[18273]
November 30, 2004
TO: CHIEF COMPLIANCE OFFICER COMMITTEE No. 31-04
COMPLIANCE ADVISORY COMMITTEE No. 116-04
SEC RULES MEMBERS No. 168-04
SMALL FUNDS MEMBERS No. 125-04
RE: INSTITUTE COMMENT LETTER ON NASD PROPOSAL TO BAN DIRECTED
BROKERAGE
The Securities and Exchange Commission recently published for comment an NASD
proposal to prohibit the practice of broker-dealers receiving mutual fund brokerage
commissions as compensation for the sale of fund shares.1 The Institute filed the attached
comment letter with the Commission on the proposal. Both the proposal and the comment
letter are briefly summarized below.
I. NASD PROPOSAL
Currently, NASD Conduct Rule 2830(k) prohibits broker-dealers from conditioning their
efforts in distributing a fund’s shares on receipt of the fund’s brokerage commissions. An
exception in the rule, however, allows a broker-dealer to sell shares of any fund that follows a
policy, disclosed in its prospectus, of considering sales of its shares as a factor in the selection of
broker-dealers to execute portfolio transactions, subject to the requirements of best execution.
The NASD proposal would eliminate this exception due to concerns that the exception
undermines the rule’s general prohibition against quid pro quo arrangements in which brokerage
commissions are used to compensate broker-dealers for selling fund shares. The proposal also
would add a provision to Rule 2830(k) prohibiting any NASD member from selling a fund’s
shares if the member knows or has reason to know that the fund (or its adviser or principal
underwriter) has entered into any agreement or understanding under which the fund is
expected to direct its portfolio transactions (or commissions or markups from such transactions)
to a broker or dealer in consideration for promotion or sale of the fund’s shares.
1 See Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by National Association of Securities
Dealers, Inc. Relating to Investment Company Portfolio Transactions, 69 Fed. Reg. 64609 (Nov. 5, 2004), available on
the SEC’s website at http://www.sec.gov/rules/sro/nasd/34-50611.pdf.
2
II. INSTITUTE COMMENT LETTER
The Institute’s comment letter expresses support for the NASD proposal. It states that
the proposal is consistent with a December 2003 recommendation by the Institute to prohibit
directed brokerage arrangements. The letter observes that adoption of the NASD proposal
would complement the SEC’s recent amendment to Rule 12b-1 under the Investment Company
Act, which prevents funds from paying for the distribution of their shares with brokerage
commissions.2 Finally, the letter expresses support for the NASD’s decision to retain language
in Rule 2830(k) clarifying that a broker-dealer would not violate the rule solely because it
promotes or sells shares of a fund that directs portfolio transactions to the broker-dealer.
Rachel H. Graham
Assistant Counsel
Attachment (in .pdf format)
Note: Not all recipients receive the attachment. To obtain a copy of the attachment, please visit our members website
(http://members.ici.org) and search for memo 18273, or call the ICI Library at (202) 326-8304 and request the
attachment for memo 18273.
2 See Institute Memorandum to Chief Compliance Officer Committee No. 5-04, Compliance Advisory Committee No.
87-04, SEC Rules Members No. 127-04 and Small Funds Members No. 98-04 [17957], dated Sept. 8, 2004.