From Ulmer’s Broker-Dealer Law Corner Blog
By Michael A. Gross
It is not a wise career move for a registered rep to leave his broker-dealer – thereby abandoning his customers, and affording competitors the opportunity to make his customers their own – and then to begin the long, expensive, and uncertain process of forming a FINRA-registered broker-dealer. Common sense, principles of fundamental fairness, and good old-fashioned capitalism warrant that a rep, while registered with another broker-dealer, be able to form his own broker-dealer (or RIA firm) without running afoul of any FINRA rules. But, as Lee Corso likes to say, “Not so fast, my friends.” FINRA’s Outside Business Activities (“OBA”) Rule, FINRA Rule 3270, provides, in pertinent part, that:
No registered person may be an employee, independent contractor, sole proprietor, officer, director or partner of another person, or be compensated, or have the reasonable expectation of compensation, from any other person as a result of any business activity outside the scope of the relationship with his or her member firm, unless he or she has provided prior written notice to the member, in such form as specified by the member.
A simple reading of the OBA rule leads to the conclusion that a rep would need to provide prior written notice to her broker-dealer of her intention to form a competing broker-dealer. Providing the notice would be comical: “I just want to give you a heads-up that I’ll be forming my own competing company where I’ll be attempting to move my customers in the next six months or so. You good with that, bro?” Needless to say, no one with a head on their shoulders would expect to receive anything but a pink slip after providing that notice.
In recognition of this quandary, FINRA’s Office of General Counsel (“OGC”) issued sound and sensible guidance in a 2001 Interpretive Letter. In the Letter, the OGC wrote that the notice requirements of the OBA Rule are not triggered when a rep takes certain steps to form a new broker-dealer, including forming a company, and filing an application on behalf of the company to become a FINRA member, and a Form U4 designating himself as a principal of the company, so long as he does not: accept compensation from the company or other person; engage in securities or investment banking business for the company; raise capital for the company; solicit customers for the company; or generally engage in business activity for the company. In sum, with a few limitations, a rep generally can sow the seeds of forming his own broker-dealer without providing notice to his current broker-dealer of his intention and efforts to do so. This makes perfect sense. And it is welcome guidance from FINRA on a potentially thorny issue.
Earlier this month, FINRA accepted AWC No. 2018057258602 from Charles Gonzalez, wherein FINRA found that Mr. Gonzalez engaged in outside business activities, in contravention of the OBA Rule, by not disclosing to his broker-dealer that he had “formed a new business entity, retained and paid for services of a consultant, bought office equipment, rented and paid for his new company’s office space, and that he solicited and raised capital from a customer at [his broker-dealer] to fund his new business.” While, on its face, this finding may seem, in part, inconsistent with the Interpretive Letter, it is not. The safe harbor detailed in the Letter does not apply if a rep, among other things, raises capital for his new company, which FINRA apparently found that Mr. Gonzalez had done.
The moral of the story is that if you are going to rely on a safe harbor or exemption, be sure to satisfy all of the criteria, or you may be found to have satisfied none of them.
 Interpretive Letter to Sheryl Anne Zuckerman, Esq., Singer Frumento LLP (Dec. 6, 2001).