Interpretive Letter to Janet Dyer, National Financial Services, LLC

A clearing member may use negative response letters to assign orphan accounts to an introducing broker-dealer on the clearing member’s platform.

Dear Ms. Dyer:

I am responding to your letter dated March 10, 2023, as supplemented by conversations with the staff, in which you seek interpretive guidance regarding the use of negative response letters by National Financial Services LLC (“NFS”) to assign certain orphan brokerage accounts to an introducing broker-dealer that clears through NFS (the “Receiving Broker-Dealer”).

Background

We understand the facts to be as follows.  NFS is a clearing firm that offers back-office services to introducing broker-dealers and institutional clients.  NFS is not itself an introducing broker-dealer.  NFS has a growing number of brokerage accounts previously introduced to the firm by introducing broker-dealers under the terms of Fully Disclosed Clearing Agreements (“FDCA”) that are no longer associated with any introducing broker-dealer.  These accounts (commonly referred to as “Orphan Accounts”) remain on NFS’ platform with NFS serving as the default broker-dealer of record.

The introducing broker-dealers previously associated with the Orphan Accounts are no longer on the NFS platform due to one of three events: (1) a broker-dealer withdrawal (“BDW”); (2) a merger or acquisition; or (3) a deconversion to another clearing platform.  NFS became the default broker-dealer of record for the Orphan Accounts in situations where either the impacted end-customers opted out of the transfer to a new broker-dealer or receiving clearing firm, the account was not eligible for transfer (i.e., non-transferable assets), or the account was not accepted by the receiving clearing firm.

NFS can only offer limited services to the Orphan Accounts because it does not provide direct client-facing services to retail customers, and it does not have the resources to provide the brokerage services customarily provided by an introducing broker-dealer.  NFS thus proposes to assign to the Receiving Broker-Dealer approximately 40,000 Orphan Accounts pursuant to negative response letters, as described below.  NFS represents that the Orphan Accounts are free of any material restrictions that would proscribe the assignment of the account assets or inhibit standard brokerage transactions.1

Your letter represents that NFS performed a reasonable investigation of the Receiving Broker-Dealer as part of its decision to assign the Orphan Accounts and has determined, to the best of its knowledge, that the Receiving Broker-Dealer:

  • has a substantially similar business model to the prior introducing firm;
  • offers customer services similar to those offered by the prior introducing firm;
  • offers products suited for the customers;
  • has sufficient resources, including staffing, capital and supervisory, to accept and service the accounts; and
  • is appropriately registered, and its associated persons have satisfied applicable qualification requirements, in all jurisdictions in which it serves customers.

Additionally, the Receiving Broker-Dealer is in good standing as a correspondent firm on the NFS platform and has cleared through NFS since 1992.  NFS is familiar with the Receiving Broker-Dealer’s business model and business mix and views the firm as a viable recipient for the Orphan Accounts.  NFS and the Receiving Broker-Dealer intend to enter into an agreement that will outline and memorialize the terms of the proposed assignment.2

NFS proposes to send two negative response letters to the Orphan Account owners to their address of record via U.S. Postal Service mail over a 120-day period before the effective assignment date to the Receiving Broker-Dealer.  The first letter would provide 120 days’ notice of the assignment, and the second letter would provide 60 days’ notice.  In addition, NFS represents that its negative response letters will adhere to the requirements in Notice to Members 02-57 (“NTM” or “NTM 02-57”).3

The Orphan Account owners would have an opportunity to opt-out of the assignment.  Those that do not opt-out would have an additional 60 days after the assignment date to transfer their account to another introducing broker-dealer without incurring a transfer fee from the Receiving Broker-Dealer.  Those that opt out of the assignment to the Receiving Broker-Dealer but do not transfer their account to a new introducing broker-dealer would have the option to remain an Orphan Account with NFS as their default broker-dealer.  Neither NFS nor the Receiving Broker-Dealer will assess transfer fees during the 120-day period before the assignment, or the 60-day period after the assignment.4

You believe that this proposed assignment of accounts is in the best interests of the Orphan Account owners for the following reasons.  Orphan Accounts do not have the same access to certain on-platform services and features available to accounts introduced to NFS by an introducing broker-dealer.  Orphan Accounts are disadvantaged by this limited access model and do not experience unabridged brokerage engagement.  The proposed bulk assignment would benefit the Orphan Account owners by giving them access to account-level features and services at the Receiving Broker-Dealer that are not available to them at NFS.  For example, upon assignment, they will be able to initiate opening position transactions and will no longer be restricted to liquidating transactions.  Additionally, it is NFS’ understanding that the Receiving Broker-Dealer offers a fee schedule comparable and for certain transactions more favorable to the Orphan Account owners than the current NFS fee schedule for similar services.

Further, you have represented that the Receiving Broker-Dealer will undertake outreach efforts to Orphan Account owners, informing them of services and capabilities offered and performing needs-based assessments with them.  Additionally, the Receiving Broker-Dealer will repaper account-level agreements and ancillary account information (e.g., margin, beneficiaries, and suitability) where applicable and provide online access capabilities.

You seek interpretive guidance regarding the use of negative response letters to accomplish the bulk assignment of the Orphan Accounts.

Response

In September 2002, FINRA (then NASD) issued NTM 02-57 concerning the use of negative response letters for the bulk transfer or assignment of customer accounts.  In general, a member must obtain a customer’s affirmative consent or instruction in order to transfer or assign the customer’s account to another member.  In NTM 02-57, FINRA identified several situations in which the use of negative response letters by a member could be appropriate to effect a bulk transfer or an assignment of customers’ accounts to another member, subject to specified conditions.  One of the situations identified allows a clearing firm to use negative response letters to assign all of the customer accounts associated with an introducing firm that is no longer in business to an introducing firm that is currently in business and that has an ongoing relationship with the clearing firm.  The NTM also states that, upon request, the staff would consider other situations where the use of negative response letters may be appropriate.

Based on the representations in your letter, the staff believes that the proposed use of negative response letters to accomplish a bulk assignment of the Orphan Accounts from NFS to the Receiving Broker-Dealer is consistent with NTM 02-57.  As stated above, the introducing broker-dealers previously associated with the Orphan Accounts are no longer on the NFS platform due to a BDW, a merger or acquisition, or a deconversion to another clearing platform.  The staff believes it is appropriate to apply the same rationale in NTM 02-57 regarding the ability of clearing firms to assign customer accounts to an introducing firm with which they have an ongoing relationship where the original introducing firm is no longer in business at the time of assignment to situations where  the original introducing firm is still in business at the time of assignment but the clearing relationship has concluded or been terminated prior to the transfer of customer accounts by the original introducing firm to another clearing firm.  Specifically, the staff believes that following the conclusion or termination of a clearing relationship with an introducing firm, a clearing firm may use negative response letters to assign to one or more other introducing firms with which the clearing firm has an ongoing relationship, customer accounts that were not otherwise transferred by the original introducing firm prior to the conclusion or termination of the clearing relationship.

We trust that this letter is responsive to your request.  This letter responds only to the issues you have raised based on the facts as you have described them and does not address any other rule or interpretation of FINRA, or all the possible regulatory and legal issues involved.  In addition, you should be aware that any changes in the facts as you have described them will require further consideration and may cause us to reach a different conclusion.

Very truly yours,

/s/ Ilana Herscovitz Reid

Ilana Herscovitz Reid

Cc:

Rafael Clemente, Fidelity Investments
Afshin Atabaki, FINRA

 

1 At this time, NFS is excluding accounts of deceased customers as well as accounts that have been abandoned by customers from the proposed assignment to the Receiving Broker-Dealer.  Additionally, as part of NFS’ review, NFS is excluding certain orphan accounts (e.g., orphan accounts with court-ordered restrictions) from consideration for assignment to the Receiving Broker-Dealer.

2 Your letter represents that NFS’ review did not include a comparative analysis of the historical profiles, including business models and products offered, of the prior introducing broker-dealers for the Orphan Accounts, against the Receiving Broker-Dealer because the vast majority (approximately 70%) of the Orphan Accounts have been in orphan status on the NFS platform for longer than eight years and up to 20 years.  Notwithstanding the foregoing, NFS did perform a review of the current holdings of the Orphan Accounts by security type to confirm the Receiving Broker-Dealer can effectively support the current holdings.

3 See Notice to Members 02-57 (September 2022).  NTM 02-57 addresses the use of negative response letters for the bulk transfer of customer accounts.  The notice includes, among other things, a reminder to firms that that they must be in full compliance with SEC Regulation S-P.  See also SEC Regulation S-P, 17 CFR 248 (2000).

4 Your letter represents that NFS will provide the Receiving Broker-Dealer with online access to historical transactions, to the extent such online transactions are available, for any assigned Orphan Account, as well as account statements, tax forms and additional documents and information that the former introducing broker-dealers may have provided to NFS (e.g., IRA beneficiary information).  The Receiving Broker-Dealer will also have access to the NFS service team that currently supports Orphan Accounts for routine inquiries for a reasonable period after the assignment.