Does she need to be registered with your FINRA firm in order to do that? Does he need to be registered with your FINRA firm before you can pay him a fee? Such registration issues often bedevil member firms and their compliance/legal staff. Unfortunately, it's not always a simple "Yes" or "No," and by the time you recognize that registration may be necessary, the subject individual has often crossed the line and dragged the brokerage firm into a quagmire. Consider this recent FINRA registration settlement.
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 Katalyst Securities LLC submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Katalyst Securities LLC, Respondent (AWC 20140393527-01, August 25, 2015).
Since 2001, Katalyst Securities LLC has been a FINRA member firm employing about 17 registered representatives at three branch office. The AWC asserts that the firm had no prior relevant disciplinary history with the Securities and Exchange Commission, FINRA, any other self-regulatory organization or any state securities regulator.
Advice and Fees
The AWC alleges that in June 2011, Katalyst retained an unregistered person to advise on an Mergers & Acquisition ("M&A") transaction. This unregistered person purportedly engaged in conduct through May 2012 which FINRA asserts required registration, namely, that the individual had:
Further, the AWC alleges that in May 2010, Katalyst improperly paid two unregistered entities (controlled by one of Katalyst's associated person) a success fee from the proceeds of the above-referenced M&A transaction.
SIDE BAR: Let's examine the current applicable FINRA registration rules:
NASD Membership Rule 1031. Registration Requirements
(a) All Representatives Must Be Registered
All persons engaged or to be engaged in the investment banking or securities business of a member who are to function as representatives shall be registered as such with NASD in the category of registration appropriate to the function to be performed as specified in Rule 1032. Before their registration can become effective, they shall pass a Qualification Examination for Representatives appropriate to the category of registration as specified by the Board of Governors. A member shall not maintain a representative registration with NASD for any person (1) who is no longer active in the member's investment banking or securities business, (2) who is no longer functioning as a representative, or (3) where the sole purpose is to avoid the examination requirement prescribed in paragraph (c). A member shall not make application for the registration of any person as representative where there is no intent to employ such person in the member's investment banking or securities business. A member may, however, maintain or make application for the registration as a representative of a person who performs legal, compliance, internal audit, back-office operations, or similar responsibilities for the member, or a person who performs administrative support functions for registered personnel, or a person engaged in the investment banking or securities business of a foreign securities affiliate or subsidiary of the member.
(b) Definition of Representative
Persons associated with a member, including assistant officers other than principals, who are engaged in the investment banking or securities business for the member including the functions of supervision, solicitation or conduct of business in securities or who are engaged in the training of persons associated with a member for any of these functions are designated as representatives.
(c) Requirement for Examination on Lapse of Registration
Any person whose registration has been revoked pursuant to Rule 8310 or whose most recent registration as a representative or principal has been terminated for a period of two (2) or more years immediately preceding the date of receipt by the Association of a new application shall be required to pass a Qualification Examination for Representatives appropriate to the category of registration as specified in Rule 1032.
FINRA Rule 2040. Payments to Unregistered Persons
No member or associated person shall, directly or indirectly, pay any compensation, fees, concessions, discounts, commissions or other allowances to:
(1) any person that is not registered as a broker-dealer under Section 15(a) of the Exchange Act but, by reason of receipt of any such payments and the activities related thereto, is required to be so registered under applicable federal securities laws and SEA rules and regulations; or
(2) any appropriately registered associated person unless such payment complies with all applicable federal securities laws, FINRA rules and SEA rules and regulations.
(b) Retiring Representatives
(1) A member may pay continuing commissions to a retiring registered representative of the member, after he or she ceases to be associated with such member, that are derived from accounts held for continuing customers of the retiring registered representative regardless of whether customer funds or securities are added to the accounts during the period of retirement, provided that:
(A) a bona fide contract between the member and the retiring registered representative providing for the payments was entered into in good faith while the person was a registered representative of the member and such contract, among other things, prohibits the retiring registered representative from soliciting new business, opening new accounts, or servicing the accounts generating the continuing commission payments; and
(B) the arrangement complies with applicable federal securities laws, SEA rules and regulations.
(2) The term "retiring registered representative," as used in this Rule shall mean an individual who retires from a member (including as a result of a total disability) and leaves the securities industry. In the case of death of the retiring registered representative, the retiring registered representative's beneficiary designated in the written contract or the retiring registered representative's estate if no beneficiary is so designated may be the beneficiary of the respective member's agreement with the deceased representative.
(c) Nonregistered Foreign Finders
A member may pay to a nonregistered foreign person (the "finder") transaction-related compensation based upon the business of customers the finder directs to the member if the following conditions are met:
(1) the member has assured itself that the finder who will receive the compensation is not required to register in the United States as a broker-dealer nor is subject to a disqualification as defined in Article III, Section 4 of FINRA's By-Laws, and has further assured itself that the compensation arrangement does not violate applicable foreign law;
(2) the finder is a foreign national (not a U.S. citizen) or foreign entity domiciled abroad;
(3) the customers are foreign nationals (not U.S. citizens) or foreign entities domiciled abroad transacting business in either foreign or U.S. securities;
(4) customers receive a descriptive document, similar to that required by Rule 206(4)-3(b) of the Investment Advisers Act, that discloses what compensation is being paid to finders;
(5) customers provide written acknowledgment to the member of the existence of the compensation arrangement and such acknowledgment is retained and made available for inspection by FINRA;
(6) records reflecting payments to finders are maintained on the member's books, and actual agreements between the member and the finder are available for inspection by FINRA; and
(7) the confirmation of each transaction indicates that a referral or finders fee is being paid pursuant to an agreement.
* * * Supplementary Material * * *
.01 Reasonable Support for Determination of Compliance with Section 15(a) of the Exchange Act. For purposes of Rule 2040, FINRA expects members to determine that their proposed activities would not require the recipient of the payments to register as a broker-dealer and to reasonably support such determination. Members that are uncertain as to whether an unregistered person may be required to be registered under Section 15(a) of the Exchange Act by reason of receiving payments from the member can derive support for their determination by, among other things, (1) reasonably relying on previously published releases, no-action letters or interpretations from the Commission or Commission staff that apply to their facts and circumstances; (2) seeking a no-action letter from the Commission staff; or (3) obtaining a legal opinion from independent, reputable U.S. licensed counsel knowledgeable in the area. The member's determination must be reasonable under the circumstances and should be reviewed periodically if payments to the unregistered person are ongoing in nature. In addition, a member must maintain books and records that reflect the member's determination.
Finally, the AWC alleges that from January 2012 through June 2014, Katalyst was aware that three associated persons were using non-firm issued email addresses for business related communications; however,Katalyst allegedly did not adopt a supervisory system that would have reasonably provided for the retention and supervision of these communications. Although the AWC concedes that the three associated persons were directed to copy a firm issued email address on their communications, Katalyst purportedly failed to take reasonable steps to ensure or verify compliance with the copying protocol (allegedly at least 10 emails were not copied to the firm address) or to otherwise retain the subject communications.
Summing It All Up
FINRA asserted that the above cited misconduct by Katalyst constituted violations of:
In accordance with the terms of the AWC, FINRA imposed upon Katalyst a Censure and $20,000 fine.
Bill Singer's Comment
Compliments to FINRA on a concise AWC that admirably sets forth the alleged misconduct at issue with compelling rationale. Given the circumstances, compliments to Katalyst's legal team for extracting a fair settlement.
FINRA's Outdated Glass NASD House
Just one quibble: It's now 2015 and the NASD has effectively been out of business and replaced by FINRA since 2007. You'd think that in the space of 8 years that FINRA could finally replace the old NASD rules with FINRA ones. It's ironic that the self-regulatory organization sanctions Katalyst for not having a reasonable supervisory system in place but regulator is charging the respondent under an anachronistic NASD Rule, which states, in pertinent part
All persons engaged or to be engaged in the investment banking or securities business of a member who are to function as representatives shall be registered as such with NASD in the category of registration appropriate . . . A member shall not maintain a representative registration with NASD for any person . . .
Corrective Action Statement
FINRA AWCs permit the attachment of a Corrective Action Statement to demonstrate the steps taken by a respondent to prevent future misconduct subject to the understanding that such an attachment may not deny the charges or make any statement that is inconsistent with the AWC. Further the Corrective Action Statement does not constitute factual or legal findings by FINRA, nor does it reflect the views of FINRA or its staff.
I am no fan of Corrective Action Statements and rarely, if ever, advocate their use. Given that the premise of an AWC is a settlement made without admitting or denying the findings, I don't understand why anyone would prepare a statement that tends to typically make admissions, promises to correct situations that have not necessarily been acknowledged, and, in the end, simply draws more undesired attention to the matter. If you feel compelled to attach a Corrective Action Statement, then you may want to pause before signing the AWC and ask yourself if you might not be better advised to argue your case before a Hearing Panel and, if necessary, on appeal afterwards.
If you conclude that the costs and/or risks of contesting the charges aren't worth it, then just sign the damn AWC and get over it. There's no need whatsoever to engage in a post-game, public analysis. Some think that this after-the-fact statement gives you a parting shot at unfair regulation or an opportunity to put your own spin on the matter. I would suggest that you simply avoid the temptation. Keep in mind that a Corrective Action Statement may actually set you and your firm up for heavier sanctions down the road if you acknowledge wrongdoing and propose a set of remedial actions. If during subsequent examinations, a regulator finds that you engaged in similar misconduct to that discussed in the statement, or, it is alleged that you failed to implement the promised revised policies and procedures, your own words may prove blunt instruments used to beat you into submission. Notwithstanding my opinion, Katalyst apparently determined that it was advisable to submit a Corrective Action Statement and hopefully that step will prove favorable to the firm:
KATALYST SECURITIES LLC.
(CRD NO. 112494)
STATEMENT OF CORRECTIVE ACTION
This Statement of Corrective Action ("Statement") is submitted by Katalyst Securities LLC ("Katalyst") to the Letter of Acceptance, Waiver and Consent ("AWC"). This Statement does not constitute factual or legal findings by FINRA, nor does it reflect the views of FINRA, or its staff. This Statement outlines the corrective steps taken to prevent future misconduct.
As a result of the examination, Katalyst revised the Written Supervisory Procedures ("WSP") to establish and implement procedures reasonably designed to achieve compliance with FINRA rules and regulations. Katalyst has taken steps to address and correct the deficiencies cited in the AWC.
Once the deficiencies were brought to Katalyst's attention, corrective actions were taken immediately.
Katalyst will continue to review and comply with the most current FINRA rules and regulations.
NASD Membership and Registration Rule 1031 and FINRA Rule 2010:
Katalyst has taken actions to prevent violations of these Rules. Only persons who are registered with Katalyst will engage in the investment banking or securities business of Katalyst. The referenced person has not been involved with Katalyst since May 2012, the end of the violation period as cited in the AWC.
NASD Conduct Rule 2420:
Katalyst has taken actions to prevent future violations of this Rule. Since May 2012, Katalyst pays the proceeds from a transaction directly to the individual registered representative. There have not been payments to any unregistered entities since May 2012, the date of the identified violation.
NASD Conduct Rule 3010(a), Section 17(a) of the Exchange Act and SEC Rule 17a-4, FINRA Rules 4511 and 2010:
Katalyst makes every effort to ensure that the Firm and its employees comply with the provisions of the rules and regulations of FINRA and the Firm's WSP. The emails of associated persons who conduct business for and on behalf of the Firm will be captured in a compliant retention system.