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Dazed and Confused by FINRA Private Securities Transaction Rule
October 17, 2017
Among FINRA's more lucrative fine-generating violations is FINRA Rule 3280: Private Securities Transactions of an Associated Person, or, in industry jargon, the FINRA PST Rule. Contrary to what some might believe, I fully appreciate the motivation for this rule and support some form of restriction on a registered representative's outside securities transactions. The problem for me is not the justification for a PST Rule but the fact that FINRA's version isn't particularly well written. Consider the all-important definition of what exactly is a PST:
FINRA Rule 3280: Private Securities Transactions of an Associated Person. . .
(e) DefinitionsFor purposes of this Rule, the following terms shall have the stated meanings:(1) "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 3210, transactions among immediate family members (as defined in FINRA Rule 5130), for which no associated person receives any selling compensation, and personal transactions in investment company and variable annuity securities, shall be excluded. . .
Frankly, that definition isn't much of a definition but, at best, an example of circuitous logic.
During my 35 years on Wall Street in compliance, regulation, and as a lawyer in private practice, I have had many discussions with registered representatives about PST violations. Okay, sure, many of those folks simply didn't give a crap about the prohibition and figured that no one would find out -- and, of course, that gambit didn't play out particularly well. On the other hand, I have spoken to many -- far too many folks -- who simply misunderstood what constituted a "securities transaction" or a "private securities transaction."
If you re-read Rule 3280(e), you should immediately spot some sources of confusion; for example, just what is "outside" an associated person's "regular" course or scope of employment?
And while you're pondering that bit of statutory vagueness, just what is the difference between the "course" and the "scope" of employment? If there is no meaningful difference between those two ideas, then why include both in a rule? Using different terms such as "course" and "scope" to suggest different ideas without a statutory definition of either is a perfect example of how poorly drafted rules confuse those who are expected to follow them. Yes, we should expect that those regulated by FINRA have commonsense but that does not give the self-regulator license to draft its rules with vague terms and amorphous concepts and then file disciplinary charges based upon the false premise that everyone reading the rulebook draws the same inference and reaches the same understanding. When your audience is left dazed and confused after reading a rule, you haven't done a great job of drafting!
Bill Singer
Case In Point
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Terrence Jeffrey Diehl submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Terrence Jeffrey Diehl, Respondent (AWC #, 2016050457601, October 11, 2017).
The AWC asserts that Diehl was registered with three FINRA member firms from 1993 to 2003, and, thereafter, in 2015 he registered with FINRA member firm LPL Financial LLC.
Nutritional (and Income) Supplements
The AWC asserts that from:
[J]anuary 2016 through May 2016, Diehl sold shares of a nutritional supplement and natural products company on behalf of a third party through a private offering. Three of Diehl's LPL customers invested a total of $500,000 in the private offering . . ."
SIDE BAR: It is not clear from the above AWC language as to whether Diehl sold the cited shares to numerous investors of which three were customers of his at LPL or, in contradistinction, said sales were made only to the three customers. Frankly, that's a fairly significant lack of clarity and we cannot infer anything one way or the other. A bit more "quality control" from FINRA over the content of its AWCs would be helpful.
In pertinent part, FINRA Rule 3280: Private Securities Transactions of an Associated Person states:
(a) ApplicabilityNo person associated with a member shall participate in any manner in aprivate securities transaction except in accordance with the requirements ofthis Rule.(b) Written NoticePrior to participating in any private securities transaction, an associatedperson shall provide written notice to the member with which he is associateddescribing in detail the proposed transaction and the person's proposed role . . .
The AWC asserts that Diehl was paid 7.5% of the $500,000 investment ($37,500) in the form of transaction-based compensation. Allegedly, Diehl had not given LPL prior notice of his participation in what was deemed a private securities transaction in violation of FINRA Rules 3280 and 2010.
A Lack of Form
The AWC further alleges that in connection with the cited share purchases by two of his LPL customers, Diehl had submitted "Move Money Non-Solicitation / Non-Compensation Acknowledgement for Non-LPL Transactions" forms and had falsely attested on each submission that he had not solicited, recommended, or otherwise participated in the customer's purchase; and he had not received any compensation or promise of compensation for the purchase. FINRA deemed Diehl's attestations to constitute a violation of FINRA Rule 2010.
Discharge
Online FINRA BrokerCheck files as of October 17, 2017, disclose under the heading "Employment Separation After Allegations" that LPL had "discharged" Diehl on May 26, 2016, based upon allegations involving a "product type" described as "Penny Stock," that:
Participation in private securities transactions without Firm approval, in violation of Firm policy.
Sanctions
In accordance with the terms of the AWC, FINRA imposed upon Diehl a $10,000 fine, a nine-month suspension with any FINRA member firm in all capacities, and ordered a $37,500 disgorgement plus interest constituting the transaction-based compensation at issue.
Bill Singer's Comment
Notwithstanding a bit of nit-picking as to whether the three LPL customers were the only investors in Diehl's cited sales, this is a fairly concise AWC and I compliment FINRA for the effort. Moreover, given the alleged violations, the sanctions seem appropriate and tailored to address the misconduct. Dazed and confused notwithstanding, this case seems a fair application of the PST Rule.
If I have one quibble, it is that failure of FINRA to better reflect the difference between the sanctioning of Diehl for the PST involving his three LPL customers versus the sanctions imposed for the additional misconduct of submitting false attestations on the LPL transaction forms. In fairness to FINRA, few, if any, reps are going to engage in non-disclosed PSTs but then make a point of disclosing those transactions on an in-house form. Still, given that there are two separate charges, I would have preferred some disclosure as to the enhanced sanctions attendant to the second charge.