Outside Business Activities—Too Much to Supervise?

One of the sessions at the recent National Society of Compliance Professionals (NSCP) conference in Philadelphia discussed outside business activities and how the new proposed FINRA Rule 3270 may impact firms.

The proposed FINRA Rule 3270 has started many member firms thinking and questioning what will really be involved in supervising outside business activities of their representatives. Is your outside business activity notification documentation strong enough? Are you asking enough questions to make the correct decision?

FINRA has indicated it believes firms must review a registered person’s outside business activity to determine whether it raises investor protection concerns. If a member determines that the outside business activity raises investor protection concerns, the firm must then implement procedures or restrictions on the activity to protect investors and/or prohibit the activity. The firm must also make the determination whether it should be treated as an outside securities transaction. Are firms in a position to do this? What exactly would/should this entail?

The panel discussing this topic at the NSCP conference indicated there are many more questions than answers surrounding the proposed rule. Some of the big areas of questions are:

1. Will registered principals also have to be licensed to supervise the OBA? For instance, with a fixed insurance sale, would registered principals also need to be insurance licensed in each state where they supervise the business. The proposed provision would require the designation of an “appropriately” registered principal - regardless of whether registration as a broker-dealer is required for that activity.
2. If a representative had accounting and/or tax preparation as an outside business activity, would the registered principal supervising the representative also need to be a tax attorney or CPA?
3. Will firms have to consider increasing their Fidelity Bond coverage and/or E & O policies?
4. Since FINRA regulations do not supersede state or federal regulations in various industries, will the firm have the authority to supervise under various laws? For independent broker-dealers, will firms need to amend contracts to require registered persons to agree to their authority in order to supervise the outside business activity?
5. Will firms need to hire more staff or implement new processes for supervision of OBAs?
6. What will the due diligence requirements of a firm be under the proposed rule?

1. Will the firm be liable for activities conducted in the outside business activity of the rep?
2. Is the activity covered under the firm’s E&O policy?
3. Who within the firm has the expertise to evaluate the activity and the potential risk to the firm?
4. What further documentation will the firm need to do in order to support their due diligence process?

Whether the new rule is passed or not, firms should always ask:

• Is the disclosure sufficient to determine the nature of the activity?
• What are the potential conflicts of interest?
• What is the purpose of engaging in the activity?
• Does the representative have the knowledge or expertise to perform the activity?
• What are the regulatory risks?
• Will a greater percentage of time be spent with the OBA than with the securities or investment advisory business of the firm?

The professionals on the panel suggested that this area will continue to be a focus of regulatory concern.  Judging by the changes that are being proposed, it would be prudent for firms to review their current approval processes around outside business activities, and make certain that each activity of their registered persons is well documented within the firm.

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