Outside Business Activities and Private Securities Transactions
Regulatory Obligations and Related Considerations
FINRA Rules 3270 (Outside Business Activities of Registered Persons) and 3280 (Private Securities Transactions of an Associated Person) require registered representatives to notify their firms in writing of proposed outside business activities (OBAs), and all associated persons to notify their firms in writing of proposed private securities transactions (PSTs), so firms can determine whether to limit or allow those activities. A 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.
- Do your firm’s WSPs explicitly state where notification or pre-approval is required to engage in an 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?
- Do you have a process in place in to update a registered representative’s Form U4 with OBAs that meet the disclosure requirements of that form?
- What methods does your firm use to identify individuals involved in undisclosed OBAs and PSTs?
- Does your firm take into account the unique regulatory considerations and characteristics of digital assets when reviewing digital asset OBAs and PSTs?
- How does your firm supervise PSTs, including digital asset PSTs, and document its compliance with the supervisory obligations?
- Does your firm record the PSTs on its books and records, including PSTs involving new or unique products and services?
Exam Findings and Effective Practices
- Incorrect Interpretation of Requirements – Interpreting “compensation” too narrowly (by focusing on only direct compensation, such as salary or commissions, rather than evaluating all direct and indirect financial benefits from PSTs, such as membership interests, receipt of preferred stock and tax benefits); and, as a result, erroneously determining that certain activities were not PSTs, or approving participation in proposed transactions without adequately considering whether the firms need to supervise the transaction as if it were executed on their own behalf.
- No Documentation – Not retaining the documentation necessary to demonstrate firms’ compliance with the supervisory obligations for PSTs and not recording the transactions on the firm’s books and records because certain PSTs were not consistent with firms’ electronic systems (such as where securities businesses conducted by a registered representative 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 notify their firms in writing of OBAs or PSTs; and WSPs not requiring the review of such notices, or the documentation that such reviews had taken place.
- No PST Monitoring – Not monitoring limitations placed on OBAs or PSTs, such as prohibiting registered representatives from soliciting firm clients to participate in the OBA or PST.
- No Review and Recordkeeping of Digital Asset Activities – Incorrectly assuming all digital assets are not securities and, therefore, not evaluating digital asset activities, including activities performed by affiliates, to determine whether they are PSTs; and for certain digital asset or other activities that were deemed to be PSTs because registered representatives received selling compensation, not supervising such activities or recording such transactions on the firm’s books and records.
Emerging OBA/PST RisksPaycheck Protection Program (PPP) Loans for Registered Representatives
FINRA noted that some registered representatives received a PPP loan for an OBA that had not been disclosed to their firms, and which may have required an update to their Form U4 as well. Firms should consider reviewing the publicly available data on PPP loans to determine if they have a registered representative who obtained a PPP loan for an undisclosed OBA.
- Questionnaires – Requiring registered representatives 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 (including asking questions relating to any other businesses where they are owners or employees; whether they are raising money for any outside activity; whether they act as “finders”; and any expected revenues or other payments they receive from any entities other than member firms, including affiliates).
- Thorough Reviews – Conducting reviews to learn about all OBAs and PSTs at the time of a registered representative’s initial disclosure to the firm and periodically thereafter, including thorough reviews of:
- social media, professional networking and other publicly available websites and other sources (such as legal research databases and court records);
- email, social media and other communications;
- interviews with registered representatives; and
- documentation supporting the activity (such as organizational documents).
- Monitoring – Monitoring significant changes in or other red flags relating to registered representatives’ 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; and
- financial records (including bank statements and tax returns).
- Affiliate Activities – Considering whether registered representatives’ 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 subject to disclosure/approval or not, as well as defining compensation, and in some cases, providing FAQs to remind employees of scenarios that they might not otherwise consider applicable to these rules.
- Training – Conducting training on OBAs and PSTs during onboarding and periodically thereafter, including regular reminders that registered representatives must give written notice of such activities to their firms and update their disclosures.
- Disciplinary Action – Imposing significant consequences—including heightened supervision, fines or termination—for registered representatives and associated persons who fail to notify firms in writing and receive approval for their OBAs and PSTs.
- Digital Asset Checklists – Creating checklists with a list of considerations to confirm whether digital asset activities would be considered OBAs or PSTs (including reviewing private placement memoranda or other materials and analyzing the underlying products and investment vehicle structures).
- Regulatory Notice 20-23 (FINRA Encourages Firms to Notify FINRA if They Engage in Activities Related to Digital Assets)
- Regulatory Notice 18-08 (FINRA Requests Comment on Proposed New Rule Governing Outside Business Activities and Private Securities Transactions)
- Notice to Members 96-33 (NASD Clarifies Rules Governing RRs/IAs)
- Notice to Members 94-44 (Board Approves Clarification on Applicability of Article III, Section 40 of Rules of Fair Practice to Investment Advisory Activities of Registered Representatives)