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As an investor, if your broker asks you to make a check to him personally for an investment, that is a sure warning sign that something is amiss. Also, if you are buying a stock or bond in a company recommended by your broker, you deposit funds into your brokerage account, and the stock/bond is purchased and placed in your account. If, however, your broker asks you to make a check payable directly to the company, that is another warning sign of an irregularity.
One of the most damaging and embarrassing headlines about a broker-dealer in an industry publication (or, even worse, the general media), has the phrase “caught selling away” in it. An arbitration award, lawsuit or regulatory finding sanctioning a firm for the improper conduct of one of its employees for selling away or trading away can be particularly attention grabbing. The cases usually involve esoteric investments such as promissory notes, unregistered shares of privately held companies or quasi-hedge funds. Unfortunately, there are frequently more than one investor – or as a claimants’ attorney would say, “unsophisticated, duped, innocent victims.”
Ponzi schemes are form of selling away. In a Ponzi scheme, the actor entices investors to give him funds to invest in some type of financial product or program (which may not even exist). As time goes on, and more investors join the scheme, the actor makes payments - purportedly “interest” or “returns” - to the earlier investors derived from the funds paid by later investors. The Ponzi scheme typically unravels when there are insufficient funds to make the promised payments to investors – but by that time, most, if not all, of investors’ funds have disappeared.
If a broker gives you some sort of account statement, not generated by your brokerage firm, reflecting your purchase of an investment through that broker, you may have been duped.
In any of the suspicious or irregular scenarios described above, you should contact knowledgeable securities attorneys like those at Lubiner, Schmidt & Palumbo to review your account activity.
Of course, FINRA has rules addressing these situations. Rule 3270 is FINRA’s outside business activity (“OBA”) rule and mandates that a registered person must give “prior written notice” to his firm before engaging in an OBA. The firm is required to evaluate whether the OBA will interfere with the registered representative’s job responsibilities at the firm, and whether clients or the public might view the OBA as related to the firm’s own securities business. Lastly, the firm must also consider whether the OBA amounts to a private securities transaction (“PST”), which is covered by FINRA Rule 3280, discussed below.
Depending on the result of that evaluation, the firm may have to impose conditions or limitations on the OBA. Of course, the firm’s evaluation and final decision must be documented and preserved.
If the firm approves the OBA, it is required to amend the registered representative’s U-4 to disclose the OBA (Question 13).
FINRA Rule 3280 deals with PSTs. Although related to the OBA rule, it is slightly different. For instance, the rule covers “associated persons,” a larger category of employees than the “registered representatives” regulated by the OBA rule. As in the case of the OBA, the associated person must give prior written notice to the firm before engaging in the PST. However, that notice must detail the nature of the PST, the role of the associated person and whether the associated person is to receive compensation, which is broadly defined.
If the associated person is to receive compensation in some form, the firm must, in writing, state its approval or disapproval of the proposed transaction. If the PST is approved, the firm must record the transaction on its books and records and also supervise the PST as if it were conducted as part of the firm’s regular business.
If no compensation to the associated person is involved, the firm must still decide, given the nature of the PST, if it has to set some conditions regarding its employee’s participation in the PST.
So that’s what the rules say…. how does a firm insure compliance with those rules in the real world?
One way, according to industry commentators, is to begin at the beginning - the employment application process. Firms can do an Internet search of applicants to see if their names appear as officers or employees of any companies, partnerships, etc. If applicants identify any outside business activities on their job applications, the firms can then do an Internet search of those activities to verify that the applicant accurately described them.
As for current employees, firms typically require brokers to identify any OBAs or PSTs on questionnaires distributed in branches prior to annual branch exams. Again, examiners can verify the accuracy of information disclosed on the questionnaires by conducting an Internet search of any identified activities prior to the branch exams, and certainly, by questioning the associated persons during the branch exams.
Firms should be diligent in their annual compliance meetings and firm element continuing education program to highlight to employees the necessity to adhere to industry and firm rules regarding OBAs and PSTs.
Some commentators suggest additional Internet searches of associated persons during the course of the year (quarterly?), but given the existing workload of auditors and compliance professionals, at least at large broker-dealers, that does not seem practical.
Firms must be diligent in their supervision of OBAs and PSTs. Assuming that the registered representatives and/or associated persons properly disclose their OBAs and PSTs, firms can take appropriate steps to protect their customers – and the firms themselves – from any inappropriate conduct or activities on the part of their employees. It is, however, the unannounced or, in a worse case scenario, actively concealed OBAs and PSTs that get firms in the most trouble. Firms must therefore diligently follow industry rules and their own internal procedures and document adherence to those procedures so as to minimize the risk of inappropriate OBAs and PSTs.