FINRA Provides The Blueprint For Monitoring Outside Business Activities

From Ulmer’s Broker Dealer Law Corner Blog
By Alan Wolper

Outside business activities are in the news. In Reg Notice 17-20, FINRA announced that it was seeking comments in an effort to learn whether or not the existing rules governing OBAs are effective.  (The comment period is open until late June, so if you have strong feelings on the subject, now is the time to speak up!)  It’s an interesting question, but, in my long experience, the effectiveness of the rules will always be dubious for the simple reason that it is impossible to prevent undisclosed outside business activities, or, worse, undisclosed private securities transactions.  It doesn’t matter how many times a firm asks its reps to make those disclosures, how dire the potential consequences for not making those disclosures, how many Enforcement cases FINRA brings, or how simple the rule is to understand, the fact is, reps have been failing to disclose OBAs since, well, forever.

I can understand why, however. In some (rare) instances, it is because somehow, despite being peppered with constant requests to disclose, beginning with the initial hiring process, a rep may fail to appreciate that something he is doing away from the firm actually constitutes an OBA.  In most cases, however, a failure to disclose is as result of the fact that the rep simply doesn’t want his firm to know what he’s doing.

Given that OBAs are impossible to prevent, it is especially frustrating when FINRA concludes – and it happens often enough – that not only did a rep violate the OBA rule, but the broker-dealer with which the rep is associated is also guilty, specifically for not having done enough to detect the undisclosed OBA. The operative question is, what is enough?

Today, in a FINRA Enforcement decision issued by a hearing panel against Jim Seol,[1] FINRA was kind enough to answer that question. While Mr. Seol was permanently barred for not disclosing his extensive outside business activities, his broker-dealer – Ameriprise Financial Services, Inc. – was not only not named as a co-respondent, but was essentially commended for the scope of the efforts it took to try to get Mr. Seol to disclose his OBAs.  The hearing panel concluded that because Mr. Seol failed to disclose his OBAs after being subjected to everything Ameriprise did, his failure had to be intentional, thus meriting the bar.

What did Ameriprise did here serves as excellent guidance to understanding just how far a broker-dealer needs to go to satisfy FINRA that its efforts to monitor OBAs are effective. Let’s look at them.

  • As one might expect, under Ameriprise policy, Mr. Seol was required to disclose and obtain prior approval from the firm before commencing any outside business activities, including any business ownership or business appointment, regardless of whether compensation was being received.
  • To that end, like most firms, Ameriprise had Mr. Seol execute an Annual Compliance Questionnaire asking about his OBA. Here, Mr. Seol failed to disclose his OBA in February 2012, February 2013, and February 2014.
  • Beginning in at least 2011, Mr. Seol’s supervisor at Ameriprise conducted annual site inspections of Mr. Seol’s office. These in-person site inspections included a detailed review of the operation, function, and management of Mr. Seol’s office.
  • During each site inspection, the supervisor conducted an extended interview with Mr. Seol to understand his business and any issues that may have impacted the operation of the branch.
  • During the interviews, the supervisor reviewed with Mr. Seol the annual attestations he
  • submitted to Ameriprise.
  • Among the attestations reviewed was Mr. Seol’s representation that he had no outside business activities.
  • The supervisor made sure Mr. Seol had “a good understanding” of what the question called for, and confirmed that the representation was accurate.
  • The supervisor “educate[d]” Mr. Seol, ensuring that he was “familiar with what needs to be disclosed – if you have any businesses, if you have any outside activities like being on a board.”
  • During the interview, the supervisor “would not only ask if he was involved in any kind of outside [activities],” he would also inquire as to “how [he] was making his money, what’s he doing, is he focusing in on his practice, has he been out of the office.
  • In addition to these annual visits by Mr. Seol’s supervisor, the firm’s compliance department also routinely inspected Mr. Seol’s branch office. In 2012, 2013, and again in 2014, a compliance inspector traveled to Mr. Seol’s office for an in-person review.
  • Importantly, some of these were unannounced, and included a detailed and careful review of all aspects of the operation and function of Mr. Seol’s office.
  • In her interviews with Mr. Seol, the compliance inspector confirmed that he had access to the firm’s compliance manual and was familiar with the firm’s policies.
  • The inspector confirmed that Mr. Seol understood that an outside business activity was required to be disclosed whether or not he was being compensated for that activity.
  • She explained that both Ameriprise policy and FINRA rules required him to disclose and obtain prior approval for all OBAs.
  • She also reminded Mr. Seol about his obligation to update his Form U4 to include any outside business activities.

Despite all that, Mr. Seol nevertheless falsely represented to Ameriprise that he had no outside business activities, over and over again.

Ameriprise deserves commendation for the amount of effort it expended in reminding Mr. Seol of his obligations regarding OBAs, and working to ensure that it gave him every opportunity to meet them. That effort was neither cheap, quick, nor easy.  But, that is the kind of supervision that FINRA expects to see from member firms.  I’d say that Ameriprise has provided a blueprint for everyone to follow to avoid being ensnared in an Enforcement action when an RR conceals an OBA. Ignore this lesson at your own peril.

[1] The decision is subject to being appealed by Mr. Seol.