Proposed FINRA Rule 2341 would govern broker-dealer sales and distribution of investment company securities, including mutual funds and ETFs.  The new rule would be based on NASD Rule 2830, subject to significant revisions. 

            NASD Rule 2830 ... currently limits the sales charges that broker-dealers may receive on the sale and distribution of investment company securities.  The rule further prohibits directed brokerage arrangements, limits the payment and receipt of cash and non-cash compensation, sets conditions on discounts to dealers, and addresses other issues such as members’ purchases and sales of investment company securities as principal.

       New FINRA Rule 2341 ... would: 

1. require a member to make new disclosures to investors regarding its receipt of, or its entering into an arrangement to receive, cash compensation.  [See comprehensive discussion, below.]
   
2. make a minor change to the recordkeeping requirements for non-cash compensation. [Link to Rule Filing for items 2,3,4.]
   
3. eliminate a condition regarding discounted sales of investment company securities to dealers.
4. codify past FINRA staff interpretations regarding the purchases and sales of exchange-traded funds (“ETFs”).

        1.  Proposed Changes to the Cash Compensation Disclosure Requirements.   NASD Rule 2830(l) governs the payment and acceptance of cash and non-cash compensation in connection with the sale of investment company securities. Among other things, NASD Rule 2830(l)(4) prohibits members from accepting cash compensation from an “offeror” (generally an investment company and its affiliates) unless the compensation is described in the fund’s current prospectus. If a member enters into a “special cash compensation” arrangement with an offeror, and the offeror does not make the arrangement available on the same terms to all members that sell the fund’s shares, the member’s name and the details of the arrangement must be disclosed in the prospectus.

The proposed rule change would modify the disclosure requirements for cash compensation arrangements. As proposed, it would no longer require disclosure of cash compensation arrangements in an investment company’s prospectus or SAI. Instead, if within the previous calendar year a member received, or entered into an arrangement to receive, from an offeror any cash compensation other than sales charges and service fees disclosed in the prospectus fee tables of investment companies sold by the member (“additional cash compensation”), the member would have to make certain disclosures.

FINRA believes that the proposed amendments to the rule would strengthen the rule’s requirements regarding cash compensation disclosure and would further inform investors of the potential conflicts that can arise from the sale of investment company securities when a member receives cash compensation other than sales charges and service fees disclosed in the prospectus fee tables of such investment companies.  While the current rule prohibits members from selling investment company shares unless certain information regarding cash compensation arrangements is disclosed either in an investment company’s prospectus or SAI, it does not impose any disclosure requirements on the member itself. Requiring disclosure of these arrangements, in the detail described below, by the member would enable investors to better evaluate whether a member’s particular product recommendation was influenced by these  arrangements, and would be an important adjunct to existing suitability, sales practice and disclosure requirements.

• First, the member would have to prominently disclose that it has received, or has entered into an arrangement to receive, cash compensation from investment companies and their affiliates, in addition to the sales charges and service fees disclosed in the prospectus fee table.
• Second, the member would have to prominently disclose that this additional cash compensation may influence the selection of investment company securities that the member and its associated persons offer or recommend to investors.
• Third, the member would have to provide a prominent reference (or in the case of electronically delivered documents, a hyperlink) to a web page or toll-free telephone number where the investor could obtain additional information concerning these arrangements.

For new customers on or after the effective date of the proposed rule change, the member would have to provide these disclosures in paper or electronic form7 to each such customer prior to the time that the customer first purchases shares of an investment company through the member. For existing customers at the time the proposed rule change becomes effective, the member would have to provide these disclosures in paper or electronic form to each such customer by the later of either: (a) 90 days after the effective date of the proposed rule change, or (b) prior to the time the customer first purchases shares of an investment company through the member after the effective date (other than purchases through reinvestment of dividends or capital distributions or through automatic investment plans).

As discussed above, if a member has received, or entered into an arrangement to receive, additional cash compensation, the member would have to establish a web page or toll-free telephone number through which a customer could obtain additional information concerning the member’s cash compensation arrangements. The web page or toll-free telephone number would have to provide:

• A narrative description of the additional cash compensation received from offerors, or to be received pursuant to an arrangement entered into with an offeror, and any services provided, or to be provided, by the member to the offeror or its affiliates for this additional cash compensation;
• If applicable, a narrative description of any preferred list of investment companies to be recommended to customers that the member has adopted as a result of the receipt of additional cash compensation, including the names of the investment companies on this list; and
• The names of the offerors that have paid, or entered into an arrangement with the member to pay, this additional cash compensation to the member.

The member would be required to update this information annually within 90 days after the calendar year end. If this information becomes materially inaccurate between annual updates, the member would have to update it promptly.

The proposal also would add supplementary material that would clarify the definition of “cash compensation,” which would supersede all prior guidance with respect to this definition.8 The supplementary material would provide that “cash compensation” includes, among other things, revenue sharing paid in connection with the sale and distribution of investment company securities.9 The supplementary material would specify that “cash compensation” includes revenue sharing payments regardless of whether they are based upon the amount of investment company assets that a member’s customers hold, the amount of investment company securities that the member has sold, or any other amount if the payment is related to the sale and distribution of the investment company’s securities. As cash compensation, members would be required to disclose such revenue sharing arrangements.

These disclosure requirements would apply only to members that receive or enter into an arrangement to receive additional cash compensation from an offeror. Thus, if a member sells a mutual fund’s shares and receives only the sales load and distribution or service fees described in the fund’s prospectus fee tables, and does not receive or enter into an arrangement to receive revenue sharing or other additional cash compensation from an offeror, the member would not be required to make the disclosures specified in proposed FINRA Rule 2341(l)(4). Likewise, a principal underwriter of a no-load mutual fund that sells shares directly to investors, and does not receive or enter into an arrangement to receive any cash compensation beyond what is described in the fund’s prospectus fee table, would not be subject to the disclosure requirements of paragraph (l)(4).

For further details on the rule changes, including those pertaining to above topics 2, 3, and 4 - which begin on page 10), go to:   [FINRA Rule Filing 11-18, 4/19/11]