Outside Business Activities and Private Securities Transactions

By Laura Crosby-Brown

Rep suspended for 30 days – Rep fined $9,000 and suspended for 3 months – Rep barred from association with any member – Rep fined $14,000 and suspended for 6 months – Rep fined $5,000 and suspended 10 days.

All of these are taken from the NASD’s report of disciplinary actions from February and March. Are you wondering what they did? They all failed to report either outside business activities or private securities transactions to their broker/dealer which is in violation of NASD Rule 3030 and 3040 respectively.

Why did this happen? Many representatives claim they are not aware of the requirements or simply did not think the activity required reporting. However, ignorance is not an excuse and it is up to broker/dealers to ensure that their representatives are educated on these requirements and that firms conduct regular reviews to try to detect such activities.

Rule 3030, which covers outside business activities, states “No person associated with a member in any registered capacity shall be employed by, or accept compensation from, any other person as a result of any business activity, other than a passive investment, outside the scope of his relationship with his employer firm, unless he has provided prompt written notice to the member. Such notice shall be in the form required by the member. Activities subject to the requirements of Rule 3040 shall be exempted from this requirement.” But what does this mean?

Basically, registered persons cannot engage in any activities outside the broker/dealer from which they derive compensation or other economic benefit. This means that activities such as acting as treasurer for the local PTA, serving on the investment committee for their church, being an umpire for the Little League, owning rental property or being a director for a charity should be reported. Why you ask? Well, in each instance the person may have financial control, be provided with a stipend or other benefit, generate income or a loss or the activity could result in a tax benefit. These situations, while not traditional compensation, are an economic benefit.  Keep in mind that if registered representatives also offer traditional insurance products, are appointed with insurance companies and this business does not flow through the broker/dealer, this is also an outside business activity that needs to be disclosed.

Rule 3040 deals with private securities transactions and the first two sections read: “No person associated with a member shall participate in any manner in a private securities transaction except in accordance with the requirements of this Rule.  Prior to participating in any private securities transaction, an associated person shall provide written notice to the member with which he is associated describing in detail the proposed transaction and the person's proposed role therein and stating whether he has received or may receive selling compensation in connection with the transaction; provided however that, in the case of a series of related transactions in which no selling compensation has been or will be received, an associated person may provide a single written notice.”  

So what is a private securities transaction? Many people think that this is a transaction in the representative’s brokerage account or for their own benefit but this is not what this rule covers. Outside Brokerage Accounts are covered in Rule 3050, which is a topic for another day. The Rule defines private securities transactions as follows: "Private securities transaction shall mean any securities transaction outside the regular course or scope of an associated person's employment with a member, including, though not limited to, new offerings of securities which are not registered with the Commission, provided however that transactions subject to the notification requirements of Rule 3050, transactions among immediate family members (as defined in Rule 2790), for which no associated person receives any selling compensation, and personal transactions in investment company and variable annuity securities, shall be excluded.”   So what does this mean?

Basically, any transaction where the representative is acting in an agent or finder capacity in which he or she may or may not receive compensation outside their activities with the broker/dealer may be considered private securities transactions. Some notable instances from recent history have been sales of equity indexed annuities, interests in telephone booths, promissory notes, and viatical settlements. Representatives are often contacted by companies or even other representatives regarding a product or service that they could offer their clients that may not seem to be a “security”, but when you look at the underlying activity, it could be considered such by a regulator. However, some other circumstances could be less transparent such as a friend asking a representative to help him raise money to open a restaurant in exchange for a small fee or even part ownership. These types of activities could be viewed as a private securities transactions under the Rule.

So what is a firm to do? Educate and follow-up. Be sure your registered persons understand their responsibilities to the broker/dealer for notification and the requirements under these Rules; follow-up annually, or more often, to find out what your representatives are doing and whether or not they are engaging in activities away from the broker/dealer; and encourage representatives to disclose everything or at least have a conversation with their supervisor or compliance officer prior to engaging in any outside activities.

If you have a question about a proposed activity or about these requirements, please feel free to contact our Compliance Partners Department directly at 603-434-3594.