Outside Business Activities and Private Securities Transactions
Regulatory Obligations and Related Considerations
Regulatory Obligations
FINRA Rules 3270 (Outside Business Activities of Registered Persons) and 3280 (Private Securities Transactions of an Associated Person) require registered persons to notify their member firms in writing of proposed OBAs, and all associated persons to notify their firms in writing of proposed PSTs, so firms can determine whether to prohibit, limit or allow those activities. A member firm approving a PST where the associated person has or may receive selling compensation must record and supervise the transaction as if it were executed on behalf of the firm.
Related Considerations
- What methods does your firm use to identify individuals involved in undisclosed OBAs and PSTs?
- Do your firm’s WSPs explicitly state when and how registered persons must notify your firm of a proposed OBA or PST?
- Does your firm require associated persons or registered persons to complete and update, as needed, questionnaires and attestations regarding their involvement— or potential involvement—in OBAs and PSTs; and if yes, how often?
- Upon receipt of a written notice of proposed OBAs, does your firm consider whether the activity will interfere with or otherwise compromise the registered person’s responsibilities to your firm and its customers, or be viewed by customers or the public as part of the member’s business? Does your firm also determine whether such activities should be treated as a PST (subject to the requirements of FINRA Rule 3280)?
- Does your firm have a process in place to update a registered person’s Form U4 with activities that meet the disclosure requirements of that form?
- Does your firm take into account the regulatory considerations and characteristics of crypto assets when reviewing crypto asset-related OBAs and PSTs?
- Does your firm record PSTs for compensation on its books and records, including PSTs involving new or unique products and services?
- How does your firm supervise activities that are PSTs for compensation, including those involving crypto asset securities, and document its compliance with the supervisory obligations?
- What training and guidance does your firm provide registered persons and associated persons, during onboarding and periodically thereafter, with regard to their potential engagement in OBAs and PSTs?
Findings and Effective Practices
Findings
- Incorrect Interpretation of Selling Compensation for Potential PSTs: Interpreting “selling compensation” too narrowly (by focusing on only direct compensation, such as commissions, rather than evaluating all direct and indirect financial benefits from PSTs, such as receipt of securities and tax benefits); and, as a result, erroneously determining that certain activities were not PSTs for compensation.
- Inadequate Approval Process for Potential PSTs: Approving participation in proposed PSTs for compensation without adequately considering how the individual’s participation in the proposed PSTs would be supervised as if the transactions were executed on the firms’ behalf.
- No Documentation:
- Not retaining the documentation necessary to demonstrate the firm’s compliance with the supervisory obligations for PSTs involving compensation.
- Not recording transactions for compensation on the firm’s books and records because certain PSTs were not consistent with the firm’s electronic systems (such as where securities transactions conducted by an associated person would not be captured in their clearing firm’s feed of purchases and sales activity).
- No or Insufficient Notice and Notice Reviews: Registered persons failing to provide prior written notice to their firms of OBAs or, for associated persons, of PSTs; and WSPs not requiring the review of such notices, or the documentation that such reviews had taken place.
- Inadequate Controls: Inadequate controls to confirm adherence to the firm’s limitations placed on OBAs or PSTs, such as prohibiting registered persons from soliciting firm clients to participate in an OBA or PST.
- No Review and Recordkeeping of Crypto Asset-Related Activities:
- Failing to disclose, approve or follow required rule steps for crypto asset-related OBAs and PSTs.
- Making a false statement related to OBAs or PSTs involving crypto assets on member firms’ annual attestations.
- Assuming that all crypto assets are not securities and therefore not evaluating crypto asset-related activities, including activities performed through affiliates, to determine whether they should be treated as PSTs.
- For certain crypto assets or other activities that were deemed to be PSTs for compensation, not supervising a person’s participation in such activities or recording such transactions on the firm’s books and records.
Effective Practices
- Questionnaires: Requiring registered persons and other associated persons to complete upon hire, and periodically thereafter, detailed, open-ended questionnaires with regular attestations regarding their involvement—or potential involvement—in new or previously disclosed OBAs and PSTs, which include questions concerning:
- any other businesses where they are owners or employees;
- whether they are raising money for any outside activity;
- whether they act as “finders” for issuers seeking new investors; and
- any expected revenues, payments, or direct and indirect financial benefits they receive from any entities other than the firm, including affiliates.
- Due Diligence: Conducting due diligence to learn about all OBAs and PSTs at the time of a registered person’s initial disclosure to the firm and periodically thereafter, including interviewing the registered person and thoroughly reviewing:
- social media, professional networking and other publicly available websites, and other sources (such as legal research databases and court records);
- email and other communications;
- documentation supporting the activity (such as organizational documents); and
- OBAs that involve investment advisers or fund companies in order to identify potential PSTs.
- Monitoring: Monitoring significant changes in, or other red flags relating to, registered persons’ or associated persons’ performance, production levels or lifestyle that may indicate involvement in undisclosed or prohibited OBAs and PSTs (or other business or financial arrangements with their customers, such as borrowing or lending), including conducting regular, periodic background checks and reviews of:
- correspondence (including social media);
- fund movements;
- marketing materials;
- online activities;
- customer complaints;
- financial records (including bank statements and tax returns);
- branch office activities; and
- gifts and gratuities logs.
- Affiliate Activities: Considering whether registered persons’ and other associated persons’ activities with affiliates, especially self-offerings, may implicate FINRA Rules 3270 and 3280.
- WSPs: Clearly identifying types of activities or investments that would constitute an OBA or PST, as well as defining selling compensation and in some cases providing FAQs to remind employees of scenarios that they might not otherwise consider to implicate these rules.
- Training: Conducting training on OBAs and PSTs during registered person and associated person onboarding and periodically thereafter, including regular reminders of written notice requirements and for registered persons to update their public disclosures.
- Disciplinary Action: Imposing significant consequences—including heightened supervision, fines or termination—for persons who fail to notify firms in writing of their OBAs and PSTs, or fail to receive approval of their PSTs for compensation.
- Controls for Outside Crypto Asset-Related Activities
- Establishing policies, procedures and controls related to crypto asset-related OBAs of registered persons that clearly detail:
- the conditions under which crypto asset OBAs will be prohibited (and when limitations on the activity will be imposed); and
- how the firm will assess whether the activity is a PST, such as when crypto assets are sold as investment contract securities.
- Searching for indicators of undisclosed crypto asset-related OBAs and PSTs during reviews of electronic correspondence.
- Establishing policies, procedures and controls requiring associated persons to disclose accounts in which they could effect crypto asset securities transactions and for supervisory review of transactions in those accounts.
- Establishing policies, procedures and controls related to crypto asset-related OBAs of registered persons that clearly detail:
- Crypto Asset Checklists: Creating checklists with a list of considerations to confirm whether crypto asset-related activities would be considered OBAs or PSTs (including reviewing private placement memoranda or other materials and public statements of promoters of crypto assets, and analyzing the underlying products and investment vehicle structures).