FINRA Rule 2040: Payments to Unregistered Persons

Rule 3210 governs where agents can hold accounts. Rule 2040 governs who can receive compensation for securities activities, and the answer is straightforward: only registered persons.

General Prohibition

No member firm or associated person may directly or indirectly pay any compensation, fees, concessions, discounts, commissions, or other allowances to:

  1. Any person who is not registered as a broker-dealer under the Securities Exchange Act of 1934 (SEA) Section 15(a) but who, by reason of receiving such payments and the related activities, would be required to register as a broker-dealer, OR
  2. Any registered associated person unless the payment complies with applicable federal securities laws, FINRA rules, and SEC regulations

The key principle: if receiving the payment and performing the related activities would require a person to register, then the person must actually be registered before receiving payment.

Reasonable Determination Requirement

Before making payments to unregistered persons, a member must:

  • Reasonably determine that the recipient's activities do not require broker-dealer registration
  • Document the determination, supported by SEC releases, no-action letters, or independent legal counsel opinions
  • Review periodically if payments are ongoing

Exception: Retiring Representatives

A member may pay continuing commissions to a retiring registered representative after the person is no longer registered, provided:

  • There is a bona fide written contract between the member and the retiring representative entered into while the person was still registered
  • The contract provides that the retiree will not solicit new business, open new accounts, or service the existing accounts that generate the commissions
  • The arrangement complies with federal securities laws

Who qualifies as a "retiring representative":

  • Persons who leave the industry due to retirement
  • Persons who leave due to total disability
  • Persons who leave due to death - payments may be made to the designated beneficiary or the estate

Exam Tip: Gotchas

  • The contract must have been entered into while the person was still registered. A contract signed after departure does not qualify.
  • Retirees cannot solicit new business, open new accounts, or service existing accounts. The exception only covers passive receipt of continuing commissions.
  • Continuing commissions can still be paid even if customers add new funds to the accounts during retirement.

Exception: Nonregistered Foreign Finders

Members may compensate nonregistered foreign persons for directing customer business to the member, subject to conditions:

  • The finder is not required to register as a U.S. broker-dealer
  • The finder is a foreign national or foreign entity domiciled abroad
  • Customers are foreign nationals or entities
  • Customers receive disclosure documents and provide written acknowledgment
  • Records and agreements are maintained for FINRA inspection
  • Transaction confirmations indicate a referral fee arrangement

Exam Tip: Gotchas

  • The foreign finder exception applies only to foreign nationals or entities directing foreign customer business. A domestic finder referring U.S. customers cannot use this exception.
  • A broker-dealer (BD) cannot pay a finder's fee or referral bonus to an unregistered domestic person for bringing in customers. If the finder's activities would require registration, the finder must register first.

Connection to Agent Registration

Rule 2040 reinforces the registration requirement under the Uniform Securities Act (USA):

  • If a person receives transaction-based compensation for securities activities, that person is likely functioning as an agent and must be registered
  • An agent cannot receive transaction-based compensation from a broker-dealer (BD) with which the agent is NOT registered
  • Paying commissions to an unregistered person violates both Rule 2040 and the USA's registration requirements

Exam Tip: Gotchas

  • An agent cannot receive transaction-based compensation from a broker-dealer (BD) with which the agent is NOT registered. If an agent refers a customer to another BD and receives a referral fee based on the resulting trade, this violates Rule 2040 unless the agent is also registered with that firm.