Understanding Selling Away or Private Security Transactions

“Selling away” refers to the purchase, solicitation, or sale by a broker of securities not offered by his/her member firm. These transactions are also not included in the firm’s official records. The Financial Industry Regulatory Authority, or FINRA, and federal securities laws forbid selling away, and brokers who engage in selling away may be subject to disciplinary action and/or expulsion from the industry.

Selling away is so problematic because, by its very nature, it attempts to deprive investors of the protections that they are afforded under the securities laws. According to partner, Jonathan Kurta, “it should not surprise anyone that selling away and fraudulent schemes often go hand-and-hand due to a lack of supervision and compliance.”

Selling Away RulesFINRA Rule 3280, formerly NASD Rule 3040, is the rule prohibiting brokers from participating in private securities transactions. The rule defines private securities transaction to mean “any securities transaction outside the regular course or scope of an associated person's employment with a member, including, though not limited to, new offerings of securities which are not registered with the Commission…”

In addition to FINRA Rule 3280, FINRA has also issued a number of regulatory notices detailing a broker’s obligations regarding private securities transactions. Once such notice is NASD Notice to Members 01-79, which warns that private securities transactions in promissory notes are the most common type of unapproved private securities transactions.

Selling Away Red Flags

  • Did your broker or financial advisor tell you not to mention the transaction to their firm because it could “get them in trouble?”
  • Does the investment appear on your monthly or quarterly account statements?
  • Were you provided with suspicious documents when you invested?
  • Was the investment a promissory note or other loan agreement? More specifically, was the “investment” a loan to the broker or a business your broker controls?
  • Were there any investment guarantees made to you in writing or orally? Is the investment simply too good to be true?
  • Did you fund your investment with a check or wire that was payable to a company other than your brokerage firm or clearing firm?
  • Was your broker paid a commission “on the side” by the issuer or promoter of your investment?
  • Did you broker encourage you to communicate with them using their private email account?

High Profile ExamplesThere have been a number of sensational stories over the years involving wide-spread selling away violations by member firms. One of the most sensational of these stories occurred in 2014, when FINRA expelled and fined Washington D.C. based Success Trade Securities, Inc. $13.7 million for selling fraudulent promissory notes in an investment, which was revealed to be a ponzi scheme. This story made headlines because the victims of the fraud mostly NFL and NBA players.

There are countless other examples of brokers and their firms being fined or reprimanded by securities regulators. see e.g. In re Royal Alliance Assoc., Exchange Act Rel. No. 38174, 1997 SEC Lexis 113 (Jan. 15, 1997) (disciplining firm that failed to stop two branch managers from selling Ponzi schemes); In re Stuart, Coleman & Co., Exchange Act Rel. No. 38001, 1996 SEC Lexis 3266 (Dec. 2, 1996) (disciplining firm where branch manager had permitted registered representatives to sell fraudulent limited partnership interests, even though firm had explicitly refused written request for permission); In re Prospera Financial Serv., Inc., Exchange Act Rel. No. 43352, 2000 SEC Lexis 2034 (Sept. 26, 2000) (holding firm responsible for failure to supervise part-time representatives, because “allowing a registered representative to engage in outside business activities involves the risk that the representative will use his outside business to carry out or conceal violations of the securities laws.”).

Can My Brokerage Firm be Responsible for a Private Security Transaction?Yes, depending on the circumstances. In general, a brokerage firm owns a duty to all its customers to properly monitor and supervise its registered agents. Specifically, FINRA Rule 3010 requires that member firms maintain a system to supervise the activities of each of its representatives. The act of successfully conducting a private security transaction with a customer should, in itself, be prima facie evidence of a firm’s failure to supervise its brokers.

FINRA Rule 3010 holds firms to a reasonable supervision standard that is to be determined based on the particular facts of each case. see Department of Enforcement v. Kernweis, 2000 WL 33299605 at *13 (N.A.S.D.R. 2000). FINRA has warned firms that it is their responsibility to “review their supervisory procedures to make sure that they are reasonably designed to achieve compliance with [FINRA] Rules 3030 and 3040 regarding outside business activities and private securities transactions…” Notice to Member 01-79.

Do Investors Have any Recourse?Possibly, but it depends on the facts of your case. If you suspect that you were a victim of a fraud that was conducted by your broker without the knowledge of their firm, you may be able to recover your investment losses. Feel free to contact attorney Jonathan Kurta at (212) 658-1502 or attorney Marc Fitapelli at (212) 658-1501 for a free consultation.

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