Referral Fees to a Private Real Estate Fund
A registered representative in the operations department is approached by a real estate developer who wants to pay him $2,500 for each client he refers to a private real estate fund. The rep would not sell securities; he would introduce the developer to clients, some of whom are firm customers. The rep's Form U4 lists no outside business activity. The developer says the fund is "not a security" because it owns physical property. The rep asks the compliance officer whether he can accept the arrangement if he discloses it verbally to his supervisor and signs a waiver.
1. Is written notice or approval required, and is verbal disclosure enough?
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Written notice is required. Under FINRA Rule 3270, an associated person must provide written notice to the firm before engaging in any outside business activity, and the firm must approve or disapprove. Verbal disclosure to a supervisor is not sufficient, and a waiver signed only by the rep does not substitute for firm approval. The firm should also update its records if the activity is approved.
2. Does the fund's status as a security matter?
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Yes. The developer's label is not controlling. A pooled real estate fund with passive investors who rely on the promoter's efforts can be a security, such as an investment contract or limited partnership interest. If it is a security, the arrangement may be a private securities transaction under Rule 3280, requiring prior written notice and firm approval, and possibly registration if the rep receives transaction-based compensation. Even if it is not a security, the referral fee and use of firm customer relationships create conflicts and privacy issues.
3. What should compliance do with the request?
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Compliance should deny the arrangement pending a full review. It should obtain the fund's offering documents, determine whether the interest is a security, evaluate Rule 3270 and Rule 3280, and assess whether using firm customer information or client relationships is permissible. If approved at all, the firm should impose written conditions, including no use of customer information without consent and no referral compensation that creates a sales-practice violation. The decision and rationale should be documented.