"Selling Away"; A Primer for Investors and Their Attorneys
by James J. Eccleston, Esq.
rokerage firm clients sometimes lose money in investments that have been "sold away" from their brokerage firm. That is, while the brokerage firm adviser indeed has sold the investment to the client, the brokerage firm has not sold it, has not approved of the sale, and likely does not even know of the sale. Such "outside" investments often are the most egregious frauds and schemes.
The question arises whether a brokerage firm nonetheless can be held responsible for a client's losses. Let's examine a brokerage firm's responsibility for what has become known as "selling away".
The regulatory basis for selling away cases is found in NASD Rule 3030 and NASD 3040. Rule 3030 provides that a brokerage firm adviser may not engage in any outside business activity unless he has provided prompt written notice to his or her brokerage firm. Rule 3040 provides that a brokerage firm adviser must not engage in private securities transactions (that is, selling away) and states the procedures that a brokerage firm must follow to approve of such investments. Once approved, the brokerage firm must supervise these private securities transactions.
As stated above, however, normally the brokerage firm has no knowledge of such sales and activities. The question then becomes whether the brokerage firm should have known of the outside sales and activities. Robert Lowry, a securities law expert, suggests that the brokerage firm must demonstrate three things. First, that the firm has a reasonable supervisory system in place. Second, that the firm implemented its procedures in a reasonable fashion. Third, that the firm vigorously investigated red flags, which would have been any suggestion of irregularity or unusual trading activity, including client complaints and disciplinary actions by a securities regulator.
Lawyers for clients, on the other hand, must demonstrate that the brokerage firm failed to establish and/or failed to implement reasonable supervisory procedures, or failed to follow-up on red flags. Robert Lowry suggests that client lawyers provide illustrations of how the brokerage firm's supervision fell through the cracks, thereby causing harm to the client.
A survey of recent NASD disciplinary actions illustrates the broad scope of not only the types of investments that are "sold away" but also the types of brokerage firms. Recently, for example, an adviser from Summit Capital Investment Group convinced 25 clients to invest in a fraudulent pay phone leasing deal. In another example, an adviser from Linsco/Prviate Ledger Corporation convinced clients to invest in a limited liability company (LLC) investing in real estate. Another example involves a PaineWebber adviser who convinced clients to invest in an IPO trading program that an outside entity ran.
These are just some examples of selling away cases, for which the brokerage firm, while not knowing of the sales, still may be held responsible.
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James J. Eccleston is a securities attorney, representing customers as well as brokers and brokerage firms nationwide in arbitration, litigation and regulatory matters. He maintains an informative website at www.FinancialCounsel.com. He is an equity partner with Shaheen, Novoselsky, Staat, Filipowski & Eccleston, and can be reached at 312-621-4400.
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