Regulatory Analysis: FINRA Rule 3270 – Disclosure of Outside Business (Part I)

Author’s Note: This article is part of an occasional series on specific rules and regulations governing financial professions.  It is also the first in a multi-part analysis of FINRA Rule 3270.

THE RULE

FINRA Rule 3270 – Outside Business Activity of Registered Persons

No registered person may be an employee, independent contractor, sole proprietor, officer, director or partner of another person, or be compensated, or have 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, unless he or she has provided prior written notice to the member, in such form as specified by the member. Passive investments and activities subject to the requirements of Rule 3280 shall be exempted from this requirement.

THE RULE’S PURPOSE

Rule 3270 requires any person registered with a FINRA member to give the member written notice before commencing an outside business activity (or “OBA”).  The rule is “prophylactic”[1] in that, ideally, it allows member firms to raise any objections to an OBA “at a meaningful time” and, if appropriate, to supervise the activity.[2]  In so doing, FINRA hopes to “prevent customer harm and avoid firms’ unwitting entanglements in legal difficulties.”[3] 

The rule’s scope is “broad”[4] and, thus, “requires disclosure of all outside business, not just securities-related business.”[5]  The idea is that, with more disclosure, fewer aspects of a representative’s professional life are obscured from monitoring.  This leaves fewer opportunities to engage in problematic conduct without the firm or FINRA stepping in to mitigate customer harm. 

For obvious reasons, there will not be many (or any) enforcement cases where an advisor disclosed an OBA properly, a firm was able to monitor and the monitoring prevented customer harm.  Enforcement would have little to sustain a charge.  Nonetheless, in some cases, the failure to disclose squelched what may have been a helpful investigation by the advisor’s firm or FINRA.

On this point, Jarrett is instructive.  Jarrett convinced two advisory clients to liquidate an annuity and a mutual fund, respectively, and transfer the proceeds to his outside company, Jarrett Financial Services.[6]  According to Jarrett, the company would then invest the clients’ money in other financial products.[7]  These promises were false, as, instead, Jarrett used the money for personal expenses.[8]  Among other rules, FINRA’s Office of Hearing Officers[9] ( the “OHO”) flagged Jarrett for violating 3270 because he did not provide written notice of Jarrett Financial Services, an outside business interest.[10]

Had he disclosed Jarrett Financial Services, the story may have been different.  Jarrett’s firm could have placed conditions on his use of the company.  Disclosure would have also alerted the firm to Jarrett Financial Services, giving it a reason to monitor the company.  In fact, even if the firm denied approval for Jarrett Financial Services, and Jarrett had continued using the company anyway, the firm still would have had reason to keep a closer eye on Jarrett.  In all these scenarios, disclosure could have either dissuaded Jarrett from using the company to scam clients or allowed his firm to intervene before clients lost money.[11]   

TEXTUAL INTERPRETATION

“Compensation, or…the reasonable expectation of compensation…”

In general, Rule 3270’s “compensation” language is not controversial.  Still, on occasion, it has sparked mild debate.[12]  Two issues fall into this category: (1) whether compensation is necessary for a violation; and (2) what qualifies as a “reasonable expectation of compensation.”

First, compensation is not necessary for a business activity to fall under 3270’s disclosure requirements.  In the absence of prior notice, 3270 bars representatives from seven relationships with outside parties.  Five of these relate only to positions held with an outside party.  Two address compensation.  Because the rule lists the seven relationships in the disjunctive, any of the five that do not require compensation can still trigger a violation.  So the rule still covers instances where a representative does not receive compensation.[13]

Second, at the very least, when tied to a business activity, an explicit promise or plan to compensate creates a “reasonable expectation.”[14]  This can apply even where the expectation is not realized.[15]  Further, the planned compensation need not be actual money to satisfy the rule.[16]   

“Outside the scope of his or her relationship with his or her member firm…”

To a large extent, the member firm determines whether a representative’s business activity falls “outside the scope” of his or her employment.  This is a simple deduction.  Through various sources, like a contract, or its written supervisory procedures, the firm defines the representative’s employment.[17]  In turn, any business activity falling outside that definition would be an “outside business activity.”[18]

Neither the rules nor case law prescribe specific means for firms to define the scope of a representative’s employment.  The firm’s written supervisory procedures are a common source – and one panels consult in most instances.  These apply generally to associated persons under the firm’s umbrella.  They also restrict certain activities or, in some instances, the financial products representatives can market.[19]

Weinstock is a good example of both.  There, Weinstock worked for Northwestern Mutual, as both an investment company products representative and an insurance agent.[20]  With a limited exception, Northwestern Mutual’s WSP’s required agents to sell only the company’s insurance products.  The one exception allowed agents to sell other insurance companies’ products, but only after completing a detailed disclosure and approval process. [21]  And approval was often denied.[22]  At bottom, this meant Northwestern Mutual representatives had only two sources of compensation: the firm or another insurance company approved through the detailed process.[23]  Specifically, the WSP’s prohibited representatives from accepting referral fees, without prior approval.[24]

Weinstock entered into a reciprocal arrangement with Corzan, an agent at a different insurance company.[25]  Essentially, Corzan wanted to steer customers toward a strategy of using interest on notes to finance high-end insurance products.[26]  Weinstock agreed to help market the notes to his Northwestern Mutual clients.[27]  In theory, if any clients decided to use Corzan’s strategy, they would purchase the high-end insurance through Weinstock.[28] 

For Weinstock’s help, Corzan paid him a $15,500 lump sum.[29]  Weinstock characterized this as an advance on commissions he would receive from selling the insurance products.[30]  But other factors undercut this claim.  For one, Weinstock told Corzan he would not pay the money back if the sales never materialized.[31] 

And ultimately, they did not materialize.  Few customers agreed to use the financing strategy.  Further, some of those who did lost money, as the notes turned out to be a Ponzi scheme.[32] 

Enforcement brought claims against Weinstock, including one for failing to disclose an outside business interest.  Among other positions, Weinstock argued that his relationship with Corzan did not extend beyond the scope of his employment with Northwestern Mutual.[33]  The NAC and OHO panels disagreed.[34]  Specifically, the NAC Panel concluded Weinstock moved outside his employment when he overstepped the restrictions in the WSP’s – specifically, those only allowing agents to sell Northwestern Mutual products.[35]  Here, Weinstock teamed with an unaffiliated person to “stimulate interest in a non-[Northwestern Mutual] product without advance notice” to the firm.[36]  And for this work, he earned a fee that was tied only to his referrals.  This went beyond what Northwestern Mutual allowed him to do and, therefore, went beyond his employment.

In defining the scope, beyond the written supervisory procedures, panels may examine the following:

Totality of the circumstances

In some instances, the employment limitations arise from a totality of the circumstances.  Giblen is such a case. In 2009, Giblen, who had spent two decades in the industry as a research analyst, joined Quint Miller & Co. (“QMC”).[37][38]  QMC was a branch of Petersen Investments, a firm without the capacity to maintain a research department.  So upon employment, Giblen became a general securities representative, not a research analyst.[39]  During the hiring process, this point was reinforced to him.  First, Petersen executives sent emails to QMC management and Giblen stating that his hiring was conditioned on him not serving as a research analyst.[40]  QMC management then held private conversations with Giblen, where they made sure he understood this.[41]  Petersen also filed an updated Form U4[42] for Giblen which did not continue his registrations as a research analyst.[43]

Nonetheless, shortly into his tenure at QMC, Giblen performed an undisclosed research project for one of QMC’s clients, PSI Corporation.  The project culminated in a research report Giblen wrote, endorsing PSI’s stock.  The report appeared on PSI’s website, and PSI paid Giblen directly for his work on the project.[44]

During his enforcement case, Giblen advanced a winding series of arguments, which, at times, claimed the project and report were within the scope of his employment at QMC.  He appeared to base this on two factors: (1) that QMC did actually hire him to be a research analyst; and (2) that the report did not differ from his approved duties, which included providing market analysis and stock recommendations to QMC clients.[45]  On both accounts, the OHO and NAC panels disagreed.[46]  First, as the OHO panel held, the clear weight of the evidence demonstrated that research analyst fell outside Giblen’s employment.  This encompassed not only statements by Petersen and QMC management but the structure of both firms, which did not accommodate the position.[47]  Second, providing market research and stock recommendations was not the same as writing research reports and did not make Giblen a research analyst.[48]  As such, the PSI project was an OBA, and Giblen violated 3270 by failing to disclose it.

The substance of the work

Panels emphasize the work’s substance, rather than its effects.  As such, business activity may fall outside the scope even where it relates to firm business or benefits the firm.[49]  In Mathieson, a Morgan Stanley representative, Mathieson, took on a significant role with Aspen, an online university.  Specifically, well before disclosing to Morgan Stanley, Mathieson advised Aspen on the structure and price for its planned reverse merger, consulted with Aspen’s inhouse and outside counsel, reviewed the university’s marketing plans and helped with its fundraising efforts.[50]  Mathieson argued his work for Aspen was not outside his employment because it was part of an attempt to get Aspen-related business for the firm.  And indeed, Mathieson did open almost 50 Aspen-related accounts for Morgan Stanley.[51]  Nonetheless, the OHO Panel held that, regardless of whether these efforts won business for his firm, the character of Mathieson’s work was “external.”[52]  That is, portions of his work for Aspen, like, for example, “reviewing marketing plans,” did not have a “Morgan Stanley purpose.”[53]

Source of compensation While the line between an OBA and one’s employment can blur, the source of compensation often serves as a telltale.  For example, in Weinstock, the NAC panel seized on Northwestern Mutual’s commission structure, which limited representatives’ commissions to two sources: the firm or, in exceptional cases, another insurance company.[54]  Weinstock, on the other hand, took his alleged commission advance directly from Corzan.  This helped the NAC panel conclude the payment stemmed from an outside activity.  Similarly, the OHO panel reviewing Giblen deemed the research project an OBA, in part, because PSI paid Giblen the $6000.[55]  In these cases, the inference is that payment for employment activities comes from the member firm or specified other sources.  Conversely, payments from undesignated sources must be the product of activities outside one’s employment – especially when the firm does not know about them.


[1] Dep’t of Enforcement v. Connors, No. 2012033362101, 2017 FINRA Discip. LEXIS 2, at *13 (NAC January 10, 2017); See Dep’t of Enforcement v. White, No. 2012033128703, 2015 FINRA Discip. LEXIS 48, at *24 (OHO June 30, 2015).

[2] Dep’t of Enforcement v. Connors, 2017 FINRA Discip. LEXIS 2, at *13; See also Blair C. Mielke and Frederick W. Shultz, SEC Exchange Act Release No. 75981, at *18 (Finding NASD 3030’s purpose consistent with the Exchange Act because it allowed member firms to object to outside activities and exercise appropriate supervision).

[3] Dep’t of Enforcement v. Connors, 2017 FINRA Discip. LEXIS 2, at *13.

[4] Dep’t of Enforcement v. Taylor, Padgett, and Farmer, No. 2017053382401, 2019 FINRA Discip., at *10 (NAC August 22, 2019).

[5] Id.; Dep’t of Enforcement v. White, 2015 FINRA Discip. LEXIS 48, at *24.

[6] Dep’t of Enforcement v. Jarrett, No. 20120315996-01, 2013 FINRA Discip., at *4-6 (OHO August 30, 2013).

[7] Id. at 5-6.

[8] Id. at 4-6.

[9] FINRA enforcement actions begin with the OHO.  If an arbitration hearing is necessary, an OHO panel conducts the hearing and renders the decision.  The decision can then be appealed to FINRA’s National Adjudicatory Council (the “NAC”), which can affirm, reverse, or modify the OHO’s decision.  In turn, the NAC panel’s decision can be appealed to the Securities & Exchange Commission (the “SEC”) and, ultimately, the federal courts.

[10] Dep’t of Enforcement v. Jarrett, 2013 FINRA Discip., at *12-13.

[11] See also Bernard G. McGee, SEC Exchange Act Release No. 80314, at *3-4 (Advisor’s failure to disclose joint venture with outside company delayed firm investigation, which could have revealed outside company was a fraud and, consequently, prevented a significant customer loss).

[12]Dep’t of Enforcement v. Mathieson, No. 2014040876001, 2016 FINRA Discip., at *6 (OHO December 16, 2016).

[13]Dep’t of Enforcement v. Schneider, No. C10030088, 2005 NASD Discip. LEXIS 6, at *7 (NAC December 7, 2005) (Interpreting NASD 3030).

[14] Dep’t of Enforcement v. Mathieson, 2016 FINRA Discip., at *6 (“Although Mathieson never received compensation from Aspen, he certainly contemplated and expected to receive compensation in the form of Aspen stock options in return for his ‘hard work’ on Aspen’s behalf.”).

[15] Id.

[16] Id. (Stock options).

[17] See e.g., Dep’t of Enforcement v. Weinstock, No. 2010022601501, 2016 FINRA Discip. LEXIS 34, at *4 (NAC July 26, 2017); Dep’t of Enforcement v. Giblen, No. 201102595702, 2013 FINRA Discip., at *13 (OHO September 17, 2013).

[18]There is some indication panels accord significant weight to how the member firm defines the scope of the rep’s employment.  For example, in Ghosh, the OHO panel noted that his firm was in the best position to determine the scope of Ghosh’s employment.  So it was telling that, twice, the firm denied approval to Ghosh’s company on the grounds it was an OBA. See Dep’t of Enforcement v. Ghosh, No. 2016051615301, 2019 FINRA Discip., at * 27 (OHO August 7, 2019).

[19] See e.g., Dep’t of Enforcement v. Weinstock, 2016 FINRA Discip. LEXIS 34, at *4.  

[20] Id. at 1.

[21] Id. at 4.

[22] Dep’t of Enforcement v. Weinstock, No. 2010022601501, 2014 FINRA Discip., at *16 (OHO August 12, 2014).

[23] Dep’t of Enforcement v. Weinstock, 2016 FINRA Discip. LEXIS 34, at *4.

[24] Id.

[25] Id. at 2.

[26] Id.at 2-3.

[27] Id. at 3.

[28] Id.

[29] Id.

[30] Id. at 8.

[31] Id.

[32] Id. at 3.

[33] Id. at 7.

[34] Id.

[35] Id.                                                                                                                                                          

[36] Both panels found that, contrary to Weinstock’s claims, his activity was not mere marketing or networking.  Rather, he and Corzan had a substantial business relationship, where, essentially, they worked together to promote and sell the premium financing solution.  Dep’t of Enforcement v. Weinstock, 2016 FINRA Discip. LEXIS 34, at *4 (Noting how the OHO panel also rejected Weinstock’s argument).

[37] Dep’t of Enforcement v. Giblen, 2013 FINRA Discip., at *2-5.

[38] In some instance, like Giblen, I will cite to an OHO decision even though it was appealed and affirmed.  Typically, this is because the OHO decision had a more complete statement of facts or raised issues that the NAC panel did not address directly.

[39] Dep’t of Enforcement v. Giblen, 2013 FINRA Discip., at *3.

[40] Id. at 3-4.

[41] Id. at 4.

[42] A Form U4 is short for Uniform Application for Security Industry Registration or Transfer.  Advisors complete and file a U4 upon their initial registration in the securities industry.  They must then update their U4’s when they change member firms.  FINRA rules and some firm written supervisory procedures also require advisors to update their U4’s periodically.

[43] Dep’t of Enforcement v. Giblen, 2013 FINRA Discip., at *4-5.

[44] Id. at 7, 10.

[45] Id. at 13-14.

[46] Id. at 13; Dep’t of Enforcement v. Giblen, No. 201102595702, 2014 FINRA Discip. LEXIS 39, at *2-5 (NAC December 10, 2014).

[47] Dep’t of Enforcement v. Giblen, 2013 FINRA Discip., at *15.

[48] Id. at 15-16.

[49] Dep’t of Enforcement v. Mathieson, 2016 FINRA Discip., at *9.

[50] Dep’t of Enforcement v. Mathieson, No. 2014040876001, 2018 FINRA Discip. LEXIS 9, at *3 (NAC March 19, 2018).

[51] Id. at 4.

[52]Dep’t of Enforcement v. Mathieson, 2016 FINRA Discip., at *9; See also Dep’t of Enforcement v. KCD Financial, No. 2011025851501, 2016 FINRA Discip. LEXIS 38, at *15 (NAC August 3, 2016) (“Security sales can often result from activities that are widely understood to constitute outside business activities.”).

[53] Dep’t of Enforcement v. Mathieson, 2016 FINRA Discip., at *9.

[54] Dep’t of Enforcement v. Weinstock, 2016 FINRA Discip. LEXIS 34, at *9-10.

[55] Dep’t of Enforcement v. Giblen, 2013 FINRA Discip., at *15.

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