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Outside Business Activity Abuses High on FINRA’s Hit List

By Erwin J. Shustak, Esq. of Shustak Reynolds & Partners, P.C. posted on Wednesday, June 6, 2018.

As a sign of just how serious FINRA considers failures by brokers to comply with their firm’s Outside Business Activity disclosure rules to be, consider this: Four of the 11 consent letters, by which a registered person agrees to a settlement with FINRA, that FINRA published last week on the FINRA website, involved violations of Rules 3270 and 3280, which require registered persons to receive written permission from their firms to engage in outside business and private securities transactions.

While many of these violations. that result in varying degrees of sanctions by FINRA, represent the crossing of a clear, bright line, some are not that clear or that bright.  At one extreme is a typical case posted by FINRA. In one case, an ex-Morgan Stanley employee, Kenneth Jobson, agreed to a sanction order for buying 39.5% of a fuel service company and helping to run it despite written assurances to Morgan that he was neither an owner of the business nor spent any time running it. Moreover, during the same period, Jobson also bought a 21.7% interest in a customized mobile home manufacturer also without notifying the firm. A clear violation for which FINRA has little sympathy and for which there is not much of a defense. Morgan fired Jobson back in 2016 for not disclosing either of these outside business activities. FINRA reached a settlement agreement with Jobson which included a $5,000 fine and a three-month suspension from FINRA.

Some of the other situations, however, are not as clear.  Asked at a recent FINRA annual conference whether the occasional rental of a vacation home rose to the level of an outside business activity that required firm approval versus a totally passive investment, FINRA Associate General Counsel Meredith Cordisco admitted there was “no clear answer”.  FINRA deliberately does not spell out what is a “passive” investment to avoid creating loopholes. Its general position, however, is that the more time and involvement a broker spends on an outside activity, the more likely it will find the activity is not passive and should be disclosed to the firm, and the public, as an outside business activity.

In the three other OBA settlements last week, FINRA fined a former Principal Securities broker, John Krohn of Des Moines, Iowa, $10,000 and suspended him for three months for allegedly failing to disclose that he was an officer or director of four companies, including one that he co-owned with a wealthy customer that invested in early stage and distressed businesses.  He also failed to advise his firm that he invested more than $7.9 million in 10 companies. Krohn is no longer registered as a broker or investment adviser. And another former Morgan Stanley broker, Morey Goldberg, agreed to a 45-day suspension and $10,000 fine for investing in four commercial real estate properties without providing “timely written notice” to his former firm.

The final of the four cases is a less obvious stumble by the broker, common when working with a relative in a family business. Carlos Velazquez, who worked at three firms in the four years he was registered with FINRA, agreed to an eight-month suspension and $10,000 fine for allegedly failing to disclose the full scope of his involvement as a secretary and “agent of record” for a tax preparation and bookkeeping company owned by his father.

We see many clients who, through design or neglect, fail to promptly and accurately disclose to their employing firms the nature, and extent, of these outside business activities.  FINRA has developed a low threshold for seeking sanctions from brokers who violate their firms’ OBA disclosure rules. Not to mention that often, violation of a firm’s OBA policy results in an involuntary suspension from the employing firm.  If FINRA has a low threshold for OBA reporting violations, so too do the member firms.

Shustak Reynolds & Partners, P.C. focuses its practice on securities and financial services law and complex business disputes. We represent many broker-dealers, registered representatives, investment advisors, investors and businesses. For more information, contact Erwin J. Shustak, Managing Partner [email protected], or call 800.496.5900 ext. 109.

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