Watch Your Business: Finra Enforcers Crack Down on Outside Activities
Highlighting its continuing concern with brokers’ failure to disclose outside business activities (OBA) and investment activities to their firms in order to help them supervise conflicts with customers, the Financial Industry Regulatory Authority’s disciplinary action roster was top-heavy this week with related fines and suspensions.
Four of the 11 consent letters published on Finra’s disciplinary action website in the past four days involved violations of its Rules 3270 and 3280 requiring brokers to receive firm permission for their outside business and private securities transactions.
“It is a continuous flow of people getting into trouble,” said Mark Attar, who is a partner at Schiff Hardin in Washington D.C., and often represents brokerage firms. “Firms are aware of how closely Finra is looking.”
But while three of the five sanctions meted out this week highlighted clear-cut violations—one ex-Morgan Stanley broker accepted a sanction for buying 39.5% of a fuel-service company and helping to run it despite the firm’s denial—compliance executives, lawyers and even Finra officials said brokers are sometimes understandably confused.
Asked at Finra’s annual conference last week whether the occasional rental of a vacation home rises to the level of an outside business activity that requires approval rather than a passive investment, Finra Associate General Counsel Meredith Cordisco, acknowledged that there is no clear answer.
“That’s certainly a gray area,” she said, noting that real-estate issues are a frequent source of questions. Finra is intentionally avoiding putting a bright-line definition around “passive,” as regulators often do to give lawyers loophole opportunities. But she noted that the more time and involvement a broker spends on an outside activity, the more likely will be a finding that it is not passive.
Kenneth Jobson, the broker who Morgan Stanley fired in December 2016 for proceeding with his fuel service business plans, not only helped operate and market the business for 18 months but concurrently bought a 21.7% interest in a customized motorhome manufacturer without notifying the firm, and failed to mention his businesses on an annual compliance questionnaire.
Jobson, who received $13,200 for his work at the motor home manufacturer in 2016, agreed to a $5,000 fine and a three-month suspension, without admitting or denying Finra’s findings.
Jobson, who joined registered investment advisory firm Platinum Wealth Partners in St. Petersburg, Florida, after leaving Morgan Stanley, could not be reached for comment at a publicly listed phone number. He left Platinum in late March to work at another RIA, Hayden Royal, but Hayden Royal CEO Louis Dworsky said it ended its affiliation with him this week.
While Jobson’s failure to report his activities may be egregious, many compliance officials say brokers stumble over the Finra rules unintentionally at times.
Failure to report and seek permission for outside business activities is the most common violation found during branch exams and reviews at Securities America, Greg Smith, senior vice president of supervision at the independent broker-dealer, said at the Finra conference panel in which Cordisco participated.
Requiring its brokers, who are almost universally licensed to sell insurance, to disclose that business to the firm and to clients (who may well be offered annuities), is obvious, Smith said. But aware of Finra’s scrutiny, Securities America scrutinizes checking account records, extensively reviews email correspondence and chatrooms, and “all the time” tells independent brokers who serve as supervisors that they must report suspicions of outside investments, whether or not they think the activities need reporting on Form U4s.
According to Cordisco, that’s a wise decision. Finra has highlighted outside business activities and private security transactions as a priority examination area for firms for at least the last two years, saying in bulletins, conferences and other missives that they can easily create conflicts of interests that firms must understand and mitigate.
“If a lot of reps at a firm seem to be in violation, we question supervisory procedures,” Cordisco said at the annual meeting.
Recognizing the complexities of defining outside-activity conflicts and properly supervising them, however, Finra also has proposed a new rule to replace the two existing ones in order to “reduce unnecessary burdens.” The comment period closed last month.
In the three other OBA settlements this week, Finra fined former Principal Securities broker John Krohn in West Des Moines, Iowa, $10,000 and suspended him for three months for allegedly failing to disclose that he was an officer or director of four companies, including one that he owned jointly with a wealthy customer that invested in early-stage and distressed businesses. He also failed to tell Principal he invested more than $7.9 million in ten companies, in part through the business he owned with the client, Finra said.
“Krohn prevented Principal Securities from considering issues such as whether his outside business activities would interfere with his responsibilities to the firm or its customers, and whether customers or the public would incorrectly view the activities as part of the firm’s business,” Finra said.
Krohn, who is no longer registered as a broker or investment advisor, according to BrokerCheck, could not be reached for comment on the settlement. His Des Moines-based lawyer, Drew Larson, did not return a call for comment.
Another former broker, Morey Goldberg, accepted a 45-day suspension and $10,000 fine for investing in four commercial real estate properties without providing “timely written notice” to independent broker-dealer M Holdings Securities, Finra said. He also allegedly distributed a presentation to eleven potential customers “that was not fair and balanced,” violating a client-communications rule.
Goldberg, now an investment adviser representative in Wynnewood, Pennsylvania at CMS Fund Advisers, did not return a call for comment.
The fourth case involved what participants at the Finra panel said is a more common stumble, working with a relative on a family business.
Carlos Velazquez, who worked at three firms in the four years that he was registered with Finra, accepted an eight-month suspension and $10,000 fine for allegedly failing to disclose the full scope of his involvement as a secretary and “agent of record” for a tax preparation and bookkeeping company owned by his father, according to Finra.
Velazquez was discharged by Waddell & Reed in December 2016, ten months after joining the independent firm from an office in Elgin, Illinois, for admitting that he made false statements about the nature of an outside business activity,” according to his BrokerCheck history. Velazquez, who is not currently registered as a broker or investment adviser representative, could not be reached for comment.