A registered representative (RR) decides to leave his current broker-dealer (“BD") and is understandably anxious to transfer all his clients to his contemplated new employer (the “Other BD”). Luckily, the Other BD uses the same clearing firm as BD. Laudably, BD decides to accommodate its soon-to-be-former clients and its departing employee.

The RR wants to send each of his clients a letter announcing his relocation to the Other BD and informing his customers that their accounts will be automatically transferred within 15 days, or within 30 days if the account is a retirement account. Further, the letter will inform the clients that they should contact BD if they do not desire the transfer, or for any problems or questions they may have.  

This approach is popularly described as a “negative response letter” --- i.e., something will happen if you don’t respond. In consideration of the negative response letter, BD has agreed not to charge a transfer fee to any customer whose account so transfers and the RR has agreed to pay the transfer fees in the event that a customer subsequently decides to return to BD.  

Although there is no specific NASD rule governing the use of negative response letters in the above context, regulators are understandably wary about any “automatic” practice; particularly one in which an account is transferred.  Under such circumstances the NASD deems it paramount that the customer is provided with an opportunity to make an informed decision and ultimately gives affirmative consent to the transfer.  NASD Conduct Rule 2510(d)(2) the NASD permits the  use of negative response letters within the context of "bulk exchanges at net asset value of money market mutual funds. . ."  Under such circumstances, if the bulk exchanges involve mergers and acquisitions of funds, changes of clearing members and exchanges of funds used in sweep accounts,  the NASD permits the utilization of negative response letters provided they:

1. contain a tabular comparison of the nature and amount of the fees charged by each fund;

2. contain a comparative description of the nature and amount of the investment objectives of each fund and a prospectus of the fund to be purchased; and

3. do not become effective ("activated") until at least 30 days after  mailing.

So, how did the NASD respond to a request for guidance citing the fact pattern above?  Well, on October 16, 2000 the NASD issued an Interpretive Letter to Ms. Justine Rusin of Merit Capital Associates (herein, the "Merit Letter") and concluded that the proposal would be inappropriate. The Merit Letter warns that the use of negative response letters to transfer customers from one introducing broker to another may conflict with a member's obligation to observe high standards of commercial honor and just and equitable principles of trade in violation of NASD Conduct Rule 2110.  Unfortunately, the Merit Letter doesn’t offer detailed explanations as to its conclusion.  

The DevilIs In the Details  

So let's see where the Merit Letter leaves us.  Customers rightfully complain about delays in transferring accounts from one BD to another.  RRs complain that their former employers attempt to retaliate against departing employees by improperly fouling up the Automated Customer Account Transfer Service process (ACATS).  And BDs complain that regulators always say "no" but rarely offer constructive help on getting to "yes."  Unfortunately, the Merit Letter seems to disappoint just about everyone.

The ACATS process is initiated when the customer fills out the Transfer Initiation Form (TIF) and forwards it to the receiving firm (to where the account is to be sent), which completes certain information and files the completed form with ACATS. Shortly thereafter the delivering firm is automatically notified of the transfer request.  Generally, the delivering firm has three business days to validate the transfer request.  Assuming there are no objections --- either by the delivering or receiving firm --- the entire validation and delivery process shouldn't take more than six business days; however, in reality, most accounts take at least ten business days to transfer.

The  negative letter approach considered in the Merit Letter would seem to benefit all parties.  The customers avoid dangerous delays that often result in lawsuits arising from the inability to enter an order while an account is in the transfer limbo.  The RR and BD apparently agreed upon a procedure that eliminated the likelihood of employer retaliation and discourages the RR from bad mouthing the firm.  Further, the customer is given ample time to object (15 to 30 days).   

However, the NASD's position rejecting the negative letter is not  without merit. Negative letters require the client to notify the delivering firm to prevent an account transfer, when fairness seems to dictate that you shouldn't be able to move my funds and/or securities without my prior, express permission.  It's somewhat like those infuriating magazine offers that promise a free subscription but then state in fine print on the back of the card that if you don't cancel within six months you will be billed for an entire year of issues.  Additionally, there's simply something unsettling about RRs and BDs being able to "conspire" as to where a public customers' securities and cash will or will not be.  Common sense seems to demand that the customer pre-approve in writing such transactions; if for no reason other than to prevent the fraudulent ACATing that has occurred all too frequently at disreputable firms.  

In the final analysis, it would seem that there's got to be a happy medium between, on the one hand, requiring an acquiescing client to fill out bothersome paperwork, and, on the other hand, allowing an RR/BD to require a client to physically do something to prevent the transfer of that same account.  If I have a quibble with the NASD's Interpretive Letter process it's that it often says "no," but frequently fails to creatively explain how "yes" can be achieved --- or how closely one can come to a similar goal. 

For more information visit http://www.nasdr.com/2910/2110_04.htm 
(NASD Interpretive Letter Submitted by Justine Rusin, Merit Capital Associates, Inc. October 16, 2000)[CONDUCT RULES: NASD Rule 2110 - Standards of Commercial Honor and Principles of Trade].