Stockbroker's Outside Business Activity Becomes FINRA Private Securities Transaction

August 16, 2012

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, Kahauanu Lake Kai submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Kahauanu Lake Kai,Respondent (AWC 2011026684201, August 9, 2012).

Kai was first registered in 2005 with Edward D. Jones & Co., L.P. ("EDJ"), until his February 16, 2011, termination . In April 2010, while registered with the EDJ, Kai disclosed his  involvement as a member in Great Pacific Holdings, LLC ("GPH"), a real estate business venture established by him and another individual. Kai stated that his responsibilities in connection with this outside business activity included retrieving mail, depositing checks from rental properties, and disbursing funds to investors.  Pursuant to Kai's request and his recitation of the extent of his affiliation, EDJ approved this outside business activity.

According to the AWC, Kai sort of left something out.  For example, allegedly, he did not disclose that he also would be soliciting investments in GPH. That activity not only altered his role at GPH but may well have constituted engaging in private securities transactions, for which separate approval is required.

During the relevant time, EDJ's Compliance Manualand Written Supervisory Procedures Manualprohibited its representatives from:

  • recommending or selling any security, insurance product or other investment opportunity, including promissory notes, not approved by the firm; or
  • raising money or participating in the raising of money for any company, individual or venture without the firm's written consent.

Typically, representatives were permitted to maintain only passive investment interests; and were pointedly prohibited from involvement in selling or promoting ventures to others, holding management positions or addressing prospective investors.

From June 2010 through September 2010, the AWC alleges that Kai solicited four EDJ customers to invest in GPH without giving the firm prior written notice of the proposed transactions and his proposed role. The four customers invested $150,000 in the form of promissory notes, which were never approved by the firm.


By engaging in private securities transactions without giving EDJ prior written notification, and recommending and selling  unapproved investments, the AWC alleged that Kai violated NASD Rule 3040 and FINRA Rule 2010. In accordance with the terms of the AWC, FINRA imposed upon Kai a $5,000 fine and a four-month suspension from association in any capacity with any FINRA member

Bill Singers Comment

As "Street Sweeper" has noted in past articles, the worlds of Outside Business Activities ("OBA") and Private Securities Transactions ("PST") often collide - and with painful regulatory consequences.  Sometimes what you think is merely an OBA morphs into a PST; and sometimes the PST requires more of your attention than you anticipated and, voila!, you get sucked into the business and it rises to the level of an OBA.

Anytime a regulatory violation is known by its acronym - OBA or PST, for example - that's a tip-off that this is a problem area being closely watched by regulators. Of course, the more cynical among us would also suggest that regulators loves these speed traps because it's a regular source of fines.

Given the recent pressures of the Great Recession many registered persons found themselves in need of or enticed by the possibility of extra income from the sale of product away from their employer FINRA member firm.  This attraction was as likely to bedazzle those at indie firms such as LPL, at discount firms such as Charles Schwab, or at any major player the likes of JP Morgan, Morgan StanleySmith Barney, Merrill Lynch, or Wells Fargo. If you feel compelled to engage in OBA or PST, make sure to follow industry rules/regulations and to abide by your employer's in-house requirements.  Otherwise, you could be paying dollars out of your own pocket while you're sitting on the sidelines.

FINRA Conduct Rule 3040. Private Securities Transactions of an Associated Person

(a) Applicability

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.

(e) Definitions

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 Conduct 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.

• • • Supplementary Material: -----

.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).