Outside Business Activities: The New Rule

Pull up Notice 10-49 to see FINRA's announcement of some recent Rule Consolidation changes. Within these is the shiny new FINRA Rule 3270 on Outside Business Activities of Registered Persons. It becomes effective December 15 for new notifications of OBA; but for reps with current outside activities, firms must comply with the supplementary material by June 15, 2011.

For what they're worth, here are my comments. Bit lengthy: my apologies.

1. This rule applies to ‘registered persons’ not ‘associated persons.’ (But the selling away rule, 3040, applies to associated persons.) Here a definitions to remind you of the difference for now--def's may change soon:

According to Article I Definitions in NASD By-Laws, "person associated with a member" or "associated person of a member" means: (1) a natural person who is registered or has applied for registration under the Rules of the Corporation; (2) a sole proprietor, partner, officer, director, or branch manager of a member, or other natural person occupying a similar status or performing similar functions, or a natural person engaged in the investment banking or securities business who is directly or indirectly controlling or controlled by a member, whether or not any such person is registered or exempt from registration with the Corporation under these By-Laws or the Rules of the Corporation; and (3) for purposes of Rule 8210, any other person listed in Schedule A of Form BD of a member

For "registered person" I offer the following: From NASD 1031(a): “All persons engaged or to be engaged in the investment banking or securities business of a member who are to function as representatives shall be registered as such with NASD in the category of registration appropriate to the function to be performed as specified in Rule 1032.” And from 1031(b): Persons associated with a member, including assistant officers other than principals, who are engaged in the investment banking or securities business for the member including the functions of supervision, solicitation or conduct of business in securities or who are engaged in the training of persons associated with a member for any of these functions are designated as representatives.

2. The rule applies to persons with a “reasonable expectation of compensation”: this broadens the scope from the prior rule. No more excuses: if the Rep may make money from an outside activity, it counts.

3. The rule newly requires “PRIOR” written notice. It used to be “prompt.” That means Reps can’t start doing outside business activities and then later inform their BD employers. Firms should have a clear pre-notification requirement in their procedures manuals and they should devise a notification mechanism, like an internal form, that prompts information from the RR about the activity. They should include a time frame for the notice that allows enough time for the firm to meet its review obligations under 3270.01 (see next comment).

4. The rule newly requires the firm to consider the ramifications of the outside activity as follows:

(1) Does it interfere with or compromise the registered person's responsibilities to the firm and/or customers?

(2) Could it be viewed by customers or the public as part of the firm’s business based upon, among other factors, the nature of the proposed activity and the manner in which it will be offered?

(3) Is the OBA really ‘selling away’ under NASD Rule 3040?

The firm should document its review of these things: it would make sense to have the results of the review appear on the notice form. If no conflict is perceived and the business is not ‘selling away,’ the firm can move forward without action (or it can document ‘approval’ of the activity—not technically required, but implicit). But if the answer to questions (1) and/or (2) is ‘yes’ then the firm has to do something about it, like imposing specific conditions or limitations on the registered person's outside business activity or outright prohibiting it. Again, the records should document all requirements/prohibitions, as well as the communications to the registered person describing the firm’s decision. If the answer to number (3) is ‘yes,’ then the firm has to apply its procedures for 3040 compliance and recordkeeping—or prohibit the activity.

5. The rule change was scaled back from the original: FINRA member voices were heard, such that now, firms will not have to supervise the surf lessons Reps are giving on the side. (However, if a firm feels like mutual customers are risking their lives by taking these surf lessons, thus increasing the possibility of losing firm accounts, firms can say CowaSorry to the Rep…no surf lessons to firm customers.)

6. Here’s what I can’t figure out: why didn’t the new rule include reference to, or somehow reflect on, the reporting requirements on U4. U4 calls for disclosure of OBA as follows:

“Enter "yes" or "no" to indicate whether you currently are engaged in any other business, either as a proprietor, partner, officer, director, employee, trustee, agent, or otherwise. Exclude non-investment-related activity that is exclusively charitable, civic, religious or fraternal, and is recognized as tax exempt.”

Better yet, why didn’t the respective Notice reflect on this subject? I have to assume the following: outside ‘business’ activities do not refer to charitable, civic, religious or fraternal organizations/activities. BUT it might be worth addressing, to a limited extent, these categories on the internal notice form. Why? So that any such activities that also include ‘investment-related activities’—for instance, helping to manage the church’s investments—are not overlooked. If these types of activities are not investment-related, then U4 reporting is not required. If they are, then the firm should complete the same review as for other OBA…and make decisions and document them. I wish I could be clear about this strategy, but I’m not. It seems like a firm could, based on the rule language, prohibit a registered person from engaging in charitable work if the firm deemed it a conflict or risk to business. But what do I know? Enough to be curious…

7. Back to the subject of effective dates: firms should notify all registered persons of this new 'prior notice' requirement--and tell them that as of Dec. 15 they must, in effect, seek pre-approval of any new OBA. And the firm must remember to review all existing OBA by next June to determine if limitations, conditions or prohibitions should be imposed.

That's all for now. Why don't you let me know what you think?