Regulators cracking down on advisers’ outside business deals
May 15, 2010 by Dan Jamieson
By Dan Jamieson
May 14, 2010 3:33 pm ET
The brokerage industry is facing a crackdown on the practice of selling away, as firms and regulators — still fearful of undetected frauds — dig deeper into the outside business activities of registered representatives.
The increased scrutiny could spill over into the independent advisory firms run by many reps, according to some observers.
Selling away involves brokers who engage in private-securities transactions and other business dealings away from the supervision of their broker-dealer firms. Brokers must have written pre-approval from their firms for such transactions.
Many firms allow outside activities, including securities transactions, to accommodate brokers involved in other businesses, such as tax planning or advisory work.
The number of private-securities cases has been growing, and the trend has continued into this year, according to a review of Financial Industry Regulatory Authority Inc. disciplinary actions.
Through April, Finra had announced actions against 21 individuals. Over the first four months of 2008 and 2009, by comparison, Finra cited 17 and 15 individuals, respectively.
For all of 2008, Finra took action against 45 individuals in such cases. Last year, that number rose to 56. Last fall, Finra fined The Bear Stearns Cos. Inc. $500,000 over the sale of private-hedge-fund offerings and hit up MetLife Securities Inc. for $1.2 million, in part for failure to oversee private-securities transactions.
“We’re definitely see more [selling- away] cases,” said Jim Shorris, Finra’s executive director of enforcement.
Brokers are tempted by the low-interest rate environment to look at outside offers such as promissory notes, he said.
“People trying to live on that yield are particularly vulnerable” to the promise of a high return, Mr. Shorris said.
Concerns about reps’ outside work, of course, have intensified in the wake of the Bernard Madoff fraud and the Stanford Financial Group case.
“Finra is taking a much closer look at firms and their outside business activity,” said Amy Lynch, founder and president of FrontLine Compliance LLC. “We’re seeing it with our [broker-dealer] clients … because of everything that’s happened with various types of schemes.”
As a result, “I think we’ll see an increase in these types of cases, the fines will continue, and individuals will continue to get barred,” Ms. Lynch said.
“Regulators are actively sifting for Ponzi schemes,” said David Rosedahl, of counsel at Briggs & Morgan PA. “That [scrutiny] will generate more selling-away cases.”
Some hard-hit brokers have also sold away in an attempt to make back money that they lost during the market crash, said Sam Edgerton, a partner at Edgerton & Weaver LLP.
“Our caseload went up at least 100% last year from [defending] selling-away cases,” he said.
In 2009, Mr. Edgerton had about five such cases. Now he is defending at least 10, which include several of his biggest.
Selling away has always been a supervisory challenge for brokerage firms, observers said.
“If you’re not really proactive about looking for it, you have no way of knowing about it,” Ms. Lynch said.
Even honest brokers aren’t always diligent about informing firms about outside activities, and sometimes they don’t understand how non-financial business opportunities can still be considered securities, observers said.
The independent model, with its remote offices and entrepreneurial representatives, is most at risk, Ms. Lynch said.
Mr. Edgerton and others said that dually licensed advisers who run their own registered investment advisory firms on the side could come under particular attention from an increased focus on outside activities.
“With an independent RIA, that’s where you see [selling-away problems] the most,” he said. “I see that time and time again.”
Ms. Lynch said that her broker-dealer clients are looking more closely at their reps’ RIA businesses during audits.
“When they go into a branch audit, they’re looking at the [adviser’s Form] ADV, looking at the trade blotters and the compliance manuals, and seeing what [a broker is] doing” on the advisory side, she said.
If outside deals go awry, lawyers said, the investor victims always sue the brokerage firm, whether or not the firm knew anything about them.
“One selling-away case can bring down your firm,” Mr. Edgerton said.
That is why securities attorney Robert Bramnik, a partner at Duane Morris LLP, recently recommended that a broker-dealer client get indemnified by a futures firm for business a registered rep wanted to do at the futures merchant.
“We are putting a much higher level of attention on selling-away situations,” he said, even when the outside business is clearly being done aboveboard and according to the rules.
Another risk is that errors-and-omissions insurance coverage may not always pay for selling-away claims.
“Basically, [E&O carriers] resist it,” Mr. Rosedahl said. “They might say that the selling away is not in the scope of your normal business,” and so it isn’t covered by the policy.
In addition, Finra will always pursue brokers and firms for any selling-away violation that it finds, said Joel Beck, founder of The Beck Law Firm LLC.
Selling-away problems “always result in formal disciplinary action,” he said.
