I've been surprised from time to time at the response of some firms to selling away issues presented by their representatives. It seems that some firms don't understand the regulatory and civil liability that can attach when they fail to supervise in this area. So, I thought this might be a topic for a good post.
Selling away, also known as participating in private securities transactions, is governed by FINRA (formerly NASD) Rule 3040. This rue applies to any person associated with a member, not just registered people ( as opposed to the outside business activity rule (Rule 3030) that is limited to folks who are registered with a broker-dealer). The rule requires that prior to participating in any manner in a private securities transaction, the associated person must provide written notice to his or her firm detailing the transaction, that person's role in it, and disclose whether he or she will or may receive any compensation.
At that point, the broker-dealer's obligations increase. The firm must then provide the associated person with written notice indicating whether the activity is approved or disapproved. Importantly, if the firm approves a transaction for which the associated person will be compensated, the firm must record the transaction on its own books and records and supervise it as if it were executed on behalf of the firm.
Did you get that? A firm cannot approve a transaction by an associated person, for compensation, and then wash its hands of it. Once approved, the firm has an obligation to supervise, and the transaction is no longer really "selling away" but it becomes a transaction of the firm, giving an additional area for regulators and plaintiff's lawyers to hone in on, particularly when the transactions are unsuitable for the clients, or when the associated persons misrepresent or make material omissions about the security.
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