A Comprehensive Guide to “Selling Away”
What is “Selling Away”?
A broker engages in “selling away” when they process private securities transactions—buying, selling, or soliciting securities not sold by their member firm. Selling away is a violation of FINRA Rule 3280, which states that a registered representative must provide written notice to their member firm (and receive the firm’s approval) before engaging in a private securities transaction. Furthermore, they must disclose if they will be receiving compensation from said transaction. Selling away is not only a violation of FINRA rules, but it is also a violation of federal securities law, primarily the Securities Act of 1933 and the Securities Exchange Act of 1934.
Promissory Notes: The Most Common Way Brokers “Sell Away”
The most common way that brokers “sell away” is by issuing promissory notes, often for companies that sound exciting but that ultimately end up collapsing (if they even existed to begin with). In explaining the promissory note, FINRA and the North American Securities Administrators Association (NASAA) write in their brochure Promissory Notes: Promises, Problems:
One interest-paying investment is the promissory note. These are an important means by which companies raise capital. Legitimate promissory notes are marketed almost exclusively to sophisticated or corporate investors that have the resources to research thoroughly the companies issuing the notes and to determine whether the issuers have the capacity to pay the promised interest and principal.
FINRA and NASAA go on to warn investors that notes marketed to the public often turn out to be scams. In one instance, “Investors in Georgia lost more than $2.5 million in a ‘risk-free’ investment after purchasing promissory notes that would pay for new ambulances for a start-up company. There were never any ambulances, only worthless notes that generated high commissions for the seller.”
You should proceed with extreme caution if your broker says, “Your principal investment is guaranteed.” No matter what your broker says, your principal is never guaranteed, and you could still lose the money you invested, even if your broker claims that the investment is a “sure bet.” Or your broker may say something like, “This is an easy way to make 12% returns.” While a steady rate of return doesn’t sound like a red flag, it is; there is no such thing as a promise of high returns with no risk. By its nature, the securities industry is inherently volatile, and any investment carries a risk that an investor may lose money.
Here are some other red flags to look out for:
- Promissory notes offered by a stranger
- “Prime quality” notes offered by a startup
Never invest in promissory notes offered by a stranger. Unscrupulous brokers often engage in “cold calling,” using convincing sales tactics to prey on inexperienced investors. Instead of accepting an investment proposal from a stranger, make sure to work only with a registered broker whom you trust. If an insurance agent or investment advisor is not registered with their state securities regulator, they cannot sell securities. Based on the definition of “prime quality” notes (which require a company to have an established operational history), startups are not eligible to offer these types of notes, so the person offering such notes may be trying to mislead you.
The Danger of Undisclosed Outside Business Activities
Brokers who sell away may sell promissory notes or other private securities as part of their “outside business activities” that they fail to disclose to their member firms. When looking up your broker’s history on BrokerCheck, you can also view a “detailed report” which includes information about all of a broker’s disclosed outside business activities. For example, some brokers also sell insurance, while others do work that is more tangential to their job as brokers, such as hosting a radio show. Even if a broker discloses certain business activities, if they are later found to not have disclosed other activities, this could be a sign that they are using “shell companies” to commit fraud.
REITs and Private Placements
Brokers who sell away, particularly those engaging in undisclosed outside business activities, often do so by hawking Real Estate Investment Trusts (REITs). While these pooled investments in large commercial real estate portfolios often sound tantalizing, these illiquid investments are not for everyone. They can be riddled with problems that leave investors with buyer’s remorse.
Another way that brokers often sell away from their firms is through private placements. These alternative investments are unregistered securities ostensibly designed to allow financially literate, high-net-worth investors to invest in smaller companies, allowing these smaller companies to raise capital faster than they would be able to with an IPO. For more information about some of the dangers of private placements to investors who are not “accredited,” please see our article “What is Reg. D?”
If a client expresses interest in a private placement, a broker may “sell away.” Knowing that this investment opportunity is not on their firm’s list of approved products but not wanting to lose out on a potentially large commission, the broker “sells away” from their member firm, disregarding FINRA rules, violating federal securities rules, and putting the client at risk for fraud and portfolio losses.
Broker-Dealers Should Prevent Selling Away Through Proper Supervision
Brokerage firms should supervise their registered representatives (brokers) to ensure that everyone is complying with applicable rules and regulations—including FINRA rules and federal laws like the Securities Act of 1933 and the Securities Exchange Act of 1934. If broker-dealers aren’t properly supervising their registered representatives, this constitutes a violation of FINRA Rule 3110, which mandates that brokerage firms must have written supervisory procedures in place to ensure compliance. If your broker sells away, engaging in private securities transactions without their firm’s knowledge, the firm may be liable for this under FINRA Rule 3110.
I Think My Broker “Sold Away”; What Should I Do Next?
Selling away undermines the relationship between broker and broker-dealer, putting clients at risk. FINRA is adamant about preventing selling away because the self-regulatory organization recognizes that selling away can conceal fraud, including Ponzi schemes.
If you fear you might have fallen victim to financial fraud, don’t hesitate to speak up. Call (877) 238-4175 or email firstname.lastname@example.org to speak with the experienced securities attorneys of Fitapelli Kurta.