This article is part of an occasional series on specific rules and regulations governing financial professions. It is also the second in a multi-part analysis of FINRA Rule 3270. Part II will analyze portions of the rule’s text that were not discussed in Part I, examine the content required for a notice under 3270 and address how a violation of internal firm policies on outside business effects whether a representative violated 3270.
TEXTUAL INTERPRETATION (CONT.)
Under Rule 3270, registered persons (or “representatives”) must notify their member firm of any outside business activity they plan to undertake. The rule itself requires “prior written notice in such form as specified by the member.”[1] In practice, this becomes three separate elements: (1) “prior” notice; (2) “written” notice; and (3) notice “in such form as specified by the member.”[2] Each of these operates according to its own unique rules.
“Prior” Notice
Commencing an outside business activity
To meet the “prior” standard, a representative must submit notice before commencing the outside business activity. For purposes of the rule, the OBA “commences” when “steps are taken” to initiate the business.[3] Effectively, this can occur when the business is “established” or “when rights to do business are acquired,” even if the representative has yet to begin “active involvement.”[4]
Indeed, the business does not have to be fully functional to require disclosure.[5] In Schneider, Enforcement[6] brought claims against former Millennium Brokerage representative Andrew Schneider, for failing to disclose his outside business, Hedgeco – a company dedicated, mainly, to organizing seminars for hedge fund managers.[7] Schneider countered that Hedgeco was not functional enough to trigger 3270’s notice requirement. His multi-step argument proceeded as follows: First, 3270 requires notice where the representative is an “employee” of the outside business.[8] Second, because Hedgeco “lacked the traditional hallmarks of an employer such as revenue, sales, an office, stationery, and business cards,” it could not employ anyone, even Schneider.[9] Therefore, Schneider could not qualify as an “employee” and was not subject to 3270.[10]
But the NAC Panel dismissed Schneider’s argument. In their view, Hedgeco “employed” Schneider at the moment he commenced the business.[11] Here, though Hedgeco may have lacked some aspects of an established business, Schneider was already marketing it to potential customers and using it to solicit business to send to another firm. He was also holding himself out as Hedgeco’s president and CEO.[12] Based on this, Schneider had not only commenced business, but conducted business for months. Thus, Hedgeco could and did employ him, and he had a duty to disclose the company.[13]
Independent of a representative’s duty to update his or her U4 form
The prior disclosure obligations are independent of an advisor’s obligation to update his or her U4. An advisor has 30 days to update a U4 to reflect a new outside business activity.[14] In Moore, Commonwealth Financial representative Ricky Moore took a new position as president and director of his church.[15] He resigned 34 days later. In response to Enforcement’s case against him, Moore argued that his failure to disclose the position was irrelevant because he resigned only 4 days after the U4 disclosure deadline.[16] But the OHO Panel held 3270’s notice requirements are independent of the U4 deadline.[17] As the Panel observed, Rule 3270 requires “advance written notice” of a new outside position.[18] Because Moore did not provide this, resigning just past the U4 deadline did not shield him from a 3270 violation.
“Written” Notice
The notice must actually be in writing.[19] Panels treat this as a black-and-white rule: either the notice is in writing or it is not. When representatives try to soften the requirement, they contend oral disclosure was sufficient or their firm was generally “aware” of the OBA. Consistently, both arguments fail. [20] In short, there is no substitute for disclosure in writing.
“In such form as specified by the member…”
While Rule 3270 establishes some universal disclosure standards (“written,” “prior,” etc.), the firms supply additional, and more detailed, requirements. Their authority to do so comes from the rule’s demand for notice “in such form as specified by the member.” Usually, the member firm’s WSP’s establish notice a procedure that addresses both the notice’s substance and the manner in which it is provided.[21] Some firms will also designate a proper person(s) to receive notice.[22] Thus, notice to certain staff members, even those with significant authority, may be worthless because the firm did not designate that person to accept on its behalf.[23] For example, in Mathieson, during his employment with Morgan Stanley, Mathieson forged an extensive working relationship with Aspen University.[24] According to Mathieson, he “regularly discussed” this work with his Morgan Stanley supervisor. The theme of these conversations was that Mathieson intended to use his ties to Aspen to recruit Aspen-related business for the firm.[25] Among other problems, the Panel deemed this notice insufficient because the supervisor did not have authority to grant final approval of OBA’s.[26] Likewise, in Giblen, Giblen claimed his immediate supervisor was aware of his OBA because the supervisor attended meetings where it was discussed.[27] Still, the OHO Panel held this did not satisfy the rule because the firm’s WSP’s mandated that written notice of outside business go through senior management, which Giblen’s immediate supervisor was not.[28]
Like the “prior” and “written” language, the “specified by the member” requirement removes significant ambiguity from the notice issue. The member provides detailed requirements for how notice must look, what information it must contain and how it must be presented. Failure to abide by any of these violates 3270. In effect, representatives have little room to piece their actions together and claim they added up to notice.
Take the written disclosure in Ghosh. There, NYLife Securities hired Ghosh, primarily, as an insurance agent.[29] When he was hired, Ghosh was attempting to run an outside consulting firm, through which he would attract NYLife insurance business.[30] The firm’s WSP’s contained a robust section on outside business activities. Notably, they identified those specific activities that qualified as OBA’s.[31] These required disclosure and approval through a formal process, which the representative initiated by submitting a standard NYLife OBA form to a managing partner. The managing partner would then sign the form and pass it along to the OBA Unit. From there, the OBA Unit would approve or deny the request.[32]
Upon joining NYLife, Ghosh submitted an OBA through this process.[33] The firm denied approval.[34] Ghosh responded by changing the outside business’s name and continued it without informing NYLife.[35] Nonetheless, NYLife discovered the business on its own and instructed Ghosh to submit a formal OBA request.[36] Ghosh resisted. Instead, he tried to convince NYLife that his company was not an OBA. His efforts included several written communications with his immediate supervisors.[37] Finally, Ghosh submitted a formal OBA request, which NYLife again denied.[38] Thereafter, Ghosh continued the OBA for a short time before resigning from NYLife.
Ghosh argued that he did not breach 3270 because he disclosed his OBA through the written communications with his supervisors. But as the OHO Panel observed, this was not notice in the form NYLife specified. Namely, before engaging in an OBA, NYLife’s procedures required Ghosh to submit a written request on a “specified online form.”[39] So while technically, Ghosh’s communications were written, and notified NYLife of his OBA, they were not in the form NYLife required. Therefore, Ghosh did not comply with Rule 3270.
CONTENT OF THE NOTICE
Rule 3270 itself provides little guidance regarding the content of a notice.[40] This leaves important questions about how specific and accurate the description of the OBA must be. Some panels have relied on 3270’s “general purposes” and the responsibilities they place on firms.[41] Here, the rule’s Supplementary Material .01 is a useful source. This provides that, upon receiving an OBA notice, firms shall consider whether to allow, deny or limit the activity. In making these calls, .01 instructs firms to evaluate whether the OBA will (1) “interfere with” or “compromise” the representative’s obligations to the firm and its customers or (2) “be viewed” as “part of the member’s business.” [42][43] So if a Panel relied on .01, the representative’s OBA disclosure would have to be specific enough for the firm to make the determinations required under these directives.
Case law can also inform on specificity and accuracy. In some instances, representatives have disclosed the general type of activity, while avoiding important details that would allow the member to target and supervise the activity.[44] This falls short of 3270.
In Mathieson, Mathieson disclosed only that he wanted to join Aspen University’s board of directors. He did not disclose that he had been heavily involved with Aspen’s operations for months.[45] After Morgan Stanley denied Mathieson’s OBA request, unbeknownst to the firm, he maintained his role with Aspen.[46] His only subsequent notice was through oral conversations, where he informed his immediate supervisor that he hoped to recruit Aspen-related business for the firm.[47] The OHO and NAC Panels ruled that Mathieson’s disclosures were insufficient under 3270.[48] In particular, the OHO Panel noted that Mathieson’s oral communications never made his supervisor aware of the details surrounding his extensive role with Aspen.[49] Nor did his earlier written disclosures notify Morgan Stanley that he had already been working with Aspen for months. As such, he did not satisfy his obligation under 3270 to “disclose in writing the particulars of his activities.”[50]
Other times, panels have found notice lacking where it omitted crucial information. Turner is such a case. There, Winston Wade Turner induced a customer to invest in his outside company “H&S Securities LLC.”[51] While Turner had disclosed H&S to his member firm, his disclosure form only listed it as “H&S LLC,” omitting “Securities.” [52] Further, Turner described the company as a “rental property co-ownership to which he devoted only 1 hour per week.”[53] An OHO panel concluded Turner’s disclosure violated 3270 because it was inaccurate.[54] Specifically, by omitting “Securities” from the title and “failing to state whether the business was investment-related,” he “misled” his firm as to H&S’ true function.[55]
A notice may also be rendered inaccurate due to changed circumstances. In Cherry, the advisor, John Cherry, disclosed an outside business to his firm, World Group Securities.[56] In his disclosures, Cherry attested that he had not discussed his outside business with any World Group customers or marketed any of the business’s products to them.[57] But two years later, he began using World Group products in a scheme to induce customers to deposit money into his outside business.[58] He also made purported interest payments to the same customers from his outside business’s account.[59] The NAC Panel ruled this violated 3270 because the new activity deviated from the original disclosures and, therefore, rendered them false and misleading.[60]
EFFECT OF FIRM OUTSIDE BUSINESS POLICY ON RULE 3270
There is some confusion as to whether representatives who their firms’ rules on OBA’s violate 3270 as well. The relevant scenario would be where (1) a representative discloses an OBA, (2) the firm either denies approval or approves the OBA with conditions and (3) the representative continues engaging in the OBA or engages it while violating the conditions.
At least one panel has deemed this solely a violation of the member’s WSP’s – an internal problem that does not implicate the FINRA rule.[61] And there is logic to this argument. The rule’s plain language requires “notice,” not approval and does not address conditions firms may place on an OBA. Further, the rule’s purpose is to enable firm supervision. In most cases, notice is enough to supervise.
An OHO panel confronted this issue in Somerindyke. There, two prospective advisors sought to join NYLife Securities. During their interviews, both disclosed their active OBA, a company called HotSpot.[62] NYL’s WSP’s allowed representatives to have OBA’s as long as they devoted less than 10 hours per week to them and only derived passive income.[63] So NYL’s compliance department approved HotSpot with conditions. Essentially, the advisors could not involve themselves in HotSpot’s day-to-day management or hold leadership positions in the company.[64]
The advisors ignored the conditions and continued participating in HotSpot’s day-to-day management.[65] Still, the OHO Panel ruled they did not violate NASD 3030. Rather, they followed the rule’s plain terms by disclosing HotSpot according to the process outlined in NYL’s WSP’s. Their misconduct stemmed from exceeding the restrictions NYL imposed. While this may have violated NYL’s internal policy, it did not violate NASD 3030.[66] On the other hand, some panels have implied that continuing an OBA after the firm denies approval does violate the rule.[67] Logic can support this view as well. Approval may be part of the notice procedure, which is the form “specified by the member.” Further, a decision on whether to allow the OBA could be necessary to confirm the appropriate parties have been notified.
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[1] FINRA R. 3270.
[2] For outside businesses, “prior” notice is unique to FINRA 3270. Its predecessor – National Association of Securities Dealers (“NASD”) Rule 3030 – only required “prompt” written notice.
[3] Dep’t of Enforcement v. Schneider, No. C10030088, 2005 NASD Discip. LEXIS 6, at *6 (NAC December 7, 2005) (Interpreting NASD 3030); Dep’t of Enforcement v. Moore, No. 2013038770901, 2016 FINRA Discip. LEXIS, at *18 (OHO November 28, 2016); Dep’t of Enforcement v. Connors, No. 2012033362101, 2016 FINRA Discip. LEXIS 1, at *12 (OHO January 15, 2016); Dep’t of Enforcement v. White, No. 2012033128703, 2015 FINRA Discip. LEXIS 48, at *24-25 (OHO June 30, 2015).
[4] Dep’t of Enforcement v. Turner, No. 2013038398401, 2016 FINRA Discip. LEXIS, at *16 (OHO July 8, 2016).
[5] See Dep’t of Enforcement v. Akindemowo, No. 2011029619301, 2015 FINRA Discip. LEXIS 58, at * 17 (NAC December 29, 2015)(Representative violated 3270 where he failed to disclose after incorporating his outside business, using it in negotiations over outside insurance clients and leasing and furnishing an office).
[6] In this case, “Enforcement” refers to the NASD’s enforcement department. For cases after 2007, “Enforcement” will refer to FINRA’s enforcement department.
[7] Dep’t of Enforcement v. Schneider, 2005 NASD Discip. LEXIS 6, at *2.
[8] Id. at 6.
[9] Id.
[10] Id.
[11] Id.
[12] Id.
[13] Id. at 6-7.
[14] Dep’t of Enforcement v. Moore, 2016 FINRA Discip. LEXIS, at *18.
[15] Id.at 19.
[16] Id.
[17] Id.
[18] Id. (Emphasis in original)
[19] Dep’t of Enforcement v. Giblen, No. 201102595702, 2014 FINRA Discip. LEXIS 39, at *2-5 (NAC December 10, 2014)(Rule 3270 “requires actual written notice of an associated person’s outside business activity.”); See Dep’t of Enforcement v. Ghosh, No. 2016051615301, 2019 FINRA Discip. LEXIS, at *31 (OHO August 7, 2019)(“[O]ral disclosure is insufficient.”).
[20] Dep’t of Enforcement v. Giblen, 2014 FINRA Discip. LEXIS 39, at *2-5 (Holding that Giblen did not provide the requisite notice even if his supervisor was present at meetings where the OBA was discussed); Dep’t of Enforcement v. Dahmer, No. C8A030086, 2005 NASD Discip. LEXIS 16, at *8-9 (OHO February 17, 2005); See Dep’t of Enforcement v. Mathieson, No. 2014040876001, 2016 FINRA Discip. LEXIS, at *10 (OHO December 16, 2016)(Notice was insufficient where Mathieson made his supervisor aware of some aspects of his relationship with an outside company through regular discussions.); See also Dep’t of Enforcement v. Akindemowo, 2015 FINRA Discip. LEXIS 58, at * 17 (Among other problems, Akindemowo’s purported oral disclosure of Goshen did not satisfy the rule because it was not in writing.).
[21] See e.g. Dep’t of Enforcement v. Ghosh, 2019 FINRA Discip. LEXIS, at *5-6
[22] See e.g. Dep’t of Enforcement v. Giblen, 2014 FINRA Discip. LEXIS 39, at *8, FN17
[23] Dep’t of Enforcement v. Mathieson, 2016 FINRA Discip. LEXIS, at *10; See Dep’t of Enforcement v. Giblen, No. 201102595702, 2013 FINRA Discip. LEXIS, at *17 (OHO September 17, 2013)(“Even written notice of the activity to a supervisor is insufficient to comply with the rule when, as here, the supervisor was not responsible for approving an OBA.”); See Dep’t of Enforcement v. Ghosh, 2019 FINRA Discip. LEXIS, at *31.
[24] Dep’t of Enforcement v. Mathieson, No. 2014040876001, 2018 FINRA Discip. LEXIS 9, at *3 (NAC March 19, 2018); Dep’t of Enforcement v. Mathieson, 2016 FINRA Discip. LEXIS, at *4-6.
[25] Id. at 6.
[26] Id. at 10.
[27] Dep’t of Enforcement v. Giblen, No. 201102595702, 2013 FINRA Discip. LEXIS, at *16 (OHO September 17, 2013).
[28] Id. at 16-17.
[29] Dep’t of Enforcement v. Ghosh, 2019 FINRA Discip. LEXIS, at *3.
[30] Id. at 7.
[31] Id. at 5.
[32] Id. at 5-6.
[33] Id. at 7-8.
[34] Id. at 8.
[35] Id. at 10-11.
[36] Id. at 12-13.
[37] Id. at 14-17
[38] Id. at 17-19.
[39] Id. at 31.
[40] Multiple panels have concluded thatdisclosure must be “fulsome.” But none have explained the level of information necessary to meet this standard. Id.; Dep’t of Enforcement v. Akindemowo, 2015 FINRA Discip. LEXIS 58, at * 44; Dep’t of Enforcement v. Weinstock, No. 2010022601501, 2016 FINRA Discip. LEXIS 34, at *24 (NAC July 26, 2017).
[41] Dep’t of Enforcement v. Connors, No. 2012033362101, 2017 FINRA Discip. LEXIS 2, at *13-14 (NAC January 10, 2017).
[42] Id.; FINRA R. 3270, Supplementary Material .01.
[43] As to the second consideration, firms should weigh a non-exhaustive list of factors, including the OBA’s “nature and “the manner in which it will be offered.” FINRA R. 3270, Supplementary Material .01.
[44] See e.g., Dep’t of Enforcement v. Mathieson, 2016 FINRA Discip. LEXIS, at *6.
[45] Id.
[46] Id. at 5.
[47] Id. at 6-7.
[48] Id. at 8-10; Dep’t of Enforcement v. Mathieson, 2018 FINRA Discip. LEXIS 9, at *7-8.
[49] Dep’t of Enforcement v. Mathieson, 2016 FINRA Discip. LEXIS, at *10.
[50] Id.
[51] Dep’t of Enforcement v. Turner, 2016 FINRA Discip. LEXIS, at *18.
[52] Id.
[53] Id.
[54] Id.
[55] Id.
[56] Dep’t of Enforcement v. Cherry, No. 20110269351, 2015 FINRA Discip. LEXIS, at *13 (NAC March 3, 2015).
[57] Id.
[58] Id.
[59] Id.
[60] Id.
[61] See Dep’t of Enforcement v. Somerindyke, No. 2009020081301, 2012 FINRA Discip. LEXIS 69, at *9-10 (OHO December 7, 2012).
[62] Id. at 5.
[63] Id. at 6.
[64] Id. at 7.
[65] Id. at 8.
[66] Id. at 9-10.
[67] Dep’t of Enforcement v. Mathieson, 2018 FINRA Discip. LEXIS 9, at *3 (Without comment, stating that Mathieson continuing with OBA after firm denied approval violated Rule 3270).
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