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Executive Summary

In the securities brokerage industry, "selling-away" refers to the prohibited practice of an Associated Person2 effecting or soliciting the sale of securities or investment products not held or approved with whom the broker is affiliated without prior written consent. FINRA regulators have seen a steady flow of selling-away cases over the years involving registered representatives who are being targeted by issuers, promoters and marketing agents to sell their nontraditional investment products to their retail customers. In many instances, promoters of these products are marketing them as non-securities products that do not have to be sold through a broker-dealer by a registered person. In a significant number of cases, associated persons have sold these investments to their customers away from the broker-dealer and without firm approval as required by FINRA Rule 3270. Selling-away often occurs in an independent branch or a satellite office, where Associated Persons are removed from the day-to-day oversight and supervision of their brokerage firm's compliance department. Investments involved in selling-away often include nontraditional products such as private placements, promissory notes, non-traded REITs, structured products, bridge loans and viatical settlements. These products are often presented as an investment opportunity that is an approved product endorsed by the brokerage firm without the firm's knowledge.

These investments generally have little to no liquidity, high fees and lack transparency. and commonly promise high-yields and returns with principal protection. These high-risk financial products are typically marketed directly to brokers by an issuer and then marketed to vulnerable investors with a thirst for higher yields or returns. These financial products are not commonly registered or approved for sale by any national or state regulatory agency and they fall under the radar of regulators.

What is most disturbing about these products is that many financial advisers do not fully understand the risks and complexities that are involved with these products. The commissions generated from these transactions can be two to three times higher than a traditional registered product and the temptation to increase their payday makes it difficult for many financial advisers to pass up, especially when they do not have to share a portion of their hefty commissions with their broker-dealer.

Though investments sold-away may indeed be legitimate investment vehicles, products sold outside the due diligence and scrutiny of brokerage firms frequently lack sufficient liquidity and solvency. These products generally have risk profiles that are unsuitable for most investors. Additionally, investments sold- away may be fraudulent and represent shares in Ponzi Schemes or in fictitious issuing companies. Cases involving products the broker-dealer did not approve or know about commonly "blow up" and harm the client's overall investment portfolio.

In disputes involving "selling-away" and outside business activities, claimants regularly state that they relied on the advice of the associated person effecting the transaction as well as the reputation and scrutiny of the brokerage firm prior to purchasing the unapproved investment. However, respondent FINRA3 member firms routinely respond that they were unaware of off-the-books activities of an Associated Person, and as such, claim no liability. For claimants, this often makes it challenging, but not impossible, that a significant portion of any losses stemming from the investment will be recovered.

Though vicarious liability claims have generally been unsuccessful against FINRA member firms in disputes involving selling away, FINRA rules and panel interpretations have established that there are instances when brokerage firms can be held liable for the unauthorized actions of an Associated Person. This discussion outlines and discusses the applicable industry rules pertaining to selling away, and examines the situations when FINRA Arbitration Panels have held Member Firms vicariously liable in Selling Away related disputes.

Regulation of Selling Away

FINRA Rules 32704 and 32805 set requirements for Associated Persons and mandated procedures for Member Firms regarding the disclosure and review of outside business activities and private securities transactions. FINRA Rules 33106 and 31307 require Member Firms to supervise the actions of Associated Persons-placing an obligation on firms to adequately monitor activities within client accounts. Relating to instances of Selling Away, FINRA supervisory requirements extend to the detection and supervision of off-the-books transactions.

The following section introduces these key items of FINRA regulation.

Requirements of Associated Persons

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Bob Lawson is the President and Chief Compliance Officer of Barrington Capital Management, Inc. He is a Securities Litigation Consultant/Expert Witness, FINRA and NFA Dispute Resolution Arbitrator, Certified Fraud Examiner, Accredited Investment Fiduciary and a Qualified Neutral under Minnesota Rule 114 of Standard of Practices.

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