Selling Concession

Kelmscott Distributors is the principal underwriter for the Kelmscott funds and has a selling group agreement with Braylock Securities that pays Braylock a 4.25% concession. Aurelia buys 10,000 dollars of Kelmscott Growth Fund Class A shares through Braylock at a public offering price carrying a 5.00% sales charge. How is the 10,000 dollars divided?

1. A.9,500 dollars is invested at net asset value, Braylock keeps 425 dollars, and Kelmscott Distributors retains 75 dollarsCorrect. The 500 dollar sales charge is 5.00% of the 10,000 dollar offering price; the 4.25% concession is 425 dollars, leaving the underwriter 75 dollars.
2. B.9,575 dollars is invested at net asset value, Braylock keeps 425 dollars, and Kelmscott Distributors retains nothingThe full 5.00% sales charge comes out before any money is invested, so 9,500 dollars buys shares, not 9,575 dollars.
3. C.9,500 dollars is invested at net asset value, Braylock keeps about 21 dollars, and Kelmscott Distributors retains about 479 dollarsThis applies the 4.25% to the 500 dollar sales charge instead of to the offering price. Both percentages use the same base.
4. D.10,000 dollars is invested at net asset value and the 500 dollar charge is billed separately to AureliaA front-end load is deducted from the payment at the point of purchase; it is not invoiced afterwards.

Why: The sales charge is 5.00% of the 10,000 dollar public offering price, or 500 dollars, so 9,500 dollars goes into the fund and buys shares at net asset value. Of the 500 dollar charge, the selling dealer concession of 4.25% of the offering price is 425 dollars, which Braylock keeps. The underwriter retains the remaining 75 dollars, the 0.75 percentage point spread between the sales charge and the concession.

Ashgrove Distributors underwrites the Ashgrove funds. Delacourt Advisory, an SEC-registered investment adviser that is not a FINRA member and operates no broker-dealer, asks Ashgrove to pay it a selling concession on the fund shares its advisory clients purchase. Under FINRA rules on investment company sales charges, Ashgrove may:

1. A.Pay the concession provided the arrangement is disclosed in the fund prospectusDisclosure does not cure this. The restriction is on who may be paid, not on whether the payment is transparent.
2. B.Pay the concession provided each Delacourt professional holds an investment adviser representative registrationInvestment adviser representative registration is a state advisory registration. It does not make the firm a broker-dealer eligible for a selling concession.
3. C.Pay half the concession, treating the balance as retained underwriter compensationA prohibited payment is not made permissible by making it smaller.
4. D.Not pay the concession, because selling concessions may be granted only to broker-dealers that are FINRA membersCorrect. Transaction-based selling compensation on fund shares may go only to a member broker-dealer. An adviser that is not a registered broker-dealer cannot receive it.

Why: A member may grant a selling concession, discount or other allowance only to a broker or dealer, and the recipient must itself be a FINRA member. An investment adviser that is not a registered broker-dealer cannot be paid transaction-based selling compensation on fund sales, no matter how the arrangement is described or disclosed.

Larkfield Corp's offering is priced at 30 dollars per share with a gross underwriting spread of 1.50 dollars, made up of a 0.30 dollar manager's fee, a 0.50 dollar underwriting fee and a 0.70 dollar selling concession. Ironvale Capital belongs to neither the syndicate nor the selling group but wants shares to fill a customer order, and the manager grants it a reallowance. That reallowance is:

1. A.Equal to the full 1.50 dollar gross spreadThe gross spread is the issuer's total cost and is never paid to a single outside dealer.
2. B.Equal to the 1.20 dollar total takedown available to a syndicate memberThe takedown belongs to syndicate members who assume underwriting risk.
3. C.A portion of the 0.70 dollar selling concession, and therefore less than 0.70 dollars per shareCorrect. A reallowance is carved out of the concession for a dealer outside both the syndicate and the selling group.
4. D.Equal to the 0.30 dollar manager's feeThe manager's fee compensates the lead underwriter for running the deal.

Why: The spread breaks down in layers. The manager keeps its fee off the top. A syndicate member that sells shares earns the total takedown, which is the spread less the manager's fee, or 1.20 dollars here. A selling group member that is not at risk on the issue earns only the selling concession of 0.70 dollars. A firm outside both groups can still obtain shares, but only at a reallowance carved out of the concession, so it is by definition smaller than 0.70 dollars. Each layer earns less as the firm's commitment to the deal decreases.

An underwriting spread of $1.20 per share is composed of a $0.20 management fee, a $0.35 underwriting fee, and a selling concession. What is the selling concession per share?

1. A.$0.65Correct. $1.20 − $0.20 − $0.35 = $0.65.
2. B.$1.75Wrong. This adds all three figures together instead of solving for the missing component.
3. C.$0.85Wrong. This only subtracts one of the two known fees from the gross spread.
4. D.$1.20Wrong. This just restates the total gross spread, not the selling concession alone.

Why: Gross spread = management fee + underwriting fee + selling concession. Selling concession = $1.20 − $0.20 − $0.35 = $0.65 per share.