Firm Fined for Failing to Evaluate Outside Business Activity
Commentary by Jeff Ziesman
A broker-dealer settled FINRA charges for failing to evaluate a registered representative's outside business activity ("OBA") which involved managing an investment fund.
According to the AWC, the firm approved a representative's OBA involving managing an investment fund that provided loans to early-stage companies. FINRA noted that the representative informed the firm when closing OBA transactions, which included over $3 million in investments, secured notes and warrants for company stock.
FINRA found that the firm failed to adequately evaluate the representative's OBA activities or determine whether they involved "securities." FINRA determined that the firm failed to evaluate the representative's activities to determine whether they (i) should be restricted/prohibited or (ii) would interfere or compromise the registered person's responsibilities to the firm, firm's customers or be viewed as a part of the firm's business. FINRA also found that the firm did not maintain records regarding its evaluation or approval of the representative's proposed OBA.
FINRA charged the firm with violations of FINRA Rules 3110 ("Supervision"), 3270.01 ("Outside Business Activities of Registered Persons") and 2010 ("Standards of Commercial Honor and Principles of Trade").
To settle the charges, the firm agreed to (i) a censure and (ii) pay a $40,000 fine.
Commentary
Outside business activities ("OBA") have been a problematic aspect of broker-dealer supervision for over 25 years. Many representatives are entrepreneurial by nature and are motivated to explore "business opportunities." When a broker-dealer receives a notice of an OBA, it is required to evaluate whether to approve it, and also assess whether the outside activity is, in fact, a private securities transaction.
According to the facts in this AWC, the representative disclosed an OBA that, on its face, suggested it could be a private securities transaction. It is incumbent on the broker-dealer to properly assess whether the activities were outside securities transactions. In this case, the broker-dealer also failed to record the activity in its books-and-records.
Notably, the fine was likely less than it might have been as none of the investors in the outside activity were customers of the broker-dealer, nor did they lose any money.