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NEWSLETTERS & ALERTS
A Broker-Dealer's 'Branches’ Run Afoul of FINRA Membership Agreement
[Photo: Paulson Investment Company - Chicago, IL]
by Howard Haykin
Paulson Investment Company agreed to pay a $50K fines to settle FINRA charges that it violated its Membership Agreement with FINRA as a result of operating more offices than permitted under that agreement, and that it failed to register 3 locations as branch offices.
BACKGROUND. Paulson is a boutique investment banking firm, headquartered in Chicago, IL. Paulson, a FINRA member since 1971, currently employs 50 registered reps and has 7 branch offices.
Relevant Disciplinary History. In January 2016, Paulson agreed to a $60K fine to settle FINRA charges that it: (i) undertook a material change in its business operations without FINRA approval, specifically hiring 35 new representatives and opening a 2nd branch office when its membership agreement limited the firm to one branch and 15 associated representatives; (ii) failed to implement adequate hiring processes; and, (iii) failed to establish, maintain, and enforce adequate WSPs to review and evaluate outside business activities.
1. Paulson Undertook a Material Change in Business Ops Without Approval. On 3/8/16, Paulson executed a Membership Agreement with FINRA that contained a restriction that states Paulson "may not operate more than  offices (registered or unregistered), including the main office." NASD Rule 1017(a) requires a member firm to file an application with FINRA for approval of “a material change in business operations as defined in Rule 1011(k)." "Material change in business operations" includes "removing or modifying a membership agreement restriction."
- On 4/22/16, Paulson began conducting securities business at a 9th office.
- On 7/8/16, Paulson began conducting securities business at a 10th office.
- Before opening these offices, Paulson did not submit a continuing membership application seeking to modify the restriction in the Membership Agreement limiting it to 8 offices.
2. Paulson Failed to Register Branch Offices. FINRA Rule 3110(a)(3) requires a firm to register and designate as a branch office each location that meets the branch office definition provided in FINRA Rule 3110(f). “Branch office” is "any location where one or more associated persons of a member regularly conducts the business of effecting any transactions in, or inducing or attempting to induce the purchase or sale of, any security, or is held out as such." However, an associated person's primary residence will not be considered a branch office, provided that certain conditions are met – one such condition is that no customer funds or securities are to be handled at the location.
- From 1/8/16 to 5/18/16, a Paulson representative regularly conducted securities business at his primary residence in Easton, MD, including the receipt and handling of customer funds.
- From 1/28/16 to 5/17/16, another Paulson representative regularly conducted securities business at his primary residence in Treasure Island, including the receipt and handling of customer funds.
- Beginning April 22, 2016, another Paulson representative conducted securities business at an office located in Memphis, TN, that was primarily used for conducting securities activities. This office was not registered until November 2016.
FINANCIALISH TAKE AWAYS. It may come as a SURPRISE that FINRA is trying to accommodate its member firms, by proposing to ease up on office inspection requirements. In early November, FINRA proposed it would eliminate on-site inspections of small and limited purpose business locations [see FINRA RegNote 17-38]. Under Proposed Rule 2110.15(b), a “qualifying office” would have to meet certain conditions, including the following:
- 3 or fewer associated persons are designated to the location;
- the location is not held out to the public as an office of the firm;
- no customer funds or securities are handled at the location;
- no registered person at the location has a disciplinary history.
However, FINRA does not appreciate ‘SURPRISES’ when it comes to Membership Agreements. And the regulator expects its members to operate within the agreed-upon parameters of the Agreement. Within the past 22 months, Paulson has violated its Membership Agreement twice – and it’s something of a SURPRISE that the firm did not receive weightier sanctions this go-around.
This case was reported in FINRA Disciplinary Actions for October 2017.
For details on this case, go to ... FINRA Disciplinary Actions Online, and refer to Case #2016047943601.