Selling Away

Consider these two opportunities:

Opportunity 1: You are approached by a businessman who offers you a generous fee to locate individuals willing to loan money to his business. He tells you these loans are not securities because they are promissory notes that mature in less than 9 months. To prove this, he gives you an impressive brochure which quotes Section 3(a)(10) of the Securities Exchange Act of 1934:

The term “security” means any note…; but shall not include…any note…which has a maturity at the time of issuance of not exceeding nine months….

He tells you that you do not need to get your broker/dealer involved and the fees can go directly to you, because the notes are not securities. Excited about this opportunity to branch out into a new area, you solicit lenders.

Opportunity 2: One of your good clients is a successful local business owner. He mentions to you that he is doing a very small private placement. He is looking for no more than half a dozen investors. He tells you that his legal counsel has said that this small offering will be exempt from securities registration laws. Being cautious, you call your supervisor at your broker/dealer. He says it is fine to help your client as long as you do not take any commission for it. You talk to a few clients and find a few who are interested.

In each situation, you may have violated the NASD rule prohibiting “selling away” (that is, selling securities away from the supervision of your securities firm). NASD Rule 3040 prohibits you from participating “in any manner in a private securities transaction” unless you comply with the requirements of the rule.

“But,” you argue, “Opportunity 1 did not involve any ‘security.’ I read the definition myself!” You have been hoodwinked. You were shown the definition under the Securities Exchange Act of 1934. The definitions in Securities Act of 1933 and in the Minnesota Securities Act do not contain the exclusion for notes with due dates less than nine months. Also, the definition of a security is the subject a multitude of court cases which apply all kinds of complexities that you would never suspect when you quickly read the language of the statute.

“But I was so careful with Opportunity 2!” you insist. “I even talked to my supervisor!” However, when securities are involved, you must give written notice to your employer. Simply calling your branch manager or even your compliance department is not enough. You must “provide written notice…describing in detail the proposed transaction and [your] proposed role therein and stating whether [you have] received or may receive selling compensation in connection with the transaction….” Also, it is not enough that you get oral approval. Your broker/dealer must advise you in writing as to whether or not it approves the transaction. If you are to receive compensation and your broker/dealer approves, it must keep written records and undertake supervisory responsibility.

The NASD views violations of this rule seriously, because a brokerage firm must know about securities activities before it can properly supervise them. The NASD Sanctions Guidelines recommend sanctions from $5,000 to $50,000 and a 10-day to one-year suspension for violations of Rule 3040.

Play it safe. If you have any doubt, contact your brokerage firm’s compliance department.

Ted Meikle has served as an attorney since 1980, including 4 ½ years as general counsel for a securities broker/dealer. He is now in private practice. This column is provided as general educational material and not as legal advice.

 © Ted S. Meikle