A FINRA Hearing Panel issued a decision on March 9, 2015 that will have a potential significant impact on any broker-dealer that allows its registered representatives to have their own investment adviser.  In light of this decision, broker-dealers should assess and evaluate the adequacy of their supervisory systems and procedures relating to supervision of a representative’s outside advisory activities.

In DOE v. Fox Financial Management Corporation (“Fox Financial”), Brian Murphy and James Rooney, the FINRA Hearing Panel found that the firm, its President, and its Chief Compliance Officer failed to adequately supervise a representative (Representative James Rooney, hereafter “JER”).  Specifically, the Respondents failed to adequately supervise JER with respect to his independent registered investment adviser (RIA).  Instead of treating JER’s RIA business as a private securities transaction, the Respondents instead treated JER’s RIA business as an outside business activity.  The Panel imposed principal bars on the supervisors, along with an expulsion of the firm.

FINRA issued Notice To Members (NTM’s) in 1994 and 1996 discussing a firm’s supervisory obligations with respect to a representative’s RIA activities.

In these NTM’s, FINRA indicated that firms were specifically required to assess whether the advisory activities of a representative constituted private securities transactions that were required to be supervised as such and recorded on a firm’s books and records.  FINRA has also issued a series of Interpretive Letters since the NTM’s were released, reiterating that firms were required to assess whether outside RIA activities needed to be treated as private securities transactions.

With respect to the specific facts of the case, the Panel found JER joined Fox Financial in May 2008, and was with the firm until October 2012.  Immediately after joining Fox Financial, the firm had JER complete the firm’s “Outside Activity Approval” form.  Beyond that, however, the firm did not take any steps to supervise JER’s RIA business.  Specifically, the Panel found Respondents’ supervision deficient in the following respects:

  • The firm did not review any customer suitability information for investors;
  • The firm failed to obtain duplicate account information, confirmations and statements from the executing broker-dealer;
  • The Respondents did not take any action to ensure that JER’s actions complied with regulatory requirements; and
  • The firm failed to record the RIA’s transactions on the firm’s books and records.

The Panel rejected the Respondents’ arguments that they relied on the advice of counsel in treating the activities as outside business activities rather than private securities transactions.  Instead, the Panel noted Fox Financial had ignored numerous findings from the SEC and FINRA that the firm needed to treat JER’s advisory business as private securities transactions.  In the end, the Panel relied on these numerous prior regulatory warnings, along with the Respondents’ prior disciplinary history, in concluding that principal bars and suspensions in all capacities were appropriate for the individuals and an expulsion was appropriate for the firm.

In light of the Fox Financial decision, broker-dealers that permit representatives to maintain their own outside RIA may want to consider the following:

  • Ensure that the broker-dealer is receiving transactional reports and data, and that such information is being reviewed;
  • Review, on a periodic basis (for instance during an office inspection or audit), aspects of the outside RIA (such as the processing of trades, etc.);
  • Consider taking steps to obtain confirmations and statements, and again conducting some type of documented review of those documents.