Some of the knowledge required to acquire Series a 7 flees a rep's brain before the test scores have even been computed — a process that takes mere minutes. The rules governing the actions of associated persons (APs) appear to be a case in point.
By the end of this year, the NASD will have taken action against over 100 people who violated its Conduct Rule 3040. This rule seems straightforward enough. It states that an AP (including both unlicensed employees and licensed reps) who would receive selling compensation for participating in a private securities transaction must first appraise his broker/dealer of his participation. If the firm approves, it must record the transaction on its books and supervise the AP's participation as if the transaction were executed on behalf of the member.
Alas, the terms and definitions involved in the rule make it difficult to understand. What follows is an attempt to demystify the rule's most hard-to-decipher aspects.
Private Securities Transaction
Rule 3040 defines a “private securities transaction” as any outside the regular course or scope of an AP's employment with a member (including new offerings). Pointedly excluded from the definition are the following transactions: those subject to the notification requirements of NASD Conduct Rule 3050 (typically trades executed at another B/D or in accounts over which the associated person has discretion); those among immediate family members (for which the AP receives no compensation); and personal transactions in investment company and variable annuity securities.
The AP's written notification to his B/D must detail the proposed transaction, the person's proposed role and whether he has received or may receive compensation. If the transaction is for compensation, the B/D must provide written notice to the AP of its disapproval or approval. However, even if an AP has not and will not receive any comp, written notice to the B/D is still required. In this case, the member must provide prompt written acknowledgment, but it cannot impose conditions on the individual's participation.
Not Involved? You Sure?
There are a number of subtle ways to be involved in a transaction. Be aware that regulators have found even limited involvement by an AP is sufficient to trigger the requirement of written notice to the member firm. In one case an AP who merely introduced clients seeking to purchase control of a company-to-company management, and later received a finder's fee when the transaction was consummated, was found to have participated in a securities transaction. In another case, an AP who did not receive any compensation was ruled a participant because he, among other things, brought a limited partnership investment to his customers' attention.
What's a Security?
This sounds like an easily answered question, and indeed it is for transactions involving common stocks and bonds. However, some APs have been charged for introducing clients into what at first blush seemed like non-securities — a restaurant franchise, viatical instrument or a commercial note, for instance. When the regulators looked behind the name of the transaction and decided a security lurked beneath, the APs lack of proper procedure constituted a violation. The point is: Know what you're selling.
“Selling compensation” is any compensation paid directly or indirectly from whatever source in connection with or because of the purchase or sale of a security. These include commissions, finder's fees, securities or rights to acquire securities, rights of participation in profits and expense reimbursements.
Here are some factors that will be considered in meting out fines and/or suspensions to Rule 3040 violators:
The dollar volume and number of customers involved in the sales.
Whether the respondent had an interest in, or was otherwise affiliated with, the selling enterprise or issuer, and whether respondent disclosed such affiliations.
Whether the respondent attempted to create the misleading impression that his employer (member firm) sanctioned a sale.
Whether the respondent's selling-away activity resulted, either directly or indirectly, in injury to the investing public.
Whether respondent misled his or her employer (member firm) about the existence of the selling away activity or otherwise concealed the selling away activity from the firm.
Violators of Rule 3040 can expect a suspension of between one month and a year, coupled with a fine of at least $5,000. In addition, a significant number of violators are barred.
Serious stuff — perhaps serious enough to convince some of you to dust off your old Series 7 study materials once in a while.
Bill Singer is a partner with the law firm of Gusrae, Kaplan & Bruno. rrbdlaw.com