In most Enforcement cases involving outside business activities, it is the registered rep who is named as the respondent, and the allegation is that the RR failed to provide notice (or timely notice) to his or her broker-dealer about the OBA. On occasion, however, it is the BD that gets tripped up, typically for not bothering to follow up appropriately (or at all) on an RR’s disclosed OBA. Cetera just learned this lesson the hard way, i.e., a $200,000 AWC for violating Rules 3010/3110 and 3270.
The facts of the case are pretty straightforward. The RR in question managed to get two of his elderly customers to grant him power of attorney, broad enough for him to be able to control their financial affairs (including the securities accounts for which he was the RR of record). According to Cetera’s perfectly reasonable policy, an RR could not do so (for a non-family member) without obtaining authorization from Compliance. Turns out that the RR never got that authorization.
But, interestingly, also turns out that the RR tried to get it. In fact, according to the AWC, on three separate occasions, the RR disclosed to Cetera that his two customers had granted him power of attorney over their financial affairs. Cetera, however, “did not timely review, evaluate or respond to [RR’s] disclosures.” In fact, Cetera “did not commence a review” of the RR’s trading on behalf of the two customers until questions were raised by a third party: a “mutual fund issuer detected that some of those transactions appeared questionable and alerted” Cetera. There’s only one thing that could have been worse than that, and that would have been if FINRA examiners discovered the problem.
There are some pretty obvious lessons to learn here. First, it is not enough to have your RRs disclose their outside business activities; you actually have to review what they disclose. (Like Jerry Seinfeld’s complaint that it’s not enough for the car rental company to “take” the reservation if it doesn’t actually “hold” the reservation.) Cetera had the right supervisory procedure in place, which required a timely review of disclosed OBAs; it just failed to follow it.
Second, don’t ignore the supplementary material for any FINRA rule; sometimes, that’s where the juiciest language can be found. Certainly, that’s true for Rule 3270. On its face, the rule is rather short and seems pretty simple to comply with, especially since approval of OBAs isn’t even required; rather, all that’s needed is that an RR provide “prior written notice.” It only gets more complicated, as I said, when you drag your eyes down to the bottom of the page and read the supplementary material. There, you will find the requirement that upon receiving notice of an OBA, a BD must “consider whether the proposed activity will: (1) interfere with or otherwise compromise the registered person’s responsibilities to the member and/or the member’s customers or (2) be viewed by customers or the public as part of the member’s business based upon, among other factors, the nature of the proposed activity and the manner in which it will be offered.”
Once the firm considers those two questions, it “must evaluate the advisability of imposing specific conditions or limitations on a registered person’s outside business activity, including where circumstances warrant, prohibiting the activity.” That includes the need to “evaluate the proposed activity to determine whether the activity properly is characterized as an outside business activity or whether it should be treated as an outside securities activity subject to the requirements of Rule 3280.” Finally, the firm “must keep a record of its compliance with these obligations with respect to each written notice received and must preserve this record for the period of time and accessibility specified in SEA Rule 17a-4(e)(1).”
In other words, the supplementary material changes the rule from merely a “notice” provision to one that actually requires “approval.” But, Cetera didn’t make any of the analyses required by the supplementary materials. As a result, it had no defense to offer to FINRA when confronted with its omissions.
The third lesson is that when considering OBAs, firms should take an expansive view. That is, RRs should be made to disclose anything and everything that could possibly be considered to be an OBA, even if it’s not obvious. Rule 3270 requires that an RR provide notice when he or she is “an employee, independent contractor, sole proprietor, officer, director or partner of another person, or be compensated, or ha[s] the reasonable expectation of compensation, from any other person as a result of any business activity outside the scope of the relationship with his or her member firm.” Based on this description, it is not entirely clear that simply being granted power of attorney over a client’s financial affairs, particularly when there is no compensation involved, technically requires an OBA notice. But, it seemed that Cetera did require it to be disclosed here (even though it then dropped the ball by not reviewing the disclosures), which is smart. The spirit of the rule is simple to divine: RRs should be required to disclose anything that they do away from the BD that could cause a conflict with what they do as an RR, or which could cause customers to be uncertain of the capacity – RR vs. non-RR – in which the RR is operating. There should be no close calls. Always err on the side of requiring disclosure.
The final lesson is the same one as always: if you actually do something to fulfill your supervisory obligations but fail to document the fact that you did it, as far as FINRA (or, sometimes, an arbitration panel) is concerned, you didn’t actually do it. So, write a memo. Write yourself an email. Make an entry on your calendar. Do something to physically record the fact that you took some action. From an evidentiary perspective, even a modest, unabashedly self-serving effort to memorialize an event is better than nothing.