Applicable law/agency: Securities and Exchange Commission (SEC), National Association of Securities Dealers (NASD)
Related topics: Securities, Breach of Fiduciary Duty, Stock Market Losses, Misrepresentation/Omissions
Selling Away Information
Under National Association of Securities Dealers (NASD) Rule 3040, brokers may not deal in private securities except in limited cases. As defined, private security transactions are those transactions which are not a part of the broker’s regular work with the brokerage house. In order to sell private securities, a broker must give written notice to the brokerage house. The brokerage firm has the discretion to approve or deny the broker’s request. If a broker tells an investor about “secret” investments that cannot be revealed to other brokers, offers securities not available through the brokerage firm or asks for payment to be rendered to a third party, rather than the brokerage house the broker may be selling away.
Private Security Transaction May Be Selling Away
When a broker sells a customer an “investment” outside the investment products offered by the brokerage firm and outside the client’s account, there may be a selling away issue. These investments, known as Private Securities, often involve investments in private limited partnerships, privately held companies, promissory notes, and real estate.
The National Association of Securities Dealers (NASD) has strict guidelines regarding private securities transactions, NASD Rule 3040 – Private Securities Transactions of an Associated Person. The Rule states that brokers may not participate in any manner in a private securities transaction except in accordance with the requirements Rule. These rules are designed to help protect individual investors and to help ensure the integrity of brokers.
Under NASD Rule 3040, a private securities transaction means any securities transaction outside the regular course or scope of broker’s employment with their brokerage house, and includes, but is not limited to, new offerings of securities which are not registered, and that the Broker receives a selling compensation.
Prior to any private securities transaction, the broker must provide written notice to their brokerage firm. The notice must include a detailed proposed transaction report and the broker’s proposed role and the selling compensation in connection with the transaction, for approval.
It is up to the brokerage firm to either approve the broker’s participation in the proposed transaction. If the transaction is approved, the transaction must be recorded on the brokerage firm’s books and records and the brokerage house must supervise the broker’s participation in the transaction (as if the transaction were executed on behalf of the brokerage house). If the transaction was disapproved, the broker’s participation the broker must not participate in the transaction in any manner, directly or indirectly. If the broker does not seek or receive approval for any transaction for a client, it is “selling away”.
Some “red flags” that a broker may be engaging in selling away are:
• The broker solicits the customer’s participation in an investment that is not offered by the brokerage firm.
• The broker suggests that the investment is a “secret” and that the customer should not mention it to anyone else at the brokerage firm.
• Payment for the investment is not made to the brokerage firm but directly to the company being invested in or to the broker or some third party.
• The broker recommends outside private placements and initial public offerings and the transactions are executed outside the brokerage firm or his employer.
If a client is concerned about that practice of “selling away” is occurring the customer should immediately contact their broker’s supervisor. In many cases, the brokerage firm is liable for the activity and needs to take appropriate action. Any losses that may have already occurred, may occur or any other financial impact (such as commissions or fees), may be able to be recovered from the brokerage house.