September 19, 2014
Action -- it's an interesting concept when it comes to both gambling and investing. Some folks love it. Crave it. Need it. Others are looking for a way to get better odds and make a quicker, bigger buck. If you find the action you're looking for, as with many things involving risk, sometimes you win, sometimes you lose. In a recent regulatory case, it seems that some public customers wanted the action offered by investing in real estate. Unfortunately, they got in around July 2007. Some historians posit the beginning of the real estate market crash around August 2007, after which that market would crater.
Case In Point
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, Michael L. Gorman submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Michael L. Gorman, Respondent (2013036727501, September 10, 2014).
In 1996, Gorman first entered the securities industry and from 2002 through May 2009, he was associated with Citigroup Global Markets, Inc. ("CGMI").
Strip Mall Action
The AWC alleges that in late 2006/early 2007, Gorman introduced two of his CGMI customers to a local property developer, who was also a customer of Gorman's. The twio customers purportedly were interested in real estate investments and the developer was soliciting investments in a strip mall project.
In July 2007, the two customers signed a limited partnership agreement setting forth the terms of their $250,000 investment in the developer's strip mall project. Pursuant to those terms, the customers were to receive a 7% preferred dividend and a 40% equity stake. The agreement also stated that upon completion of the project, the partnership would seek an immediate buyer for the mall, after which 40% of the proceeds would be paid. If, however, no buyer was found, the two customers wold receive 40% of the cash flow.
A Little Sumthin'
The developer allegedly paid to Gorman a $15,000 referral fee. Seems that Gorman not only failed to disclose his role in referring his two CGMI customers to the developer but, in addition, he also failed to disclose his acceptance of the fee.
A Thud And A Crash
As these things tend to go (otherwise they generally don't wind up in the BrokeAndBroker Blog), the mall did not get completed. On top of that, all hell broke lose as the financial markets cratered into the Great Recession. According to the AWC, the two customers complained in April 2013 to a successor firm to CGMI. I'm wondering, what took them so long.
The AWC doesn't specify the date on which the project fell through, so we don't know if the developer was trying to get the deal done from 2007 until, perhaps,finally throwing in the towel sometime around April 2013; or, maybe the project had collapsed much earlier and the two customers were hoping for some settlement that eventually fell through. I think it would have been helpful for FINRA to offer a bit more explanation in that regard. The self-regulatory organization apparently didn't agree.
FINRA deemed that Gorman's referrals of the two customers to the developer and his acceptance of a $15,000 referral fee constituted his participation in a private securities transaction; and, accordingly, he failed to provide written notice of his participation in the transaction to CGMI, in violation of NASD Rules 2110 and 3040. In accordance with the terms of the AWC, FINRA imposed upon Gorman a three month suspension in all capacities and a fine of $20,000 (which include a disgorgement of the $15,000 referral fee).
Bill Singer's Comment
You wouldn't think that such a simple prerequisite as providing prior written notice to your employer FINRA member firm 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 PST or outside business activities ("OBAs"). 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.
What a registered person sees as a business venture 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.
(b) Written Notice
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.