SEC Allows Personal Services Entities to Receive Transaction-Based Compensation
Commentary by Steven Lofchie
In a no-action letter, the SEC Division of Trading and Markets ("Division") permitted Personal Services Entities ("PSEs") owned by registered representatives to receive transaction-based compensation ("TBC") without registering as broker-dealers.
Under the no-action position, the Division said a PSE may receive TBC without triggering broker-dealer registration under SEA Section 15 ("Registration and regulation of brokers and dealers"). The Division permitted this compensation only if the PSE does not perform any broker-dealer activities—such as soliciting, negotiating, or executing securities transactions—and the sponsoring broker-dealer retains full supervisory responsibility over all brokerage functions. The Division explained that the relief addresses uncertainty over whether representative-owned entities must register when used as compensation pass-throughs and is based on representations that the structure preserves, rather than circumvents, broker-dealer supervisory control.
The relief is contingent on the broker-dealer and PSE satisfying operational and compensation conditions, including: (i) all PSE owners must be registered persons of the broker-dealer; (ii) the PSE must be designated as a branch office or Office of Supervisory Jurisdiction; (iii) the broker-dealer must retain final discretion over the timing and amount of TBC; and (iv) the broker-dealer must maintain detailed compensation records under SEA Rule 17a-3 ("Records to be made by certain exchange members, brokers and dealers") and Rule 17a-4 ("Records to be preserved by certain exchange members, brokers and dealers").
The Division stated that the broker-dealer and PSE must also execute a written agreement that: (i) affirms the exclusive control over all securities-related activities; (ii) confirms the broker-dealer’s sole responsibility for hiring, registration, training, supervision, and discipline; (iii) guarantees regulators full access to books and records held by the PSE; (iv) prohibits the PSE from engaging in any broker-dealer activity or holding itself out as a broker-dealer; and (v) limits unregistered PSE personnel to clerical tasks with no TBC-based compensation.
The Division noted that the relief supersedes any prior staff guidance to the extent inconsistent with this position.
Commentary
This is quite a significant change in the very longstanding interpretation that transaction compensation should be paid to a natural person and not to a personal service entity. The revised interpretation will undoubtedly lead to quite a bit of restructuring of compensation arrangements at broker-dealers that work on the independent contract model, rather than on the employee model.
The significance of the interpretation potentially extends well beyond the immediate topic of the letter. It has been long understood that transaction-based compensation is a hallmark of broker-dealer activity. As a result, if two legal entities (not themselves directly engaged in broker-dealer activities) were providing identical support services to broker-dealers, the one that received transaction-based compensation would be required to register, but the other might not if it were paid in other ways. It has always seemed an oddity of broker-dealer law that the registration requirement could be based on the manner of compensation, as opposed to the scope of the activities. This letter challenges that concept: a legal entity that receives TBC is not required to register so long as it does not conduct activities requiring registration.