September 1, 2009

Schapiro Warns Broker/Dealer CEOs About Enhanced Compensation Arrangements

Reminds them of their supervisory duties

SEC Chairman Mary Schapiro shot off a letter to broker/dealer CEOs on August 31 reminding them of their supervisory obligations under federal securities laws after recent reports have said that some broker/dealer firms may be engaging in special recruiting programs that offer enhanced compensation arrangements.

"Reports suggest some firms are offering substantial inducements to potential registered representatives, including large up-front bonuses and enhanced commissions for sales of investment products," Schapiro wrote in her August 31 letter to broker/dealer CEOs. "In light of these reports, I want to remind broker/dealer firms and their CEOs of the significant supervisory responsibilities you have under the federal securities laws to oversee broker/dealer activities, particularly with respect to sales practices."

Schapiro went on to say that certain forms of potential compensation may carry with them enhanced risks to customers. "Some types of enhanced compensation practices may lead registered representatives to believe that they must sell securities at a sufficiently high level to justify special arrangements that they have been given," she wrote. "Those pressures may in turn create incentives to engage in conduct that may violate obligations to investors. For example, if a registered representative is aware that he or she will receive enhanced compensation for hitting increased commission targets, the registered representative could be motivated to churn customer accounts, recommend unsuitable investment products or otherwise engage in activity that generates commission revenue but it's not in investors' interest."

As firms' sales forces grow in size, Schapiro stressed that "the firm's supervisory and compliance infrastructure retains sufficient size and capacity."

While Schapiro's letter didn't state which type of broker/dealers she was addressing, David Bellaire, general counsel and director of government affairs for the Financial Services Institute (FSI), says that within the independent broker/dealer channel, upfront bonuses have only been a development that has happened in the last 10 years, and even now when these upfront bonuses are paid "they tend to be much smaller those paid at wirehouse or regional firms and they are intended to cover the cost of the transition from one firm to another rather than to pay for or buy production." As far as enhanced commission programs, Bellaire says, "I don't know of any going on at independent firms." Again, the independent broker/dealer "model is much less of an emphasis on proprietary products, and as a result the reasons behind an enhanced commission program are really diminished within the channel."

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