[ by Howard Haykin ]

In compliance, very often 'it's not what you know that counts, it's what you don't know!'

The following 9 types of violations were highlighted in:  [FINRA Quarterly Review, October 2012].

1. Sharing Commissions With an Unregistered Individual and Providing False Information to Firm.  [posted Fri, 10/5]
2. Fraudulently Misappropriating Customer Funds.  [Mon, 10/8]
3. Recommending Unsuitable Transactions to a Customer.  [Mon, 10/8]
4. Willfully Failing to Disclose Material Information on a Form U4.   [Tue, 10/9]
5. Exercising Discretion Without Customer and Firm Approval.   [Tue, 10/9]
6. Improperly Engaging in Outside Business Activities, Improperly Accepting Gifts From a Customer, and Misrepresenting to a Member Firm the Receipt of Monetary Gifts From a Customer.  [Wed, 10/10]
7. Recommending Unsuitable Transactions to a Customer. 
8. Improperly Borrowing From a Customer and Misrepresenting Facts to a Member Firm
9. Selling Away

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FINRA Priority #6 for October - Outside Business Activities, Accepting and Disclosing Receipt of Gifts from Customers.

A registered rep ("RR") allegedly committed 3 violations:  (i) improperly engaged in outside business activities, (ii) improperly accepted gifts from customers, and (iii) misrepresented on firm questionnaires that he had received the gifts.  Let's review.

(i) O/S Business:  Over a one-year period, an RR incorporated 3 separate entities. 

• Entities 1 and 2 were a Private Equity Group and an IA for high-net-worth individuals, respectively.
  • For each, RR: (i) filed articles of incorporation and annual reports;  (ii) established a website;  (iii) drafted website content;  and, (iv) actively managed the entity's bank accounts.
  • Initial funding for each financed through borrowings from the same customer.
  • RR served as a Principal and registered agent for both
  • RR actively promoted their businesses.
  • RR received no compensation from either company, but used PE Group funds to cover personal expenses;  he wrote $25,000 worth of checks from the Investment Adviser's account to himself, family members and cash.
• Entity 3 was a Consulting Group that serviced international companies for renewable energy projects and business development.
  • RR filed articles of incorporation, established a website and prepared website content.
  • RR received no compensation from this entity.

• RR never discloses any of these outside businesses on firm questionnaires.

(ii) & (iii) Gifts From Customer:   The customer, 70 and without any close relatives, not only funded Entities 1 and 2, but had over a 3-year period gifted to the RR and members of his family approximately $1 million in cash and securities.

• Firm pols and procedures prohibits RRs from accepting gifts and gratuities from customers.
• RR failed to disclose his receipt of the gifts to his firm.
• RR failed to seek firm's approval.
• RR specifically misrepresented these facts on at least 3 compliance questionnaires.
• RR affirmatively misrepresented in compliance questionnaires that he had been named beneficiary on the customer’s individual retirement account and 4 annuity policies, conduct which the firm’s policies also prohibited.
• RR also misrepresented on a firm questionnaire that he had arranged to receive mail at his home address that the firm sent to the customer.
• RR further misrepresented on a firm questionnaire that an address that he had provided for the customer was in fact one of the RR's outside business addresses, and that he was acting as the customer’s power of attorney.
• NOTE:  We interpret FINRA's use of "misrepresented" as meaning that he never disclosed any of these facts - even though they may have been addressed in questions on the firm questionnaire.  

FINRA Sanctions.   FINRA charged the RR with having violated NASD Rules 3030 (outside business activities) and 2110 (ethical standards), and FINRA Rule 2010 (ethical standards).  The RR settled FINRA's charges by agreeing to a $50,000 fine and 8-month suspension in any capacity.

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C-I Take Away: 

Every employee with a support function in a broker-dealer probably has little or any free time to conduct additional procedures.  But some background checking of current employees can yield dividends - i.e., critical information that the employee had not disclosed to the firm. 

We'd suggest any of the following tasks be assigned to someone involved with Human Resources, and can be conducted periodically on randomly or based on some objective criteria.  The objective here is to determine if an employee has been involved or associated with an outside business activity that was not adequately or completely disclosed to the firm, as required.  The same search can possibly yield criminal or civil violations, bankruptcies and other information that the firm would want to know about.

A couple of simple methods for conducting the search:  (i) google;  (ii) www. spokeo.com.  Whether it's either of these methods, or some other ways, we would encourage firms to carry out those procedures. 

Remember:  In compliance ....   IT'S NOT WHAT YOU KNOW THAT COUNTS, IT'S WHAT YOU DON'T KNOW!