Let's see . . . you had the outside business activity and the customer investment. That's $5,000 and three months. Will that be cash or charge?
In response to the filing of a Complaint on January 5, 2012, by the Department of Enforcement of the Financial Industry Regulatory Authority ("FINRA"), Respondent Michael S. McGee submitted an Offer of Settlement dated May 16, 2012, which the regulator accepted. Under the terms of the Offer of Settlement, without admitting or denying the allegations in the Complaint, Respondent Michael S. McGee consented to the entry of findings and violations and to the imposition of the sanctions. FINRA Department of Enforcement, Complainant, vs Michael S. McGee, Respondent (Offer of Settlement, 2009017511901, June 11, 2012).
Between September 1, 2006 and November 3, 2008, Respondent was registered as a General Securities Representative with H&R Block Financial Advisors, Inc.
The Offer of Settlement asserts that around December 2007, McGee induced a retired 63-year old H&R Block customer to withdraw $20,000.70 from her H&R Block Individual Retirement Account and, after combining that sum with other funds, the customer gave to McGee a $21,000 check, which she had made payable to herself upon McGee's instructions and indorsed to "CMOR."
FINRA asserted that CMOR was the doing-business-as name of a real estate company owned by McGee's mother and sister. Around December 24, 2007, McGee deposited the customer's $21,000 check into a CMOR checking account, over which he, his mother, and his sister had signature authority.
Following the deposit of the check and through October 2008, McGee allegedly used a portion of the customer's funds to pay certain expenses of a restaurant that was managed by Davis McGee, LLC, a company in which McGee had an ownership interest. The customer purportedly had no knowledge as to how her investment would be used in the restaurant, nor any agreement whereby she would share in any profits or she would receive any benefit. The Offer of Settlement alleges that there was a "vague, ill-defined agreement" between McGee and the customer that her funds would be deposited into real esate or some other business venture.
At some point, the customer apparently contacted H&R Block directly to inquire about her $21,000 payment and McGee then paid the full amount to the firm, which then refunded the customer's payment.
SIDE BAR: The Offer of Settlement is inexplicably vague as to what prompted the repayment by McGee. An investigation of online FINRA records as of June 18, 2012, discloses this explanation to FINRA by H&R Block the disposition of a September 4, 2008, customer complaint:
THE FIRM RECEIVED A COMPLAINT ALLEGING UNAUTHORIZED TRADING AND ACCOUNT MISMANAGEMENT. THE CUSTOMER ALSO SAID THAT MR. MCGEE HAD HER WRITE A CHECK TO HERSELF AND THAT SHE NEVER RECEIVED THE MONEY. A REVIEW OF THE ACCOUNT ACTIVITY INDICATED THAT A CHECK WAS PAID OUT OF THE CLIENT'S ACCOUNT AND ENDORSED BY THE CLIENT TO A THIRD PARTY. DURING THE FIRM'S REVIEW, MR MCGEE, BY LETTER DATED OCTOBER 06, 2008, NOTIFIED THE FIRM THAT HE WAS RESIGNING. SUBSEQUENTLY, MR. MCGEE PRESENTED A CASHIER'S CHECK TO THE FIRM, FROM THE SAME THIRD PARTY FOR THE AMOUNT INITIALLY ENDORSED OVER TO THE THIRD PARTY BY THE CLIENT. THE ALLEGATION OF UNAUTHORIZED TRADEING WAS DENIED.
FINRA found that McGee had violated NASD Conduct Rule 3030: Outside Business Activities of an Associated Person and NASD Conduct Rule 2110: Standards of Commercial Honor and Principles of Trade by not properly disclosing to his member firm his outside business activities in Davis McGee, LLC and the restaurant; and for engaging in the financial arrangement with the customer.
In accordance with the terms of the Offer of Settlement, FINRA imposed upon Respondent McGee a $5,000 fine and a three-month suspension from association in any capacity with any FINRA registered firm.
Bill Singer's Comment
In many of these situations, the customer is ripped off and it's often left to the employer firm to make good - or to defend itself by arguing that there was absolutely no way for it to know the registered person was engaged in unapproved outside activity. Another compelling defense is that the customer was put on warning that there was something odd going on here because of the demand that the check not be written out to the brokerage firm; and, moreover, upon receipt of the cashed check via her monthly statement, she should have noticed the indorsement of an entity other than H&R Block. All of which might have set up in a customer arbitration case as a pretty decent defense by H&R Block that it was unreasonable for the customer to believe that H&R Block was legitimately backing the transaction.
Regardless of the merits of any possible defense, none were needed because McGee promptly repaid all the disputed funds. To that extent, all's well that ends well but for the nasty bit about FINRA's fine and suspension.
Particularly since the onset of the Great Recession, many registered persons have found it necessary to seek additional sources of income to supplement their reduced commissions. If you peruse the past few years of arbitration and regulatory cases, you will see an increase in these outside business activity situations - and it's not merely at smaller indie or regional firms but something that's also going on at Merrill Lynch, Morgan Stanley, Wells Fargo, and JP Morgan. Now, mind you, there's nothing inherently wrong or evil about registered persons engaging in outside business activities. Current FINRA Rule 3270: Outside Business Activities of Registered Persons provides for the following:3270.
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. Passive investments and activities subject to the requirements of NASD Rule 3040
shall be exempted from this requirement.
Frankly, not all that onerous a rule to follow. The registered person is obligated to provide "prior written notice to the member, in such form as specified by the member." The key elements is that you must provide "prior" notice, which means not after the fact and particularly not following the receipt of a customer's complaint. Also, the notice cannot be oral but must be written. Finally, if your firm has an "Outside Business Activity Notice Form," then you can't simply send in an email to comply with the rule.
I would have preferred just a bit more background in FINRA's Order accepting this settlement. While the published material provides a fair explanation of the underlying issues, both the public and the industry would have benefited from just a bit more discussion about how this matter came to the employing firm's attention. Similarly, it's puzzling that although McGee resigned in 2008, it took some four years to finalize the self-regulatory organization's response. Given the relatively open and shut nature of this case, I truly don't understand why so much time elapsed.