Broker Rules for Outside Business Activities and Private Securities Transactions

The rules for brokers or registered representatives in the securities industry engaged in a side business outside business activity or “OBA’s” in FINRA jargon are difficult to comprehend. FINRA Rule 3270 and 3280 covers OBA reporting requirements for investment advisors and members of the securities industry.

FINRA Rule 3270 states no registered person may be an employee, independent contractor, sole propertier, officer, director, or partner of another person, or be compensated or have a reasonable expectation of compensation, from any other person as a result of any business activity outside the scope of the relationship with his or her member firm unless prior written notice has been given to the firm in the form specified by the firms rules.

This OBA rule for broker dealers covers a broad array of activity and must be broker down carefully.

The rule requires written notice whether or not the registered representative is receiving compensation from the OBA if the broker is an officer, director, or “employee” or working as an independent contractor or sole propertier in any form. If the broker is assisting a friend in managing company assets and has no expectation of compensation but is instead working for free the broker would be exempt from reporting under the rule. If the broker is working for free, has no expectation of compensation but still serving in one of the roles listed at the start of FINRA Rule 3270 then written notice must be provided to their member firm.

Going to the second half of FINRA Rule 3270 after “or” if the registered representative is receiving money or is expecting some form of compensation, the actual job title of the individual is meaningless, and written notice must be given.

The rule requires investment advisors to provide written notice to the broker dealers they’re members of (AKA the “member firm”) whenever they receive compensation in connection with a business they own or receive compensation from.

The manner in which disclosure must be made whether it be by email, fax etc. depends on the internal rules of the member firm/broker dealer. Common situations in which brokers act in OBA’s are financial advisors who also operate as Certified Public Accountants or insurance agents. OBA’s also of course include non-securities related activities which a financial advisor operates outside of his involvement with his broker dealer. According to the Financial Services Institute, some of the most common include fixed insurance sales, operating as a registered investment advisor, providing legal advice if the registered representative is also a practicing attorney.

Other common OBA’s are financial advisors serving as president, treasurer, trustee or working in some other capacity for a startup for no compensation. FINRA Rules demand this be reported to prevent any instances of selling away. As explained in another post selling away involves a registered representative soliciting a client to aquaria securities not being held by their member firm or the broker dealer they are working for.

The member firm broker dealer compliance department must then consider:

1. Whether the OBA will interfere with brokers business activities
2. Will be considered part of the brokers business as an investment advisor by the general public – broker dealer must consider the nature of the OBA to make this determination

If the member firm considers whether a reasonable investor would consider the OBA as part of the business or if there is a likelihood that the business will interfere or bias stockbroker as an impartial fiduciary then the firm should consider prohibiting the activity by the advisor.

The rules also cover the requirements for disclosure of private securities transactions or (“PST”) placed by brokers or investment advisors.

FINRA Rule 3280 governs PST’s of associated persons. The rule states that prior to participation in a private securities transaction the associated person or broker must provide written notice explaining the transaction and the brokers role and stating whether he has received or may receive selling compensation in connection with the transaction “outside the regular course or scope of an associated person's employment with a member”

This includes new offerings of securities which are not registered with the Commission, provided however that transactions subject to the notification requirements of Rule 3210, transactions among immediate family members (as defined in FINRA Rule 5130), for which no associated person receives any selling compensation, and personal transactions in investment company and variable annuity securities, shall be excluded.

If the associated person is receiving selling compensation in connection with the PST the member firm must grant approval. Even if compensation is not expected in connected with the PST notice must still be given to the broker dealer.

With very limited exceptions a brokers personal investment may be seen as a PST. Under accordance with Rule 3280(E)(1) (1) (2) "Selling compensation" shall mean any compensation paid directly or indirectly from whatever source in connection with or as a result of the purchase or sale of a security, including, though not limited to, commissions; finder's fees; securities or rights to acquire securities; rights of participation in profits, tax benefits, or dissolution proceeds, as a general partner or otherwise; or expense reimbursements.

Brokers who make “passive investments” in index funds or placing their assets into blind trusts are not covered by this rule.

One interesting gray area for investment advisors and broker dealers that covers the pitfalls of both OBA’s and PST’s are Pension Income Stream Products. These products as stated in FINRA Regulatory Notice 16-12 operate by giving a pensioner a one-time lump sum payment in exchange for rights to the pensioners future income from the pension plan. Pension Purchasing companies use investment advisors to market these products to investors. While some firms do not treat Pension Income stream products as securities and brokers may not report them under FINRA Rule 3280 they still then have to be reported as OBA’s under Rule 3270. The broker dealer must then determine whether to treat the Pension Product as a security subject to the limitations of FINRA Rule 3270 or as an OBA.

If you are an investment advisor or broker dealer who has been dealing with a regulatory inquiry or internal firm review in connection with an Outside Business Activity or Private Securities Transaction please contact the law firm of Lubiner Schmidt and Palumbo for a consultation.