement to a new firm with which the financial institution has formed a networking arrangement using negative response letters.

It is important to note, that this capability is predicated upon on the broker-dealer transferring out the customer accounts as the decision-maker in determining whether to utilize a negative response letter process. This is consistent with the obligation placed upon NASD member firms in Uniform Practice Rule 11870. Thus, it is important for financial institutions entering into networking relationships with broker-dealers to have a clear agreement as to whether and how the broker-dealer will cooperate with the financial institution’s desire to have the brokerage accounts transferred to a new broker-dealer in the event of termination of the networking relationship. In this context attempts to define the "ownership" of the accounts are pointless. The real issue is whether the current broker-dealer can and will cooperate with a negative response letter process regarding the transfer of the customers brokerage account to a different broker-dealer.

NTM 04-72
NTM 02-57 does not apply to transfers of direct mutual fund or variable annuity positions. In light of this the brokerage industry has continued to rely upon the long standing industry practice of using "broker-dealer of record change letters" to change the mutual fund or insurance company records to reflect a different broker-dealer as the firm responsible for the "direct" customer positions. In follow-up to NTM 02-57, the NASD in NTM 04-72 addressed transfers of direct held mutual fund and variable annuity positions from one broker-dealer to another. Prior to NTM 04-72 a financial institution changing broker-dealer networking relationships would inform the new broker-dealer of the mutual fund companies and insurance companies where customer positions were held. The new broker-dealer would, for each company, enter into a broker-dealer of record change letter with the former broker-dealer. The broker-dealer of record change letter, signed by both broker-dealers is then sent to the mutual fund or insurance company requesting transfer of all customer positions assigned to the representative located at the financial institution to the new broker-dealer.

In NTM 04-72 the NASD specifically rejected the idea that broker-dealer of record changes for direct held mutual funds and variable annuities could be treated the same as the transfer of brokerage accounts, via a negative response letter process, at the termination of a financial institutions networking relationship with a broker-dealer. Thus, under this Notice to Members a broker-dealer of record change letter cannot be used, and the "direct" held position can not be changed using a negative response letter process. Therefore, the only means available to change the broker-dealer responsible for a direct held mutual fund or variable annuity position is by prior affirmative approval from each customer.

On October 20th, only 15 days after issuing NTM 04-72, the NASD issued an interpretive letter to Banc of America Investment Services, Inc stating that "the staff believes that, in situations involving the acquisition or merger of a member firm, where the acquiring or surviving entity is the legal successor-in-interest to the member firm, it would be appropriate to use negative response letters to change the BD of record for customers' "direct application" mutual fund and variable annuity accounts from the member firm to the successor-in-interest". While this position is of limited use in changing networking relationships, it does align the transfer of direct mutual fund and variable annuity positions with the more flexible treatment available for brokerage accounts transfers provided in NTM 02-57.

WHAT CAN YOU DO?
If you are interested in participating in efforts, lead by BISA, to encourage the NASD to adopt a more practical approach to the transfer of direct mutual fund and variable annuity positions please contact Dick Starr at rstarr@bisanet.org

NASD Notice to Members links: (PDF files)
(NTM) 02-57
(NTM) 04-72

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Richard D. Starr is President of Financial Institutions Group, Inc. in Sammamish, Washington, providing insurance and securities consulting services to banks and insurance carriers. He is also a Director of Bank Insurance and Securities Association and is its Director of Government Affairs. He can be contacted via email at rstarr@bisanet.org.

Kevin Maas is Vice President and Chief Compliance Office for PrimeVest Financial Services, Inc. Kevin has spent 15 years addressing the regulatory and compliance needs of financial institutions with a focus on brokerage and insurance networking arrangements.