Outside Business Activities and Private Securities Transactions

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 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 prohibit, 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. 

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, 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.
• No Documentation:
  • Not supervising a person’s participation in PSTs for compensation or recording such transactions on the firm’s books and records.
  • 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. 

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.
• 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, which could 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.

Additional Resources

• FINRA
  • Notice to Members 96-33 (NASD Clarifies Rules Governing RR/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)