April 28, 2014
Great disasters often start from simple ideas. Take today's BrokeAndBroker Blog case involving the the opening of some burger joints under the name of a sports celeb. You got name recognition. You got chopped meat. You got fries. You got a stockbroker putting the deal together. It's that last ingredient that sort of messes this all up.
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, David Diehl, submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of David Diehl, Respondent (AWC 201409725001, April 15, 2014).
Since entering the securities industry in 2004, David Paul Diehl was registered with seven FINRA member firms and during the times relevant to this matter, he was registered with First Liberties Financial from July 2010 through March 2012. During his career, Diehl was also registered with investment advisors and in October 2010 he established Diehl Wealth Management Group, which he thereafter terminated its registration in August 2011.
SIDE BAR: In December 2012, Diehl was the subject of a FINRA AWC, which cited him for indirectly borrowing money from a customer without his firm's approval as part of an arrangement to train the customer's son in the securities industry. In accordance with the terms of that AWC, FINRA imposed upon Diehl a $7,500 fine and a four-month suspension in all capacities.
Sports Celeb Burger Joint
The AWC asserts that during his registration with First Liberties Financial, Diehl "approached a client who was a well-known sports figure with the idea of opening local "high quality" burger restaurants under the client's name." In furtherance of those discussions, the AWC asserts that during the second half of 2010, Diehl participated in establishing the business, and the first of three restaurants opened in April 2011. The restaurants were managed by an individual brought into the business by Diehl, although Diehl purportedly continued to be involved in the business.
Pickly On The Side: Maybe it's just me being a bit picky or pickly here but, geez, if FINRA is going to make such a big deal about this sports celebrity, why the hell are they playing games with us and not telling us the name of the athlete?
The AWC asserts that a corporate entity was created to pursue the business. The corporation provided Diehl's home address on its state filings, and Diehl's office address was also given as the corporation's on the registration form for the restaurants' name.
Raising The Dough
The AWC alleges that in March 2011 and February 2012, Diehl arranged for the sports celebrity/client to invest in the restaurant business, which was memorialized by a promissory note at 10% interest per annum. Thereafter, at least six other investors were solicited by Diehl, among which were five of Diehl's First Liberties Financial customers. The six additional investors received promissory notes at 8 to 10% interest per annum payable for up to 10 years. In total, the AWC asserts that Diehl raised $480,000 from seven investors.
Sometime during 2013, the AWC alleges that the restaurant business was failing to bring in the anticipated bucks and the corporation defaulted on the interest payments on the various notes.
The AWC deemed Diehl's conduct to constitute a violation of NASD Rule 3040 because he failed to provide prior written notice to First Liberties Securities of his participation in a private securities transaction and also failed to obtain the firm' authorization to engage in the contemplated venture. Similarly, the AWC alleges that Diehl's conduct constituted further violations of NASD Rule 3030 and FINRA Rule 3270 because he had failed to provide prior disclosure of to his member firm of his outside business activity. Finally, his conduct also constituted a violaton of FINRA Rule 2010.
In accordance with the terms of the AWC, FINRA imposed upon Diehl a $10,000 fine and a suspension of nine months.
Bill Singer's Comment
You wouldn't think that such a simple prerequisite as providing prior written notice to the member would trip us so many folks, but it does. Industry outsiders may wrongly perceive that the motivation behind such non-disclosure is nefarious with the intent to conceal all sorts of shenanigans from both the employer member firm and the regulators. Often - okay, yeah, quite often - that's likely the reason for not telling the firm about the Private Securities Transaction ("PST") or the Outside Business Activity ("OBA"). On the other hand, very often the non-disclosure arises out of a lack of awareness. Sometimes, the registered person just doesn't view the cited conduct as a "securities" or a "business" activity. Sometimes the registered person was engaged in the PST or OBA before joining the firm and the need to disclose just never got recognized. Sometimes the broker-dealer was aware of the PST or OBA through numerous conversations and communications but the required "written" notice just never got sent in the proper form.
Few compliance issues are ever so hermetically sealed as to result in a single, isolated regulatory violation or a one-cause-of-action civil lawsuit; which may well explain the reluctance of many brokerage firms to permit PSTs or OBAs. When a firm approves a registered person's proposed PST or OBA, the unexpected and the unanticipated can come home to roost with a vengeance; and, accordingly, those uncertainties also explain why FINRA and other regulators focus on these violations.
What a registered person sees as a modest restaurant business with absolutely no connection to his securities industry job can easily result in all sorts of lawsuits alleging apparent or actual authority to act on behalf of the brokerage firm - replete with astronomical demands for damages accompanied by outlandish allegations. And even if the case is so much garbage, the brokerage firm may still need to peel off a lot of large denomination bills to pay a defense lawyer and to also deal with the ensuing regulatory demands for explanations.
NASD Conduct Rule 3040:
Private Securities Transactions of an Associated Person
No person associated with a member shall participate in any manner in a private securities transaction except in accordance with the requirements of this Rule.
Prior to participating in any private securities transaction, an associated person shall provide written notice to the member with which he is associated describing in detail the proposed transaction and the person's proposed role therein and stating whether he has received or may receive selling compensation in connection with the transaction; provided however that, in the case of a series of related transactions in which no selling compensation has been or will be received, an associated person may provide a single written notice.
(c) Transactions for Compensation
(1) In the case of a transaction in which an associated person has received or may receive selling compensation, a member which has received notice pursuant to paragraph (b) shall advise the associated person in writing stating whether the member:
(A) approves the person's participation in the proposed transaction; or
(B) disapproves the person's participation in the proposed transaction.
(2) If the member approves a person's participation in a transaction pursuant to paragraph (c)(1), the transaction shall be recorded on the books and records of the member and the member shall supervise the person's participation in the transaction as if the transaction were executed on behalf of the member.
(3) If the member disapproves a person's participation pursuant to paragraph (c)(1), the person shall not participate in the transaction in any manner, directly or indirectly.
(d) Transactions Not for Compensation
In the case of a transaction or a series of related transactions in which an associated person has not and will not receive any selling compensation, a member which has received notice pursuant to paragraph (b) shall provide the associated person prompt written acknowledgment of said notice and may, at its discretion, require the person to adhere to specified conditions in connection with his participation in the transaction.
For purposes of this Rule, the following terms shall have the stated meanings:
(1) "Private securities transaction" shall 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, provided however that transactions subject to the notification requirements of Rule 3050, transactions among immediate family members (as defined in Rule 2790), for which no associated person receives any selling compensation, and personal transactions in investment company and variable annuity securities, shall be excluded.
(2) "Selling compensation" shall mean any compensation paid directly or indirectly from whatever source in connection with or as a result of the purchase or sale of a security, including, though not limited to, commissions; finder's fees; securities or rights to acquire securities; rights of participation in profits, tax benefits, or dissolution proceeds, as a general partner or otherwise; or expense reimbursements.
FINRA Rule 3270:
Outside Business Activities of Registered Persons
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.
.01 Obligations of Member Receiving Notice. Upon receipt of a written notice under Rule 3270, a member shall consider whether the proposed activity will: (1) interfere with or otherwise compromise the registered person's responsibilities to the member and/or the member's customers or (2) be viewed by customers or the public as part of the member's business based upon, among other factors, the nature of the proposed activity and the manner in which it will be offered. Based on the member's review of such factors, the member must evaluate the advisability of imposing specific conditions or limitations on a registered person's outside business activity, including where circumstances warrant, prohibiting the activity. A member also must evaluate the proposed activity to determine whether the activity properly is characterized as an outside business activity or whether it should be treated as an outside securities activity subject to the requirements of NASD Rule 3040. A member must keep a record of its compliance with these obligations with respect to each written notice received and must preserve this record for the period of time and accessibility specified in SEA Rule 17a-4(e)(1).