NASD REVISES ITS NEGATIVE THOUGHTS ABOUT NEGATIVE RESPONSE LETTERS

 by Bill Singer, Esq.,bsinger@rrbdlaw.com
September 16, 2003

A registered representative decides to leave her current broker-dealer ("Old BD") and is understandably anxious to transfer all her clients to her contemplated new employer (the "New BD"). Luckily, New BD uses the same clearing firm as Old BD. Laudably, Old BD decides to accommodate RR and agrees to ease the transition of her customers. 

RR and Old BD want to send each of RR's clients a letter announcing her relocation to New BD and informing her customers that their accounts will beautomatically transferredwithin 15 days, or within 30 days if the account is a retirement account. Further, the letter will inform the clients that they shouldcontact Old BD if they do not desire the transfer, or for any problems or questions they may have. Finally, Old BD has agreed not to charge a transfer fee to any customer whose account so transfers and RR has agreed to pay the transfer fees in the event that a customer subsequently decides to return to BD.

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 use of the proposed negative response letter would be inappropriate.  When the Merit Letter was issued, I promptly wrote an article criticizing its conclusion (READ CRITIQUE AT THIS LINK) as an example of self-regulation at its worst: a denial of what was essentially a sound idea without an offsetting solution. 

I've never been a big fan of just saying "no." When a reasonable request has been denied, a regulator has an obligation to suggest workable alternatives or to revise its rules to accommodate the issues. It reminds me of a disagreement I overheard many years ago when working in-house in the legal department of a wirehouse. Apparently, an investment banking associate asked a staff counsel for permission to do something, which the attorney clearly thought was illegal (and it was). The attorney said, "no --- end of conversation." The head of the investment banking department then called down to the General Counsel and complained. The General Counsel then lambasted the attorney and issued this  admonishment: 

I didn't hire you to tell people what they can't do. I hired you to find creative solutions. Don't just say "no," but offer suggestions as to how close they can come to the edge without falling off. That's what you're getting paid for. 

NASD received many inquiries from members seeking guidance as to the use of negative response letters on the heels of the Merit Letter. My intuition is that a number of those communications likely conveyed the same frustration as my critique did. Accordingly, NASD recently issued Notice to Members 02-57: Use of Negative Response Letters for the Bulk Transfer of Customer Accounts, to provide additional interpretive guidance to the membership on this topic. 

What's likely going on behind the scenes? The brokerage industry remains very weak, with increasing numbers of failures and firms on the brink. Consequently, many BDs are up for sale or seeking to dump assets. Imagine you've just determined that you've got to close down within a week. What are you going to do --- telephone each and every account and try to get them to return letters authorizing their transfer to the acquiring firm? And what if you can't quickly obtain approval? Are you simply going to leave your clients in the lurch, without the ability to buy or sell and with no one to speak to? 

The sensible solution is to use a negative response letter to effectuate a prompt bulk transfer of your accounts. The Merit Letterseemed set against using a negative response letter under such circumstances; obviously, NASD has been forced to adjust its policy to the realities of present-day Wall Street. 

NASD believes that a customer should affirmatively consent to the transfer of his or her account to another firm. I agree wholeheartedly. No one should be able to transfer a public customer's funds or securities without some form of authorization. To this extent, NASD has properly functioned as the guardian of the public's trust. We do not diverge on this point. Consequently, NASD correctly enunciates the position that the transfers of customer accounts by a member using negative response letters must be carefully circumscribed. 

Perhaps in reconsideration of a somewhat strident pronouncement in the Merit Letter, NASD NTM 02-57 now clarifies that where there is a demonstrated compelling need to effect a timely transfer of accounts and the practice would be in the best interests of the affected customers, the use of negative response letters may be appropriate. Thankfully, the staff has provided some helpful examples of circumstances that might warrant such approval: · 

A Member Experiencing Financial or Operational Difficulties
An introducing firm that is experiencing financial or operational difficulties may seek the transfer of all of its customer accounts to another introducing firm using negative response letters; 

An Introducing Firm No Longer in Business
When an introducing firm has gone out of business, the clearing firm may effect the transfer of all of the introducing firm's customer accounts to another introducing firm using negative response letters;

Changes in a Networking Arrangement with a Financial Institution
Upon the conclusion or termination of a networking arrangement with a financial institution pursuant to NASD Rule 2350, a member may seek the transfer of all customer 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;

Acquisition or Merger of a Member Firm
When a firm is acquired by or merges with another firm, the firm originating the accounts may seek the transfer of all of its accounts to the new firm using negative response letters; and

Change in Clearing Firm by an Introducing Firm
When an introducing firm decides to enter into a clearing arrangement with a different firm, the introducing firm may use negative response letters to transfer customer accounts to the new clearing firm.  

1. NTM 02-57 underscores the need to provide accounts with adequate time and information concerning any proposed transfers. How can you best ensure that you are complying with NASD's policy? Include the following information --- at a minimum --- in the negative response letter: 

2.  

3. (1) A brief description of the circumstances necessitating the transfer; 
   

4. (2) A statement that the customer has the right to object to the transfer; 
   

5. (3) Information on how a customer can effectuate a transfer to another firm;
    

6. (4) A sufficient time period for the customer to respondto the letter (at least 30 days from the receipt of the letter unless exigent circumstances exist that warrant a shorter timer period); 
   

7. (5) Disclosure of any cost that will be imposed on the customer as a result of the transfer, including costs to the customer if the customer initiates a transfer of the account after the account is moved pursuant to the negative response letter; and 
   

8. (6) A statement regarding the firm's compliance with Securities and Exchange Commission (SEC) Regulation S-P (Privacy of Consumer Financial Information) in connection with the transfer. 

A PERSONAL NOTE

For the past several months I have been spearheading a national grassroots movement of NASD dissident firms.  Paramount among the causes that unite these firms is a belief that self-regulation must become more responsive.  Our detractors depict that issue as indicative of an effort to water down regulation.  We will continue to wage the battle by publicly stating our positions and demonstrating our integrity through engaging in substantive, constructive dialog (and by showing a willingness to modify any item in the face of credible persuasion to the contrary).

NTM 02-57 is a perfect example of what's right --- and wrong --- with self-regulation and NASD in specific.  For years firms have sought reasonable use of negative response letters, only to be confronted with a maze of if, ands, and buts(and those qualifications frequently colored by whichever staff member happened to take the call).  When given an opportunity in the Merit Letter to promulgate a more cohesive approach to this thorny issue, quite frankly, NASD simply dropped the ball.  However, to the SRO's credit, it appears to have revisited the issue (albeit in response to pressure from the membership).  The resulting NTM is an excellent revision of a previously questionable policy.  It is well written and shows an understanding of the key questions confronting members seeking to transfer accounts through the use of negative letters. The SRO finally appears to be responding to the voice of its members.

Few regulatory issues lend themselves to black-and-white determinations.  That is the challenge to our self regulators.  By and large, NASD does an excellent job protecting the public investor --- but that's only part of the self-regulatory equation.  It is the upholding of the reasonable and appropriate interests of the membership that is often fumbled.  Worse, when you protest to the SRO about a misguided ruling or rule, it is often viewed as an intolerable affront --- how dare you!

Maybe, just maybe, things are beginning to change.  Hopefully in the face of the economic realities of a faltering Wall Street and in response to better enunciated dissent, NASD is prepared to work with us.  Clearly, when the interests of the public and the industry come into conflict, the SROs must defer to the former.  We seek no change of that posture.  What must continue is the professional courtesy inherent in the concept of self-regulation:  the industry must be given a voice in the creation and implementation of rules; not one that must be deferred to but one which should be given due weight.  Nothing more but nothing less.