Selling away

Last updated

Selling 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 (affiliated). [1] An 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 one or more Brokerage firms and must obtain licenses by passing standardized Financial Industry Regulatory Authority (FINRA) exams such as the Series 6 or Series 7 exam. See List of Securities Examinations for types of securities licenses in the U.S.

Contents

More specifically, selling away describes the situation in which 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 analyzed during the brokerage firm's due diligence process, which includes receiving the necessary risk and compliance department reviews and approvals.

Selling away often involves investment securities that are in the form of a private placement or other non-public investment, [1] 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 deliberately solicited one or more investments without approval of the firm with which he is associated. Selling away is often conducted in conjunction with a broker's outside business activity (another business or activity that a broker conducts outside of and separate from the securities brokerage activities at his/her associated firm.)

Selling away situations may result from a broker's desire not to pass up on earning a commission on an investment product his client is willing to buy, and further, not to have to share the commission with his/her associated firm. Selling away schemes may be especially dangerous for investors because the investor may end up becoming a victim of theft, securities fraud, or other loss related to the investment. These schemes often involve the sale of promissory notes which are essentially loans to the broker wherein the borrower promises to pay investors a high rate of interest for the loan from the investor. Once the investor (client) remits the money, the borrower may sooner or later stop (or never begin) paying the interest and the client’s investment may not be returned. [2]

Securities regulations; liability of the brokerage firm

Generally, selling away is a violation of securities regulations and the firm's compliance procedures unless it is approved in advance. Further, such "outside" investments may in themselves be fraudulent. The regulatory basis for selling away cases is found in FINRA rule 3270 (formerly NASD rule 3030). Rule 3270 provides that a brokerage firm representative 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 representative must not engage in private securities transactions (that is, selling away) unless approved by the firm 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.

Brokers are cautioned by FINRA about practices that could violate securities regulations, including selling away. "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." [3]

The firm may not have advance knowledge of such sales and activities. The question then becomes whether the brokerage firm "should have known" of the outside sales and activities. Robert Lowry, 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.

Claimants' lawyers, 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., (i.) failed to establish and/or (ii.) failed to implement reasonable supervisory procedures, or (iii.) failed to properly follow-up on red flags. Robert Lowry suggests that client lawyers provide illustrations of how the brokerage firm's supervision fell through the cracks, thereby causing the client harm.

A survey of some FINRA/NASD 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 representative 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, even if they were unaware of the sales, may still be held responsible, in whole or only in part. [4]

SEC reverses FINRA ruling

Right or wrong, FINRA likely prevails with brokers and firms settling arbitration disputes and complaints according to FINRA's final decision, however, according to Nov. 2008 articles published online by Securities Industry News and Investment News, the U.S. Securities and Exchange Commission (SEC), in a highly unusual move, reversed FINRA in a recent selling away case appeal.

The SEC set aside a FINRA decision in a selling away case where reps allegedly engaged in private securities transactions in violation of NASD Conduct Rule 3040. In its November 7, 2008 opinion, the SEC reversed FINRA predecessor NASD, explaining that the self-regulatory organization (SRO) had presented a “new theory of liability” that amounted to a novel interpretation of Rule 3040, which requires registered representatives to obtain approval before engaging in business activity away from their firm. It concluded that the record “provides insufficient support” that either of the two reps involved (James Browne or Kevin Calandro, two Dallas-based brokers formerly of PaineWebber Inc. of New York) participated in transactions in violation of the rule. “In sum, we … dismiss those charges,” said the commission. FINRA spokesperson Herbert Perone declined to comment on the decision.

For 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.”

In its ruling, the SEC countered that NASD had created a new interpretation of Rule 3040 without providing prior notice to the applicants. “This lack of notice alone raises sufficient concerns to warrant dismissal of the charges,” said the commission, adding that the SRO also failed to establish a connection between the reps’ referrals and the e2 stock transactions. “There was no proof that they were making introductions for investment purposes. Plus there was a significant time period between the introductions and the purchases,” said Brian Rubin, a Washington D.C.-based partner in law firm Sutherland Asbill & Brennan (now renamed "Sutherland") who represented Browne in the appeal. Rubin added that he has been unable to find another instance of the SEC reversing an NASD ruling for at least a decade.

Rubin, 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.

In upholding the NASD hearing panel’s 2006 decision, the NASD National Adjudicatory Council in December 2007 agreed that the case presented “uncommon and unusual” facts, added Rubin. “In our view, NASD pushed the envelope too far with respect to this type of violation,” he said. “And the SEC agreed with us.” As a result, “Individuals and firms should think long and hard before they decide to settle with FINRA."

FINRA's theory in going after Mr. Browne and Mr. Calandro was that, since startups like e2 often seek funding from various individuals involved with the company, the brokers should have known that introducing their clients to e2 would lead those clients to make investments in e2. "This was a junk case that never should have been brought," said Mr. Calandro's attorney, E. Steve Watson of E. Steve Watson Attorney at Law in Allen, Texas. Watson said the decision will "cut down the boundaries" of prior selling-away cases that gave enforcers wide latitude.

"I'm using it [the decision] a lot" in arguing other cases, said Jonathan Kord Lagemann, a Chatham, N.Y.-based defense attorney who is not connected to the case. "The moral here is ... there is value in forcing regulators to try their cases," said Pete Michaels, a defense attorney at Michaels Ward & Rabinovitz LLP in Boston who is not involved in the case. [5] [6]

Related Research Articles

<span class="mw-page-title-main">Investment banking</span> Type of financial services company

Investment banking is an advisory-based financial service for institutional investors, corporations, governments, and similar clients. Traditionally associated with corporate finance, such a bank might assist in raising financial capital by underwriting or acting as the client's agent in the issuance of debt or equity securities. An investment bank may also assist companies involved in mergers and acquisitions (M&A) and provide ancillary services such as market making, trading of derivatives and equity securities, FICC services or research. Most investment banks maintain prime brokerage and asset management departments in conjunction with their investment research businesses. As an industry, it is broken up into the Bulge Bracket, Middle Market, and boutique market.

In financial services, a broker-dealer is a natural person, company or other organization that engages in the business of trading securities for its own account or on behalf of its customers. Broker-dealers are at the heart of the securities and derivatives trading process.

<span class="mw-page-title-main">Securities Exchange Act of 1934</span> 1934 U.S. legislation establishing rules and regulatory bodies for financial markets

The Securities Exchange Act of 1934 is a law governing the secondary trading of securities in the United States of America. A landmark piece of wide-ranging legislation, the Act of '34 and related statutes form the basis of regulation of the financial markets and their participants in the United States. The 1934 Act also established the Securities and Exchange Commission (SEC), the agency primarily responsible for enforcement of United States federal securities law.

Churning is the practice of executing trades for an investment account by a salesperson or broker in order to generate commission from the account. It is a breach of securities law in many jurisdictions, and it is generally actionable by the account holder for the return of the commissions paid, and any losses occasioned by the broker's choice of stocks.

Prime brokerage is the generic term for a bundled package of services offered by investment banks, wealth management firms, and securities dealers to hedge funds which need the ability to borrow securities and cash in order to be able to invest on a netted basis and achieve an absolute return. The prime broker provides a centralized securities clearing facility for the hedge fund so the hedge fund's collateral requirements are netted across all deals handled by the prime broker. These two features are advantageous to their clients.

<span class="mw-page-title-main">Securities Investor Protection Corporation</span> American financial non-profit

The Securities Investor Protection Corporation is a federally mandated, non-profit, member-funded, United States government corporation created under the Securities Investor Protection Act (SIPA) of 1970 that mandates membership of most US-registered broker-dealers. Although created by federal legislation and overseen by the Securities and Exchange Commission, the SIPC is neither a government agency nor a regulator of broker-dealers. The purpose of the SIPC is to expedite the recovery and return of missing customer cash and assets during the liquidation of a failed investment firm.

Raymond James Financial, Inc. is an American multinational independent investment bank and financial services company providing financial services to individuals, corporations, and municipalities through its subsidiary companies that engage primarily in investment and financial planning, in addition to investment banking and asset management. Headquartered in St. Petersburg, Florida, Raymond James is one of the largest banking institutions in the United States.

World Group Securities (WGS) is an American broker-dealer that provides exclusive services to World Financial Group a multi-level marketing financial and insurance services company. WGS is a subsidiary of the Dutch-owned AEGON insurance Group. WGS has been involved in a number of lawsuits with state regulators alleging the selling of unsuitable products to elderly people.

Front running, also known as tailgating, is the practice of entering into an equity (stock) trade, option, futures contract, derivative, or security-based swap to capitalize on advance, nonpublic knowledge of a large ("block") pending transaction that will influence the price of the underlying security. In essence, it means the practice of engaging in a personal or proprietary securities transaction in advance of a transaction in the same security for a client's account. Front running is considered a form of market manipulation in many markets. Cases typically involve individual brokers or brokerage firms trading stock in and out of undisclosed, unmonitored accounts of relatives or confederates. Institutional and individual investors may also commit a front running violation when they are privy to inside information. A front running firm either buys for its own account before filling customer buy orders that drive up the price, or sells for its own account before filling customer sell orders that drive down the price. Front running is prohibited since the front-runner profits come from nonpublic information, at the expense of its own customers, the block trade, or the public market.

<span class="mw-page-title-main">Ameriprise Financial</span> American financial services company

Ameriprise Financial, Inc. is an American diversified financial services company and bank holding company based in Minneapolis, Minnesota. It provides financial planning products and services, including wealth management, asset management, insurance, annuities, and estate planning.

<span class="mw-page-title-main">United States securities regulation</span> Law and regulations that relate to Securities

Securities regulation in the United States is the field of U.S. law that covers transactions and other dealings with securities. The term is usually understood to include both federal and state-level regulation by governmental regulatory agencies, but sometimes may also encompass listing requirements of exchanges like the New York Stock Exchange and rules of self-regulatory organizations like the Financial Industry Regulatory Authority (FINRA).

<span class="mw-page-title-main">Financial adviser</span> Professional who renders financial services to clients

A financial adviser or financial advisor is a professional who provides financial services to clients based on their financial situation. In many countries, financial advisors must complete specific training and be registered with a regulatory body in order to provide advice.

A registered investment adviser (RIA) is a firm that is an investment adviser in the United States, registered as such with the Securities and Exchange Commission (SEC) or a state's securities agency. The numerous references to RIAs within the Investment Advisers Act of 1940 popularized the term, which is closely associated with the term investment adviser. An investment adviser is defined by the Securities and Exchange Commission as an individual or a firm that is in the business of giving advice about securities. However, an RIA is the actual firm, while the employees of the firm are called Investment Adviser Representatives (IARs).

In the United States, a pattern day trader is a Financial Industry Regulatory Authority (FINRA) designation for a stock trader who executes four or more day trades in five business days in a margin account, provided the number of day trades are more than six percent of the customer's total trading activity for that same five-day period.

<span class="mw-page-title-main">Stratton Oakmont</span> Defunct American brokerage house (1989–1996)

Stratton Oakmont, Inc. was a Long Island, New York, over-the-counter brokerage house founded in 1989 by Jordan Belfort and Danny Porush. It defrauded many shareholders, leading to the arrest and incarceration of several executives and the closing of the firm in 1996.

Manuel P. Asensio is the founder, chairman and president of Asensio & Company, LLC an investment firm established in 1992.

The Financial Industry Regulatory Authority (FINRA) is a private American corporation that acts as a self-regulatory organization (SRO) that regulates member brokerage firms and exchange markets. FINRA is the successor to the National Association of Securities Dealers, Inc. (NASD) as well as to the member regulation, enforcement, and arbitration operations of the New York Stock Exchange. The U.S. government agency that acts as the ultimate regulator of the U.S. securities industry, including FINRA, is the U.S. Securities and Exchange Commission (SEC).

Payment for order flow (PFOF) is the compensation that a stockbroker receives from a market maker in exchange for the broker routing its clients' trades to that market maker. It is a controversial practice that has been called a "kickback" by its critics. Policymakers supportive of PFOF and several people in finance who have a favorable view of the practice have defended it for helping develop new investment apps, low-cost trading, and more efficient execution.

<span class="mw-page-title-main">Securities market participants (United States)</span>

Securities market participants in the United States include corporations and governments issuing securities, persons and corporations buying and selling a security, the broker-dealers and exchanges which facilitate such trading, banks which safe keep assets, and regulators who monitor the markets' activities. Investors buy and sell through broker-dealers and have their assets retained by either their executing broker-dealer, a custodian bank or a prime broker. These transactions take place in the environment of equity and equity options exchanges, regulated by the U.S. Securities and Exchange Commission (SEC), or derivative exchanges, regulated by the Commodity Futures Trading Commission (CFTC). For transactions involving stocks and bonds, transfer agents assure that the ownership in each transaction is properly assigned to and held on behalf of each investor.

<span class="mw-page-title-main">Citadel Securities</span> American market making firm

Citadel Securities LLC is an American market making firm providing liquidity and trade execution to retail and institutional clients, headquartered in Miami. The firm also trades futures, equities, credit, options, currencies, and Treasury bonds. It is the largest designated market maker on the New York Stock Exchange.

References

  1. 1 2 Hayes, Adam (July 10, 2022). "What is Selling Away?". Investopedia. Archived from the original on May 25, 2024.
  2. ↑ "Securities Fraud Lawyer | the Doss Firm, LLC". The Doss Firm LLC. Archived from the original on March 3, 2016.
  3. ↑ "FINRA - Registered Representative Brochure - Sample Practices That Violate Regulations". Archived from the original on 2009-06-09. Retrieved 2009-05-13.
  4. ↑ Eccleston, James J. ""Selling Away"; A Primer for Investors and Their Attorneys". FinancialCounsel.com. Archived from the original on May 17, 2008.
  5. ↑ Curtis, Carol E. (November 11, 2008). "SEC Reverses Finra in 'Selling Away' Case". Archived from the original on July 22, 2012.
  6. ↑ Jamieson, Dan (30 November 2008). "Brokers are cleared in selling-away case". Archived from the original on March 4, 2016.{{cite web}}: CS1 maint: unfit URL (link)
This page is based on this Wikipedia article
Text is available under the CC BY-SA 4.0 license; additional terms may apply.
Images, videos and audio are available under their respective licenses.