FINRA recently released Regulatory Notice 22-23 providing guidance on what firms should consider when constructing succession plans for Financial Advisors (“FAs”) who will no longer service their customers do to expected or unexpected life events.

The Need for a Plan

The Notice begins by listing the various cost/benefits of having or not having a succession plan, which would seem obvious to all.  It takes no great imagination to see the benefits of a sound succession plan in the event of an FA’s sudden death or the consequent difficulties of not having such a plan.  The Notice, however, provides some interesting real-life anecdotes that FINRA Staff have witnessed of the years regarding succession failures and successes.

The Notice also addresses the much trickier issue of an FA’s possible diminished capacity.  FINRA noted that some firms have implemented comprehensive policies regarding possible diminished capacity among employees.  These include:

  • training on signs of cognitive decline,
  • having a formalized escalation process to raise concerns,
  • establishing a diminished capacity committee to evaluate and decide next steps,
  • developing a committee to evaluate representatives’ limitations, engage their physicians, protect their privacy and implement working arrangements that comply with relevant employment laws and accommodated their disabilities; and
  • engaging with representatives and, depending on the circumstances, supporting the representatives with implementing a new working arrangement, developing a succession plan, providing assistance with performance issues or recommending termination.

Types of Plans

FINRA notes that there is no set way to craft a succession plan and that the complexity and details of any plan may vary greatly based on the firm but, in general, plans can broadly be divided into two categories: (1) internal programs, or (2) an external sale or other transaction.

Internal programs can come in many forms.  One answer to the succession problem is for firms to encourage teams of FA’s to work together.  Many large firms are actively encouraging FA’s to join teams and actively discouraging solo FA’s.  The team can come in different forms.  For example, it could consist of two or more FA’s of similar seniority who put a plan in place to purchase the others book of business should the need or desire arise.  The team could also involve the hiring of younger FA’s with the goal of developing them to someday take over the more senior FAs book.

An FA, not with a team, might designate in advance an FA as his successor or the firm may make such designation, in each case informing customers of the new arrangement.  Many, if not all, of these transition plans incorporate agreements to pay retiring representatives commissions once they leave.

External plans generally consist of a sale of the book of business to another firm or an FA at another firm or a merger of two firms.  In the case of an external succession plan, the retiring FA often agrees to continue to work for a certain amount of time to help transition the clients to the new FA.

Relevant FINRA Rules

FINRA Rule 4370 (Business Continuity Plans and Emergency Contact Information) requires firms to adopt Business Continuity Plans (“BCPs”) designed to ensure that firms continue to meet customers’ needs in the event of an emergency or significant business disruption.  Depending on the size of the firms and role of an individual FA, a succession plan may need to be part of the BCP.

A member firm’s succession plan may involve the Membership Application Program rules, FINRA Rules 1011 – 1019, that could include filing a Continuing Membership Application (CMA), or engaging in the materiality consultation process (MatCon).  A change in ownership could trigger an obligation for member firms to file a CMA under FINRA Rule 1017 (Application for Approval of Change in Ownership, Control, or Business Operations).  Rule 1017(a) specifies the changes in firms’ ownership, control or business operations that require a CMA, such as a merger with another member firm; an acquisition or transfer of 25 percent or more of the member firm’s assets; or a material change in business operations as defined in FINRA Rule 1011(m).  In general, the Notice encourages firms to work closely with their Risk Monitoring Analysts at FINRA and share relevant succession planning for control person.

The Notice also highlights the concern of a succession being necessitated by the lengthy suspension or bar of an FA.  In these situations, FINRA sees a heighted risk that the disciplined FA may sell his book of business to another FA who will improperly act as a proxy while sharing commission with the former FA.  FINRA suggests that firm’s monitor for, “an unusually high degree of engagement between the representative and former representative or an unusually low degree of engagement between the new representative and that representative’s customers . . . .”  FINRA also suggests that firm’s conduct customer “check-in calls” to determine of the terminated FA is improperly engaging with former customers.

Firms will also have to consider the payment of commissions to an unregistered person if that is part of the succession plan.  FINRA Rule 2040 governs the payment of transaction-based compensation by member firms to unregistered persons.  Subject to conditions, under Rule 2040(b), member firms can pay continuing commissions to their “retiring registered representatives,” after they cease to be associated with the firms, derived from accounts held for continuing customers of the retiring registered representative regardless of whether customer funds or securities are added to the accounts during the period of retirement.

Rule 2040(b) incorporates guidance from prior SEC no-action letters on the payment of commissions to retired registered representatives (referred to herein as SEC Staff Retired Representatives Guidance).  Accordingly, firms and representatives who are drafting, reviewing or executing agreements for continuing commission payments to retired representatives should consider the requirements of Rule 2040 and the prior SEC Staff Retired Representatives Guidance.  See SEC No-Action Letter to the Securities Industry and Financial Markets Association and SEC No-Action Letter to Amy Lee, Chief Compliance Officer, Co-CEO, Packerland Brokerage Services

Questions for Consideration

The Notice concludes with a lengthy set of “Questions for Consideration” with regard to succession planning.  For example, FINRA urges firms to consider such things as:

  • Does the firm have a plan that addresses both retirement as well as unplanned life events?
  • Does the plan account for both external and internal transitions?
  • Are there different procedures for key personnel?
  • Does the firm’s plan address risks of diminished capacity?
  • Are written succession agreements required? Can they be customized?
  • Does the plan address FAs’ disciplinary histories and other regulatory risks?
  • Does the plan address continuing commissions in a way that complies with FINRA Rule 2040?
  • Does the plan protect nonpublic customer information?
  • Does the plan address the required customer communications necessary upon transition?

These are only a small sample of the questions that FINRA poses and suggests that firms consider when constructing a succession plan.  What the Notice makes abundantly clear is that, given that over 16% of all FAs are over the age of 60, the issue of succession is only going to grow in the coming years and firms would be wise to be prepared for the many pitfalls involved.

Herskovits PLLC represents financial advisors in litigation, arbitration and regulatory matters.  Feel free to contact us at (212) 897-5410

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