By Brooke Nelson
Sam’s long time broker tells him about a special investment that is only available for the broker’s special clients. Sam invests $10,000 of his retirement savings in this special investment because he not only trusts the broker, but he trusts the broker’s firm as well. However, Sam later finds out that this was a scheme by his broker that was not conducted at the firm and that the broker has lost Sam’s entire investment. However, when Sam tries to pursue his claim for legal damages, he learns that the firm had no duty to supervise his broker’s outside activities. He will also learn that his broker has no money to pay. Sam is left with no redress to his $10,000 loss. The above situation is what could occur if FINRA’s proposed new rules regarding outside business activities and private securities transactions are adopted.
With Regulatory Notice 18-08, FINRA asked for comment on its new proposed rule that would replace FINRA Rule 3270 (Outside Business Activities of Registered Persons) and FINRA Rule 3280 (Private Securities Transactions of an Associated Person). These rules make firms primarily responsible for identifying and supervising certain broker activity outside the firm. Under the current rules, firms are required to know about their brokers’ outside business activities and supervise investment-related activities at third-party investment advisers.
FINRA asserts that the proposal would “reduce unnecessary burdens while strengthening investor protections relating to outside activities.” This may not be the reality. FINRA intends to remove obligations that would require firms to supervise their broker’s outside activities; this may lead to a mass of “rogue brokers” taking advantage of investors through outside activities.
Hypothetically, brokers would be able to engage in, and get away with, schemes (such as “selling away”) with no supervision by the firm. “Selling away” is when a broker sells private securities that have not been sponsored or vetted by the broker’s firm, to an investor that is a customer of the broker’s firm. These scenarios mislead the investor into believing that their security transactions are legitimized by the firm; without that misrepresentation, the sale would probably not have occurred. “Selling away”, along with other outside business schemes, would dramatically increase investor risk because of the “regulatory black hole” the proposed rule under Regulatory Notice 18-08 would create.
Additionally, these acts would leave many investors unable to collect their full extent of damages from such broker misconduct because liability would now not be directly traceable to the firm; the firm would have no supervisory duty on such activities. Fortunately, many groups, namely the Public Investor’s Arbitration Bar Association (PIABA), have come out to condemn the proposed changes because of the risks this would pose to investors. While the comment period for this notice has closed, FINRA has stated that it will continue to “listen to stakeholders and is reviewing all comments on this issue.” You may view the Investor Rights Clinic’s comment letter on the proposed rule here.
Hopefully, FINRA will realize that this proposal would create unnecessary risks for investors and does eliminate the protections of Rules 3270 or 3280. As for investors, regardless of the outcome, do not purchase anything you don’t understand; make sure the securities you are buying are sold and/or vetted by the firm your professional works for.