FINRA Rule 2040: Payments to Unregistered Persons

This rule reinforces the registration requirement from a different angle: it targets the firm's side of the transaction, not just the unregistered individual.

What Does the Rule Prohibit?

A member firm (BD) and its associated persons may not pay any compensation, fees, commissions, concessions, discounts, or other allowances, directly or indirectly, to any person who is required to register as a broker-dealer under federal law but is not so registered.

• The rule's trigger is broker-dealer registration, not agent registration. In practice the two overlap heavily: a person paid transaction-based compensation for securities activity is frequently also functioning as an unregistered agent under the USA, so paying that person can violate both this rule and the USA's registration requirements at once
• A BD cannot split commissions with, or pay a referral fee to, a person who should be registered as a broker-dealer but is not
• A BD also cannot pay even a properly registered associated person unless that specific payment itself complies with applicable federal securities laws, FINRA rules, and SEA rules
• Before paying an unregistered person, a member must reasonably determine, and document, that the payment does not require the recipient to register as a broker-dealer, and revisit that determination periodically if the payments continue

Exam Tip: Gotchas

Labeling a payment a "referral fee," "finder's fee," or "bonus" does not exempt it. If the payment is tied to a securities transaction and the recipient should be a registered broker-dealer, the payment is prohibited regardless of what it is called.

Can a BD Keep Paying a Retired Representative?

Yes, under a narrow exception. A "retiring registered representative" is someone who retires from the member and leaves the securities industry, including through total disability. A BD may continue paying commissions to that person, for accounts held by the representative's continuing customers, regardless of whether those customers add funds or securities to the accounts during retirement, provided:

• A bona fide, written contract for the continuing payments was entered into in good faith while the person was still registered with the member
• The contract prohibits the retired representative from soliciting new business, opening new accounts, or servicing the accounts that generate the continuing commissions
• The arrangement otherwise complies with applicable federal securities laws

This exception also extends to the beneficiary the retiring representative named in the written contract, or to the representative's estate if no beneficiary was named, in the event of the representative's death.

Exam Tip: Gotchas

The contract has to exist before the person stops being registered. A new payment arrangement negotiated after the person has already left the industry does not qualify, no matter how the parties describe it.

Can a BD Pay a Foreign Finder?

Yes, subject to conditions. A BD may compensate a nonregistered foreign finder for directing foreign customer business, provided:

• The member has assured itself that the finder need not register as a U.S. broker-dealer, is not subject to a FINRA disqualification, and that the compensation arrangement does not violate foreign law
• The finder is a foreign national (not a U.S. citizen) or a foreign entity domiciled abroad
• The customers are foreign nationals or foreign entities domiciled abroad, transacting in either foreign or U.S. securities
• Customers receive a disclosure document describing the compensation being paid to the finder
• Customers provide written acknowledgment of the compensation arrangement, retained and available for FINRA inspection
• Records of payments and the underlying agreement are maintained and available for FINRA inspection
• Each transaction confirmation indicates that a referral or finder's fee is being paid under an agreement

What Should You Check on Exam Day?

• The rule bars paying transaction-based compensation to anyone required to register as a broker-dealer who is not registered; that is a different legal hook than agent registration, even though the two usually travel together
• A member must reasonably determine, and periodically re-check, that an unregistered payee's activity does not require broker-dealer registration
• The retiring-representative exception requires a person who has left the industry entirely, a written contract that predates the departure, and a bar on soliciting new business
• The foreign-finder exception requires the member's own due-diligence assurance, foreign nationals on both sides, disclosure, written customer acknowledgment, and FINRA-inspectable records