Financial Industry Regulatory Authority (“FINRA”) Rule 3270 governs a registered person’s obligations to report outside business activities (“OBAs”) to their employing broker-dealer.1 In summary, the rule prohibits compensating a registered person for any business activity outside the scope of the relationship with the member firm unless the person has provided written (or electronic) notice to the member. The notice should include a complete description of the representative’s involvement with the OBA.
A designated principal of the firm (often from Compliance) must review the description of the OBA. The review should include an assessment of any conflicts of interest related to the activity. The assessment also should determine whether the activity would interfere with the registered person’s responsibilities. The member may choose to limit the person’s activity if the activity would compromise the person’s responsibilities to the firm or the firm’s customers, or if the activity would be seen by the person’s potential customers as part of the business of the broker-dealer. If the designated principal grants approval, the firm must then disclose the OBA on the individual’s Form U4 in the Central Registration Depository system, thereby satisfying the member’s notification to FINRA.
As a best practice, firms should conduct Internet searches at the time of hire for all new employees. The firm may also include Internet searches of incoming employees who will be non-registered fingerprinted persons of the broker-dealer. By taking this extra measure, firms can spot potential relationships that employees failed to disclose on their initial OBA notices. These Internet searches should also be conducted periodically (e.g., quarterly or annually).
ACA’s reviews and FINRA staff's comments from examinations have noted that firms are failing to conduct complete reviews of the OBAs reported by employees. By reviewing OBA notices, FINRA has found that firms are not disclosing OBAs on the registered persons’ Forms U4, despite being required to do so. FINRA has also cited firms for failing to conduct any assessment of the disclosures of OBAs on periodic employee certification forms. In order for these certifications to be effective, they must address whether the employee has engaged in any new outside business activity. The certification should also include a description of the undisclosed OBA for the firm’s review and assessment.
Firms should provide these certifications to their employees during the annual compliance meeting. The annual compliance meeting should also include training on the firm’s policies and procedures governing the reporting of OBAs to the designated principal.
In addition, an analysis of OBAs may bring to light activities subject to the requirements of FINRA Rule 3280, which govern the private securities transactions of associated persons of members.2 FINRA defines a private securities transaction as “any securities transaction outside the regular course or scope of an associated person’s employment with a member.” It is important for firms to note that FINRA Rule 3280 applies to associated persons of a member. According to the FINRA by-laws, associated persons include both registered and non-registered persons. Therefore, all employees of a broker-dealer should report outside business activities regardless of the employee’s activities with the member. If the firm fails to conduct a thorough analysis of an OBA, that could put the member at risk of violating FINRA Rule 3280.
The designated principal (generally from Compliance) should identify whether or not an employee’s activity would constitute a private securities transaction by asking questions such as these:
- Do you find, or assist others in finding, investors for any type of offering as part of your outside activity?
- Will you ever be involved in buying or selling interests in any type of offering as part of your outside activity?
- Do you receive direct or indirect compensation for involvement in any of the above activities?
A “Yes” answer to any of the above questions could indicate the employee’s involvement in private securities transactions. FINRA Rule 3280(b) requires that the employee provide written notice to the member prior to any manner of participation in a private securities transaction for another entity. In addition, the firm would have to supervise the activity related to the private securities transactions.
After verifying that an OBA constitutes involvement in private securities transactions, the designated principal should request that the employee complete the notice required by FINRA Rule 3280(b). The notice should include details of the proposed role of the employee and, most importantly, whether the employee has received or may receive selling compensation in connection with the transaction. The firm should provide a hard-copy private securities request form directly to the employee. If completed electronically, the firm must ensure that the request allows the employee to disclose the proposed role, date and type of the proposed transaction, and well as any compensation (direct or indirect) that he or she will receive.
The designated principal must approve or disapprove the proposed transaction in writing (or electronically) before an employee participates in a private securities transaction. The decision the firm makes for each private securities transaction request should also specify any conditions by which the employee must abide in connection with his or her participation in the transaction. Firms also frequently overlook paragraph (c)(2) of Rule 3280, which requires that they record each private securities transaction on the books and records of the member, and that the firm supervise the transaction as if it were executed on behalf of the broker-dealer. Therefore, it is not sufficient to grant approval for an employee to participate in a private securities transaction for selling compensation without also supervising the employee’s activity throughout his or her involvement. Transactions not involving selling compensation would not require the firm to abide by paragraph (c)(2) of Rule 3280. However, FINRA defines “indirect” compensation very broadly, and may include salary and fees (e.g., management fees).
Firms can comply with FINRA Rules 3270 and 3280 by taking the following precautionary steps:
- Revisit your firm’s OBA requests to make sure you provide adequate information. Also, confirm that certifications and acknowledgements have appropriate questions, and confirm the employee provides information necessary to identify a private securities transaction.
- Investigate the businesses that are reported on each request to determine whether the activity should be characterized as a private securities transaction.
- Train employees to request approval for participation in a private securities transaction whether selling compensation is involved or not. The training should be included during the firm’s annual compliance meeting and firm element training.
- Notify the requestor in writing (or electronically) with approval or disapproval of his or her role in the activity, and maintain a copy of the decision for the firm’s books and records.
- Assign a principal to monitor and supervise the activities of any employee who receives direct or indirect selling compensation in private securities transactions.
- Record and maintain books and records of the transaction documents and the supervisory reviews conducted by the member.
If you have questions regarding any of these issues or requirements, please contact your ACA consultant or Dee Stafford in the Los Angeles office at (310) 322-8840.