May 3, 2002
Karl E. May
Re: Denial of No-Action to Herbruck, Alder & Co.
Dear Mr. May:
In a letter dated November 27, 2001, on behalf of Herbruck, Alder & Co. ("HACO"), you have asked for assurances that the staff of the Division of Market Regulation ("Division") will not recommend enforcement action to the Commission under Section 15(a) of the Securities Exchange Act of 1934 ("Exchange Act") if HACO processes the payment of securities commissions received by employees as described in your letter without registering as a broker-dealer in accordance with Section 15(b) of the Exchange Act.
We understand the facts to be as follows:
You state that HACO is an "employee benefits firm" with approximately 30 employees. HACO's nine shareholder/owners, together with one additional employee, also are registered representatives with an independent broker-dealer. The nine shareholder/owners are licensed to sell non-security insurance products through HACO, and, as registered representatives, are qualified to sell securities products through the broker-dealer. The broker-dealer pays commissions for the sale of securities products directly to the registered representatives, not to HACO.
You propose that when a registered representative receives a commission check from the broker-dealer, the representative will deposit the check in the representative's bank account, and then will write a separate check to HACO. HACO would combine those securities revenues with the other revenues earned by the employee, deduct "overhead, payroll taxes, and fringe benefit costs" and remit the balance to the employee. Those amounts would be considered part of the employee's W-2 income from HACO, rather than being considered income from the broker-dealer.
You state that "HACO does not intend to earn any distributable profit" from those transactions, and that "net commissions (i.e., gross commissions less overhead, taxes and benefits) are paid only to the employee who produced the business." You also state that securities commissions would not be reallocated to any person other than one who generated the commissions, and that securities commissions would not be reallocated to someone who is not a registered representative.
You suggest that if those arrangements are not permitted, then HACO and its employees will suffer certain consequences: the registered representatives' employment benefits from HACO (such as life insurance, long-term disability and retirement plans) may be "in jeopardy"; the registered representatives would be subject to self-employment tax and quarterly tax estimates; HACO would face an administrative burden in charging expenses on "self-employment" income; the amounts that could be contributed to the registered representatives retirement plans through HACO would be reduced; and the mechanism for allocating overhead would be "complicated and inexact."
In support of HACO's proposal, you argue that securities commissions will not be paid to unregistered persons directly or indirectly, and that "all of the securities commission-derived revenue will be returned (after expenses) to the same persons who generated it."
Response of the Division of Market Regulation
Based on the facts and representations set forth in your letter, the Division is unable to assure you that it would not recommend enforcement action to the Commission under Section 15(a) of the Exchange Act if HACO enters into the arrangements described in your letter.
The Division previously has noted that the receipt of compensation related to securities transactions is a key factor that may require an entity to register as a broker-dealer. Absent an exemption, an entity that receives securities commissions or other transaction-based compensation in connection with securities-based activities that fall within the definition of "broker" or "dealer" generally is itself is required to register as a broker-dealer.1
Registration helps to ensure that persons who have a "salesman's stake" in a securities transaction operate in a manner that is consistent with customer protection standards governing broker-dealers and their associated persons. That principle not only encompasses the individual who directly takes a customer's order for a securities transaction, but also any other person who acts as a broker with respect to that order, such as the employer of the registered representative or any other person in a position to direct or influence the registered representative's securities activities.
In recent no-action letters involving "employee leasing" companies, the Division has accommodated proposals to permit alternative business arrangements to promote efficiency in the employment relationship between registered representatives and broker-dealers, consistent with the principle that registered broker-dealers must be responsible for all securities activities of their employees.2 Those letters permitted unregistered entities to employ the securities personnel of broker-dealers, and permitted those unregistered entities to intermediate the broker-dealers' compensation of those representatives. The relief in those letters was subject to conditions requiring, among other things, that the broker-dealers would be solely responsible for determining the amount and frequency of their employees' securities-related compensation, and that the employee leasing companies would not make any promotional efforts on behalf of the broker-dealers. The employee leasing companies, moreover, would provide those services to the existing jobsite employees of their client broker-dealers, and therefore had no ability to determine which specific individuals they would employ. Those conditions were designed to ensure that the broker-dealers remained in a position to fully control the securities activities of their employees. This assurance of control is not present in HACO's proposal.
We note in particular that HACO does not appear to occupy a wholly indifferent and ministerial position with regard to its employees' securities activities. In contrast to your characterization of HACO as an employee benefits firm with no interest in the securities activities of those persons, HACO's Internet website (www.herbruckalder.com) characterizes HACO as an "Employee Benefits & Financial Services" firm that provides investment consulting among other services. Several pages on the website contain the caption: "Securities offered through: Valmark Securities/Member NASD, SIPC." Thus, HACO appears to view its employees' securities activities as linked to HACO's own business operations. Indeed, HACO itself may be providing de facto marketing services to Valmark Securities.
Moreover, the proposal to use deductions from securities commissions to pay for "overhead, payroll taxes, and fringe benefit costs" suggests that securities commissions may be used to pay for benefits through HACO in a manner that is inconsistent with the primacy of the employment relationship between the broker-dealer and its registered representatives. For example, using securities commissions to pay for benefits raises the potential that the benefits may be linked to securities activity. Conversely, if the benefits that a dual employee earns through HACO are unrelated to securities activity, there is no demonstrable need to use securities commissions to pay for the benefits. It would be inappropriate to permit an unregistered entity to be in a position to supplant the broker-dealer's control over the registered representative's activities, such as by permitting unregistered persons to indirectly share in benefits paid for by the securities commissions, or by allocating securities-related benefits among registered representatives in a way that differs from the compensation chosen by the broker-dealer.
Also, in contrast to the "employee leasing" letters, HACO can select which broker-dealer registered representatives it will dually employ. HACO therefore would be in a position to provide benefits related to securities activities at the same time as it is in the position to determine who is eligible to obtain those benefits. That formulation has the potential to interfere with the employment relationship between the registered representatives and the broker-dealer, and could give HACO undue influence over those representatives' employment relationship with the broker-dealer.
For the above reasons, the Division is unable to grant the relief you have requested. This response expresses only the Division's position on enforcement action and does not purport to express any legal conclusion on the question presented.
1 See, e.g., Letter re: Birchtree Financial Services, Inc. (Sept. 22, 1998); Letter re: 1st Global, Inc. (May 7, 2001).
2 See Letter re: EPIX Holdings Corp. (March 12, 2001); Letter re: Staff Management, Inc. (April 27, 2000).
Incoming LetterThe incoming letter is attached in PDF format.