Quick Answer
The payments-to-unregistered-persons rule bars a member or AP from paying compensation to anyone required to register as a broker-dealer for those payments. Two exceptions apply: a retiring registered rep may receive continuing commissions under a pre-retirement written contract, and a foreign finder may be paid for foreign customers it directs to the firm, under seven conditions.
The general prohibition is the federal expression of "if you are paid like a broker, you must be registered as a broker." The two exceptions are narrow and tested literally for their preconditions.
The General Prohibition
No member or associated person (AP) may, directly or indirectly, pay any compensation, fees, concessions, discounts, commissions, or other allowances to any person that is not registered as a broker-dealer under the SEA's broker-dealer registration requirement but is, by reason of the payments and related activities, required to be registered.
The rule's supplementary material places the work on the member firm. FINRA expects the firm to:
- Make a determination that the proposed activities would not require the recipient to register as a broker-dealer
- Reasonably support the determination. A firm that is uncertain can draw support from, among other things:
- Previously published releases, no-action letters, or interpretations from the SEC or its staff that apply to the firm's facts and circumstances
- A no-action letter that the firm seeks from SEC staff
- A legal opinion from independent, reputable U.S.-licensed counsel knowledgeable in the area
- Keep the determination reasonable under the circumstances, and review it periodically if the payments are ongoing
- Maintain books and records that reflect the determination
Think of it this way: A firm cannot simply pay an unregistered finder and assume the finder is not required to register. The firm must reach its own conclusion, reasonably supported, that the finder's activities fall outside the broker-registration requirement, and keep records of it. Paying without that determination falls short of the rule even if the finder turns out not to need registration, and paying a finder who does need registration violates the prohibition itself.
Exam Tip: Gotchas
- The rule sets no presumption about the recipient; it puts the determination on the firm. FINRA expects the member to determine, and reasonably support, that the recipient need not register, to review that determination periodically while payments continue, and to keep records of it. The size or label of the payment does not replace that work.
- "Compensation" reaches indirect and non-cash transfers. A firm cannot avoid the prohibition by routing payment through a third party, paying the recipient's family member, or substituting non-cash items for cash. The substance of the arrangement controls.
Retiring Representative Continuing Commissions
A FINRA member may pay continuing commissions to a retiring registered representative (or the retiree's beneficiaries) for continuing customer accounts of the retiring rep, provided the arrangement satisfies all three of the following preconditions.
| # | Precondition |
|---|---|
| 1 | A bona fide written contract entered into while the rep was registered, calling for the payments |
| 2 | The retiring rep does not solicit new business, open new accounts, or service existing accounts of the firm after retirement |
| 3 | The arrangement complies with applicable federal securities laws (e.g., the rep's activities post-retirement do not require registration) |
What "Bona Fide" and "Continuing" Mean
- Bona fide means the contract was entered for a legitimate business purpose, not as a pretext for paying compensation to an unregistered person who will keep doing broker activity informally
- Continuing customer accounts means the retiree's own customer accounts that existed before retirement. The rule expressly permits continuing commissions regardless of whether customer funds or securities are added to those accounts during retirement; new money or new business flowing into an existing account does not, by itself, disqualify the arrangement
- What disqualifies the arrangement is the retiree's own conduct, not new activity in the account: the retiree cannot solicit new business, open new accounts, or service the accounts. The retiree may receive continuing commissions on trail commissions (e.g., 12b-1 fees, ongoing variable-annuity payments) and on new transactions in the account, as long as someone other than the retiree is soliciting or handling them
Death of the Retiring Rep
The continuing-commission exception extends to the retiree's beneficiaries. If the retiring rep dies, the firm may continue to pay the rep's contractual continuing commissions to the rep's estate or designated beneficiary, provided the original written contract addressed the death contingency.
Exam Tip: Gotchas
- The written contract must be entered while the rep is still registered. A handshake or post-retirement side letter does not qualify. A firm that fails to put the contract in place before retirement has no authority to pay continuing commissions to the now-unregistered ex-rep, and the payments would violate the general prohibition.
- The retiring rep cannot service the accounts post-retirement. "Servicing" includes calls, account reviews, recommendation discussions. A retiree who continues to talk to the customer about the customer's investments has crossed into broker activity that requires registration, and the continuing-commission exception evaporates.
Foreign Finders
A member may pay a non-registered foreign finder transaction-related compensation based on the business of customers the finder directs to the member, provided all seven of the following conditions are met.
| # | Condition |
|---|---|
| 1 | The member has assured itself that the finder is not required to register in the U.S. as a broker-dealer, is not subject to a disqualification under FINRA's By-Laws, and that the compensation arrangement does not violate applicable foreign law |
| 2 | The finder is a foreign national (not a U.S. citizen) or a foreign entity domiciled abroad |
| 3 | The customers are foreign nationals (not U.S. citizens) or foreign entities domiciled abroad, transacting in foreign or U.S. securities |
| 4 | The customers receive a descriptive document, similar to one required under the Investment Advisers Act, that discloses the compensation being paid to finders |
| 5 | The customers give the member a written acknowledgment of the compensation arrangement, which the member retains and makes available for FINRA inspection |
| 6 | The member keeps records of payments to finders on its books, and the finder agreements are available for FINRA inspection |
| 7 | Each transaction confirmation states that a referral or finder's fee is being paid under an agreement |
The Finder's Own Activities
The rule does not list activities a finder may or may not perform. Its limit on the finder comes through condition 1: the member must assure itself that the finder is not required to register as a U.S. broker-dealer.
A finder who goes on to act as a broker for the customers, for example by taking or relaying their orders, puts that condition at risk, so the firm weighs what the finder actually does when it makes and reviews its determination.
Customer Acknowledgment
The customer must acknowledge in writing that the finder is being compensated. This acknowledgment serves both the customer-protection purpose (the customer knows the finder has a financial interest) and the firm-protection purpose (the firm has documentation that the customer was informed).
Exam Tip: Gotchas
- Two conditions are about the finder, not the customers. The finder itself must be a foreign national or a foreign entity domiciled abroad, and the member must be assured the finder need not register in the U.S., is not disqualified, and is not paid in breach of foreign law. A U.S.-citizen finder fails even when every customer is foreign.
- The customer condition for individuals is citizenship only. A U.S. citizen living abroad still does not qualify, but a non-U.S. citizen qualifies regardless of residence, even a foreign citizen who has become a U.S. resident. A residency-abroad requirement applies to foreign entity customers, not to individuals.
What Should You Check on Exam Day?
- Can you state the three preconditions for paying continuing commissions to a retiring registered representative?
- Do you know when the written continuing-commission contract must be entered, while the rep is still registered or after retirement?
- Can you list the seven foreign-finder conditions, including the two that concern the finder itself?
- Do you know how a firm can reasonably support its determination that an unregistered recipient need not register, that it should review the determination periodically while payments are ongoing, and that it must keep records of it?