On May 16, 2022, FINRA published an Acceptance, Waiver and Consent (“AWC”) in which FA, Robert Bennett Zamani, accepted a 14-month suspension and a $27,500 fine for violations of FINRA Rule 3270 (Outside Business Activities), Rule 2210 (Communications with the Public), Rule 4511 (Books and Records) and, as always, Rule 2010 (Standards of Commercial Honor). The investigation of Zamani was triggered by a Form U5 filed by his former firm, Morgan Stanley.

The Rule 4511 violation was based on Zamani’s alleged use of business-related text messages that were not retained by Morgan Stanley, effectively causing Morgan Stanley to violate its obligation to maintain such communications under Rule 4511. This is an easily avoidable rule violation that many FAs fall prey to.

More interesting, however, are Zamani’s alleged violations of 3270 and 2210. Zamani formed a company in 2015 before becoming associated with Morgan Stanley. Without ever disclosing the company to Morgan Stanley, between January 2017 and April 2020, Zamani, through this company, offered subscription-based investment content. On its website, which was established and operated by Zamani, the company touted itself as a subscription-based platform providing investment content for aspiring day traders to “learn from professionally licensed stock traders the skills needed to become a profitable trader.” The company maintained a blog on its website, containing investment-related content, and maintained a publicly-available YouTube channel, with investment-related videos and distributed periodic newsletters to subscribers. Remarkably, during that 3-year stretch, Zamani earned $360,000 from his subscriber-based investment advice company.

FINRA Rule 2210 requires “an appropriately qualified registered principal of the member to approve each retail communication . . . .” Retail communication is defined broadly as “any written (including electronic) communication that is distributed or made available to more than 25 retail investors within any 30 calendar-day period.” A retail investor is anyone other than an institutional investor “regardless of whether the person as an account with a member.”

An important exception to this review process is that it does not apply to a communication “that does not make a financial or investment recommendation or otherwise promote a product or service of the member.” Interestingly, the AWC accuses Zamani of “disseminating investment-related communications” which is significantly different from the language in the rule, which requires the recommendation of an investment or promotion of a product.

FINRA Rule 2210 not only calls for a review of communications with the public but also sets forth Content Standards and Zamani was accused of violating several of these standards. The AWC accused Zamani of disseminating communications that (a) were not fair and balanced because, among other things, he failed to explain any risk associated with investing, (b) made “promissory statements” regarding returns, (c) made projections of investment performance, (d) contained testimonials without the required disclosures, (e) contained securities recommendations without the required disclosures, (f) contained performance data without the required disclosures, and (g) failed to disclose Zamani’s association with Morgan Stanley. Each of these Content Standards are specifically addressed under Rule 2210.

As you might imagine, Zamani apparently never disclosed this activity to Morgan Stanley or asked Morgan Stanley to review and approve any of the communications he released through YouTube, his website or his newsletters. Undoubtedly, Morgan Stanley would not have permitted any of it and a profit of $360,000 over three years is likely more money than Zamani was making at Morgan Stanley.

Zamani’s alleged conduct violated FINRA Rules 3270 and 2210. This was not a close case but FA’s should be knowledgeable about the constraints of Rule 2210. It is one of FINRA’s more complicated and detailed rules and FA’s would be well advised to seek legal or compliance advice before sending any investment-related communication to more than 25 people.

Herskovits PLLC has a nationwide practice defending investigations by FINRA, the SEC and state securities regulators. Call us for a consultation at (212) 897-5410.

FINRA recently published its 2022 Report on FINRA’s Examination and Risk Monitoring Program to provide member firms with guidance and insights gathered by FINRA’s Examinations and Risk Monitoring programs over the course of the year. The report also serves to inform firms what FINRA sees as “emerging” compliance risks that FINRA’s Examinations and Risk Monitoring programs intend to focus on for 2022.

Among the various areas covered by the report is a section addressing outside business activities (“OBAs”) (FINRA Rule 3270) and private securities transactions (“PSTs”) (FINRA Rule 3280). FINRA noted in its “Exam Findings” section a number of common mistakes being made by firms.

FINRA Rule 3270 requires registered representatives to notify their firms in writing of any proposed outside business activity. Member firms are then required to “evaluate the advisability of imposing specific conditions or limitations on a registered person’s outside business activity, including where circumstances warrant, prohibiting the activity.”

FINRA Rule 3280 requires registered representatives to notify their firms in writing of any proposed PST and get firm approval for any PST for which the registered representative will receive compensation. 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.

Exam Findings

The first finding concerned the failure to properly interpret the rules. FINRA found that firms were interpreting “compensation” too narrowly and not taking into account such things as the registered representatives’ receipt of membership interests, preferred stock or even tax benefits. FINRA found instances where no notice of an OBA or a PST was provided which is an obvious rule violation. FINRA also found that firms were not retaining the necessary documents to demonstrate compliance with the rule, such as documentation of the review, approval or disapproval of OBA and PST notices.

Where firms’ approvals contained limitations, such as not soliciting firm clients, FINRA found that firms failed to monitor if these limitations were being followed. FINRA also found that firms were incorrectly assuming that all digital assets were not securities and therefore not categorizing certain transaction as PSTs.

FINRA Recommended “Effective Practices”

Not surprisingly, FINRA suggests that registered representative be required to complete periodic questionnaires regarding their involvement or potential involvement in any PST or OBA. This would seem to be a fairly universal practice among firms. As a side note, “potential involvement” is an area that gets many financial advisors in trouble. Approval must be sought before any action is taken by the registered representative. It is not uncommon for a registered representative to set up a company for some future, sometimes even unknown, purpose. Even if the company is inactive, it must be disclosed before it is formed.

Some of FINRAs other suggested practices are a bit more extreme. For example, Firms may be surprised to find that FINRA expects them to not only review the PST or OBA at the time of disclosure but continue to monitor it through periodic reviews of social media, internet websites, e-mails and interviews of registered representatives.

FINRA also suggests monitoring the other “red flags” such as the changes in a registered representatives’ “performance, production levels or lifestyle . . . .” FINRA recommends regular, periodic background check and reviews of such things as bank statements and tax returns.

Key Takeaways

It seems likely that few firms have procedures in place for monitoring OBAs and PSTs that include “regular, periodic background checks” or regular reviews of registered representatives’ tax returns and bank statements or “lifestyle.” Similarly, it is hard to envision a firm that regularly reviews registered representatives’ social media accounts. Indeed, at larger firms, such monitoring and supervision would likely be a full time job for several employees. That being said, FINRA’s report makes it clear that firms must do more than simply having registered representatives fill out an annual questionnaire. FINRA also makes it clear that, even if a firm conducts a thorough review at the time of approval an OBA or PST, a firm must also having procedures in place to continue to monitor and supervise that OBA or PST after that initial approval.

Herskovits PLLC has a nationwide practice defending against FINRA investigations and disciplinary proceedings. Feel free to contact us at (212) 897-5410 for a consultation.

Maybe it’s just me, but it feels like FINRA has ramped up its caseload for undisclosed outside business activities and unapproved private securities transactions. This week alone, FINRA resolved two such cases in FINRA Matter No. 2018058026701, Alexander Jon James and FINRA Matter No. 2019061490801, Barry Robert Bode. Before analyzing the cases, it’s worth re-visiting the scope of these rules:

FINRA Rule 3270 (Outside Business Activities)

The rule is designed to prevent FAs from engaging in outside business activities absent written approval from the member firm. Generally speaking, the rule does not apply to the registered person’s personal passive investments (e.g., buying away) and activities conducted on behalf of a member firm’s affiliate (e.g., work for an affiliated investment advisory firm or insurance arm). Examples of reportable outside business activities could include providing accounting or consulting services, working for a start-up or sitting on a board of directors, acting as a real estate broker, and serving on the board of a religious or civic organization, among other things.

FINRA Rule 3280 (Private Securities Transactions)

Private securities transactions are transactions outside the regular scope of the FAs employment. Excluded from this broad rule are transactions subject to FINRA Rule 3210 (meaning, accounts at other broker-dealers and financial institutions), transactions among immediate family members without any selling compensation, and personal transactions in investment company and variable annuity securities. For those transaction covered by this rule, the FA is required to provide written notice to his employer and indicate his role in the transaction and he has received or may receive compensation. “Selling away” violations are typically covered by this rule.

Alexander Jon James — FINRA Matter No. 2018058026701

Alexander James was formerly associated with Voya Financial Advisors, Inc. According to FINRA, from January 2013 through July 2016, James engaged in an undisclosed outside business activity by forming and incorporating a company that charged users a monthly subscription fee for access to a website that could be used to seek funding for ventures. Apparently, James helped run the day-to-day operations and was paid $16,000 for his services. James’ arguably more serious violation was his decision to solicit 2 customers to invest a total of $667,000 in his company. This conduct causes obvious litigation risk for a broker-dealer since the customer may have believed the investment was vetted by the firm. According to BrokerCheck, one of James’ customers complained about an “unapproved, outside investment” which resulted in a $75,000 settlement. As a result of FINRAs alleged violations, James consented to a 1 year suspension and a fine of $10,000.

Barry Robert Bode — FINRA Matter No. 201906140801

Barry Bode was formerly registered with The O.N. Equity Sales Company. He was discharged by the firm in early 2019 for allegedly engaging “in an unapproved outside business activity related to the negotiation and sale of mineral rights on behalf of a client for compensation.”

According to FINRA, Bode violated Rule 3270 (outside business activity rule) by (a) forming an LLC and servicing as managing partner without notice to the member firm; (b) performing business consulting services that resulted in $7,000 of consulting fees; (c) contracting with an individual to market the mineral rights associated with property in Colorado; and (d) soliciting offers to purchase the mineral rights from energy and mineral companies. Although, according to FINRA, Bode ultimately submitted an outside business activity disclosure form, Bode failed to disclose the existence of the LLC or his role in it, or that he entered into contract to market, or that he, in fact, marketed the mineral rights. According to FINRA, Bode misled his employer failing to acknowledge that he had been a fee of $12,000 for his work in connection with the mineral rights. As a result of FINRAs alleged violations, Bode consented to a 2 month suspension and a fine of $5,000

Herskovits PLLC has a nationwide practice defending against FINRA investigations and disciplinary proceedings. Feel free to call us for a consultation at 212-897-5410.

On December 20, 2019, FINRA announced a settlement with John Carneglia. According to the AWC, Carneglia violated FINRA Rule 3210 for failing to notify his member firm of a brokerage account and violated FINRA Rule 3270 for failing to timely disclose an outside business activity.

Underlying Facts

Carenglia was registered with BNP Paribas from June 2006 through July 2017. According to FINRA, Carneglia didn’t inform BNP of his wife’s brokerage account and likewise failed to inform the firm that maintained his wife’s account of his association with BNP. Further, FINRA alleges that Carneglia was a member of an LLC that owned an income-generating rental property (ski-resort condominium), yet failed to timely notify BNP of that outside business activity.

Relevant Rules FINRA Rule 3210

This rule is called “Accounts At Other Broker-Dealers and Financial Institutions.” The basic requirements of this rule are:

• You need written permission from your member firm to open or maintain an account at another institution in which securities transaction can be effected.
• You need to inform the executing member of your association with an employing member.
• This rule applies to any account “in which the associated person has a beneficial interest.” Beneficial ownership is presumed for accounts of the FA held by:
  • The spouse of the FA;
  • The children of the FA;
  • Any other related individual over whose accounts the FA has control; or
  • Any other individual over whose account the FA control and to whom the FA offers material financial support.

FINRA Rule 3270

This rule is called “Outside Business Activities of Registered Persons.” The basic requirements of this rule are:

• You need to give your employer prior written notice of any business activity outside the scope of the relationship with your firm.
• This includes being an employee, independent contractor, sole proprietor, officer, director or partner of any business from which you receive compensation or expect to receive compensation.
• EXEMPTED from this rule are passive investments and activities subject to the requirements of Rule 3280 (private securities transactions of an associated person).

Sanction Guidelines

According to FINRA’s Sanction Guidelines, failing to comply with Rule 3210 can result in a fine between $1,000 and $39,000 and “in egregious cases” a suspension up to 2 years or a bar. For undisclosed outside business activities, the Sanction Guidelines provide for a fine between $2,500 and $77,000 and a suspension of 10 days to 3 months.

Upshot of Carneglia’s Alleged Violations

FINRA suspended Carneglia for 2 months and fined him $15,000.

Herskovits PLLC

Herskovits PLLC has a nationwide practice defending individuals and institutions that are subject to regulatory investigations (including FINRA investigations) and disciplinary proceeding. Please feel free to call us for a consultation 212-897-5410. Also feel free to view our practice area page.