"Selling away" cases
Brokers are trying to lure investors with high-yield investmentsWith more Americans hurting for money, and interest rates at a low, more brokers are trying to lure investors with high-yield investments. Since more investors are trying to make short-term money, they will worry less about the source of the investment.
It is mandatory for brokers to get approval from their employer on every transaction, and for good reason. Even though broker-dealer firms tend to plead ignorance whenever nabbed by regulators for securities violations, they have a good grasp of which securities are disreputable and risky. If a broker fails to get his firm's permission to buy or sell a security on the behalf of a customer, it likely means the broker prohibits such activity.
Selling away in the U.S. securities brokerage industry is the inappropriateSelling away in the U.S. securities brokerage industry is the inappropriate practice of an investment professional (such as a registered representative, stockbroker, or financial adviser) who sells, or solicits the sale of, securities not held or offered by the brokerage firm with which he is associated (affiliatedAn example of the term expressed in a sentence is, "The broker was selling investments away from the firm." Brokers marketing securities must have obtained the appropriate securities licenses for various types of investments. Brokers in the U.S. may be "associated" with only one Brokerage firm and they obtain such licenses or "series" by passing standardized Financial Industry Regulatory Authority (FINRA) exams such as the Series 6 or Series 7 exam
Not approved for sale by the firmselling away describes the situation where the transaction or securities in question are not approved for sale by the firm, they are not on the firm's approved product list. The approved product list identifies the types of securities and investments that are approved for brokers to sell after the securities have been subjected to the brokerage firm's due diligence process which includes receiving the necessary risk and compliance department reviews and approvals, and so forth.
Selling away often involves investment securities that are in the form of a private placement or other non-public investment though not always. Sometimes a transaction may not be an obvious or apparent 'investment' or security. Selling away may not always be deliberate or intentional or with even intent to deceive an investor, but in many cases, the broker knew what he or she was doing. Selling away is often associated with a broker's other ("outside") business activities
Selling away situations result from a broker's desire to not pass up on earning a commissionSelling away situations result from a broker's desire to not pass up on earning a commission on an investment his client is willing to buy, and further, to not have to share any of the commission with his/her associated firm. Selling away schemes are particularly dangerous for investors because they usually end up becoming victims of theft, securities fraud, or some other loss related to the investment. These schemes also often involve the sale of promissory notes which are essentially loan investments wherein the borrower promises to pay investors high interest rates in exchange for the loan amount from the investor. Once the investor (client) pays the money, the borrower sooner or later stops (or never begins) paying interest payments and the client's investment vanishes
Violation of securities regulationsGenerally, selling away is a violation of securities regulations and the firm's compliance procedures by which its brokers must abide. Further, such "outside" investments may be in themselves fraudulent. The regulatory basis for selling away cases is found in NASD (now FINRA) Rule 3030 and NASD 3040. Rule 3030 provides that a brokerage firm adviser may not engage in any outside business activity unless he has provided prompt written notice to his or her brokerage firm. Rule 3040 provides that a brokerage firm adviser must not engage in private securities transactions (that is, selling away) and states the procedures that a brokerage firm must follow to approve of such investments. Once approved, the brokerage firm must supervise these private securities transactions.
Practices that could violate securities regulationsBrokers are cautioned by FINRA in their Registered Representative brochure about practices that could violate securities regulations, including selling away. "Selling away (NASD Rule 3040)--Selling securities without processing the order through your firm and without your firm's permission or knowledge is a violation of FINRA rules. Even products that you may not consider to be securities, such as leasing arrangements or promissory notes, may be securities under federal or state law. Check with your firm before engaging in any securities transactions for any purpose
Reasonable supervisory system in place?Usually the firm has no knowledge of such sales and activities. The question then becomes whether the brokerage firm "should have known" of the outside sales and activities. Howard Roitman, a securities law expert, suggests that the brokerage firm must demonstrate three things to prove it is not liable. First, that the firm has a reasonable supervisory system in place. Second, that the firm implemented its procedures in a reasonable fashion. Third, that the firm vigorously investigated red flags, which would have been any suggestion of irregularity or unusual trading activity, including client complaints and disciplinary actions by a securities regulator.
Lawyers for clients, on the other hand, must demonstrate that the brokerage firm essentially failed to execute properly on one or more of the three foregoing points, i.e., failed to establish and/or failed to implement reasonable supervisory procedures, or failed to properly follow-up on red flags.
Examples of selling awayA survey of some NASD/FINRA disciplinary actions illustrates the broad scope of not only the types of investments that are "sold away" but also the types of brokerage firms. In one example, an adviser from Summit Capital Investment Group convinced 25 clients to invest in a fraudulent pay phone leasing deal. In another example, a rep from Linsco/Private Ledger Corporation (now rebranded LPL Financial) convinced clients to invest in a limited liability company (LLC) investing in real estate. Another example involved a PaineWebber rep who convinced clients to invest in an IPO trading program that was run by an outside entity.
These are just some examples of selling away cases, for which the brokerage firm, while not knowing of the sales, may still be held responsible, even if only in part
Private dealsFor conduct dating to 1998, NASD had ordered that Browne be suspended for six months and fined $25,000, and Calandro three months and $5,000; because they were appealed, the suspensions never went into effect. The reps allegedly engaged in private deals without first providing written notice or obtaining approval from their member firm. The stock involved was that of e2 Communications, a software provider that filed for bankruptcy in 2002. Subsequent to e2's bankruptcy filing, NASD filed a complaint alleging that between 1999 and 2000, Browne and Calandro referred a number of investors to the vendor and received compensation in the form of shares. In its explanation of liability, NASD said that "the receipt of selling compensation alone constitutes participation in the transactions for purposes of Rule 3040."
Not unusual for reps that are selling away to avoid telling their firmsRubin, a former NASD deputy chief counsel of enforcement, said it is not unusual for reps that are selling away to avoid telling their firms because they are selling questionable products. However, "In this case," he said, "the representatives knew people at the firm, e2, and introduced friends and clients to persons involved at e2, for the purposes of networking and for potential business between the two sides--but not for investment reasons." Mr. Browne, who was once one of PaineWebber's biggest producers, was fired from now defunct Lehman Brothers Holdings Inc. of New York in 2003 because of the FINRA investigation, said Rubin. Browne now works for a hedge fund and Calandro now works at SMH Capital Inc., a subsidiary of Sanders Morris Harris Group Inc. of Dallas.
Selling away cases can be very seriousSelling away cases can be very serious because they often involve a bit of deception on behalf of the broker. Clients are attracted to brokers with connections, including with an employing broker dealer. If an investor is purchasing a financial product from a Securities broker, he or she could assume that product was approved and protected by the broker.
Brokers are always permitted to work outside their firm in a variety of ways. But if you suspect your broker is involving you in an investment, especially a private security transaction, without the approval of a FINRA member firm, it is certainly worth taking a closer look.
Additional resources provided by the author
- arbitration awards, even ones with glaring errors on their face, are not subject to judicial scrutiny
- securities broker-dealers impose mandatory FINRA arbitration agreements on their customers
- Howard Roitman's on avvo
- Howard Roitman on AVVO
- Howard Roitman on Justia
- Howard Roitman on Linkedin
- Howard Roitman & Assoc
- Howard Roitman on HG
- Howard Roitman on FaceBook
- FINRA Selling Away