Legal: Selling Away Your License

Engaging in an outside business activity puts your career at risk. Why? Because your firm will be on the hook if things go wrong. Lets start with this assumption: Youre not a modern day Charles Ponzi, engaging in nonexistent securities transactions or business ventures, promising great returns and achieving them by robbing Peter to pay Paul. But you have encouraged some friends and relativeswho may

Engaging in an outside business activity puts your career at risk. Why? Because your firm will be on the hook if things go wrong.

Let’s start with this assumption: You’re not a modern day Charles Ponzi, engaging in nonexistent securities transactions or business ventures, promising great returns and achieving them by robbing Peter to pay Paul. But you have encouraged some friends and relatives—who may not have brokerage accounts with you—to invest in either private placements, a real estate agency or in your soon-to-be-published book, “Gullible Investors.”

You believe these ventures to be unrelated to your day-to-day responsibilities as a broker. Therefore, you have not advised your firm of them.

Engaging in an outside business activity puts your career at risk. Why? Because your firm will be on the hook if things go wrong.

As bad luck will have it, the private placements that invested in a trendy business venture soon fail. Your real estate agents become franchisees of a competitor. And too few readers are gullible enough to buy your book.

The friends and relatives who invested are upset. Some are mad enough to sue you.

You can’t believe what you discover next: The investors in your failed ventures cite court cases that, under the law, make them customers of your firm despite never having an account there.

Once in arbitration, the attorney for the “customers” argues that since the firm clothed the broker with the “apparent authority” to engage in these outside business activities, the firm is liable for the broker’s acts. The attorney cites the agency law theory of “respondeat superior,” which makes employers liable for actions of employees, including independent contractors.

Why Outside Businesses Can Kill Careers

Under agency law, an investor claiming this apparent authority on the part of the broker must prove that he or she exercised reasonable reliance on the broker’s representations. Reliance by itself isn’t sufficient. A blind confidence or trust won’t give rise to apparent authority under the law.

It must be a reliance based on good faith and made in the exercise of reasonable prudence. The question arbitrators ask, after it’s clear the person relied on the broker’s representations, is this: Under all the circumstances, was the person justified acting as a reasonable man, in believing the broker acted on the authority of the brokerage firm?

The firm will attempt to cut itself loose from the case. It will argue it had a reasonable supervisory system in place designed to prevent selling away and to monitor outside activities. It will attempt to show that the branch manager implemented these internal rules in a reasonable manner. If it can show that a reasonable (not perfect) supervisory system was implemented, the firm has a safe harbor.

If a broker did not get prior written approval from the firm to engage in outside business activities or private securities transactions (NASD Rules 3030 and 3040), this will increase the chances of the broker alone being liable for an arbitration award. If the broker did get such approval, the firm may also be liable.

So be forewarned: Any kind of outside business activity puts your career as a broker at risk. If “customers” of an outside venture complain, the firm will put the blame on you. You may indeed be the one at fault under the law. The firm may have no choice but to fire you and disclose that your termination was the result of unreported outside business activity and selling away.

And having that kind of disclosure on your record could end your career.

Securities attorney David E. Robbins is a partner in the New York law firm of Kaufmann Feiner Yamin Gildin & Robbins. He is the author of many books on securities arbitration.

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