FINRA Stretches Definition of Participating in a Private Securities Transaction

May 18, 2018

What's a lot? What's reasonable? How many times is frequently? When is enough, enough? What does it mean to participate? These and other mysteries of the Universe keep publisher Bill Singer awake through the night and into the early morning. You are able to sleep soundly because of the unselfish efforts of folks like Bill who man the ramparts of philosophical thought and aimless rumination. In today's blog, Bill has tanked up on coffee after spending staying awake to ponder whether hand delivering a check rises to the level of participating in a private securities transaction. Bill is also wondering how his New York Mets started off with 11 wins and 1 loss and now have a record of 20 wins and 19 losses.

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, Joshua David Stamm submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Joshua David Stamm, Respondent (AWC 2016050765201. May 14, 2018).

2017 Virginia Settlement

The AWC asserts that Stamm was first registered in 2002 and by 2008, he was registered with FINRA member firm Merrill Lynch, Pierce, Fenner & Smith, Inc. 

Under the heading "Relevant Disciplinary History," the AWC discloses that:

On January 11, 2017, Stamm was sanctioned by the Virginia State Corporation Commission Division of Securities and Retail Franchising ("VSCC") for failing to gain approval of Merrill Lynch prior to engaging in outside securities activity involving a $20,000 promissory note issued by the ammunition manufacturing company described below and for not causing that sales activity to be recorded in Merrill Lynch's books and records. Stamm agreed to a $10,000 monetary penalty, $2,000 in costs, heightened supervision upon employment with a broker-dealer, and a four-year supervisory bar. 

Sound Familiar?

Following the "Relevant Disciplinary History" reference to a promissory note "issued by the ammunition manufacturing company described below," the FINRA AWC alleges that in April 2014, Stamm introduced the owner of an ammunition manufacturing company to one of his Merrill Lynch customers, who was also involved in the manufacturing business. The AWC alleges that in May 2014 the: 

[C]ustomer, through the manufacturing company owned by the Customer, purchased a $300,000 promissory note issued by the Ammunition Company. Although Stamm did not receive any compensation as a result of the transaction, he participated in the purchase by reviewing the promissory note, making corrections to it, obtaining a signature on the note, delivering a check for the investment to the issuer, and providing the executed note to the Customer. 

Following the May 2014 transaction noted above, the AWC asserts that in April 2015, the:

Customer also purchased a $200,000 promissory note issued by the Ammunition Company. Again, although Stamm did not receive any compensation as a result of the transaction, he participated in the purchase by delivering a check for the investment to the issuer and providing the executed note to the Customer.  


Online FINRA BrokerCheck records as of May 18, 2018, disclose one disclosure under the heading "Employment Separation After Allegations." Oddly, there appear two separate entries under what is presented in BrokerCheck as "Disclosure 1 of 1." 

For "Reporting Source: Firm" we have a "Merrill Lynch, Pierce Fenner & Smith Incorporated" statement that asserts that the firm had discharged Stamm on June 29, 2016, based upon allegations that:

Conduct including selling away, assisting a client in making credit arrangements outside the Firm and sending written correspondence without management review.

Under that same "Disclosure 1 of 1" BrokerCheck record, for "Reporting Source: Broker" we have a "Merrill Lynch" statement that asserts that the firm had discharged Stamm on June 29, 2015, based upon allegations that:

The Retail Franchising ("Division") alleges that the Defendant violated 21 VAC 5-20-280 B (2) of the Commission's Rules governing Broker-Dealers, BrokerMDealer [sic] Agents and Agents of the issuer, 21 VAC 5-20-10 et seq. ("Rules"), by (i) failing to gain approval from Merrill Lynch prior to engaging in securities activity; and (ii) for the sales activity that was not recorded on the books and records of the broker-dealer the Defendant formerly represented. The Division identified at least one individual who invested in the Fund who was provided wire instructions by the Defendant's office, specifically regarding his purchase of the unregistered securities in Expansion.

Based on the investigation, the Division alleges the Defendant violated Rule 21 VAC 5-20-280 B (2) by effecting any securities transaction not recorded on the regular books or records of the broker-dealer which the agent represents, unless the transaction is authorized in writing by the broker-dealer prior to execution of the transaction.

What is the difference between a "Reporting Source" identified as "Firm" and another identified as "Broker"? Given that the former is referenced in the BrokerCheck record as "Merrill Lynch, Pierce Fenner & Smith Incorporated" and the latter is referenced only as "Merrill Lynch," is that a distinction? In my experience, the use of the terms "Firm" and "Broker" for different reporting sources under the "Employment Separation After Allegations" usually distinguishes from the broker-dealer versus the stockbroker or other associated person. I'm not quite sure what to make of the nomenclature here.

FINRA Sanctions

The AWC asserts that in violation of NASD Rule 3040: Private Securities Transactions of an Associated Person, Stamm did not provide any notice to Merrill Lynch regarding the promissory note transactions prior to his participation in them. FINRA deemed Stamm's conduct to constitute violations of both NASD Rule 3040 and FINRA Rule 2010. In accordance with the terms of the AWC, FINRA imposed upon Stamm a $5,000 fine and a six-month suspension from association with any FINRA member firm in any capacity.

Bill Singer's Comment

Stamm was discharged by Merrill Lynch on June 29, 2016 -- as in nearly two years ago. If we want to talk about robust and aggressive regulation, let's consider the pertinent part of the Virginia's Settlement Order executed on December 16, 2016, and filed on January 11, 2017
The Virginia Settlement Order alleges in part that:

In April, 2016, the Division became aware of an investment opportunity being offered by Expansion Industries, LLC ("Expansion") in an Ammo Component Fund ("Fund"). Expansion, although incorporated in Delaware, has been registered to conduct business in the Commonwealth of Virginia ("Virginia") since March 2014. Expansion is located in Evington, Virginia, and is in the business of firearm ammunition production. 

According to the Fund brochure, Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch") would administer the fund. The Fund brochure included the Defendant's picture, title, branch office address, phone number, and Merrill Lynch email. The Fund brochure also included a draft promissory note for prospective investors to review. Information pertaining to the Fund was found on Expansion's website,, and also was known to have been promoted at gun shows throughout Virginia. 

At the time of the alleged activity, the Defendant was an investment advisory representative and registered representative of Merrill Lynch. Based on its review of the records produced, the Division concluded that the Defendant played an active role in the development of the draft promissory notes which were subsequently used to solicit the general public. Records indicate that the Defendant failed to obtain the proper approval and authorization from Merrill Lynch prior to engaging in the outside business activity involving Expansion. In addition, the securities which were being offered and sold in the company were not recorded on Merrill Lynch's books and records. 

Review of the appropriate registration filings revealed that the securities which were being offered and sold in Expansion were not registered or exempt from registration. 

The Division identified an investment of $20,000 made by an individual into the Fund on April 12, 2016. This individual received "Wire Instructions for Funding" from a client associate located in the Defendant's office. Moreover, this was all without the authorization and approval from Merrill Lynch. The individual has not complained to the Division regarding the Defendant or the individual's investment into the Fund. 

On April 13, 2017, the State entered a "Final Order" dismissing the case against Stamm and noting that "Stamm has fulfilled the requirements of the Order." 

Piggyback Regulators

Note that the Virginia Settlement Order was dated December 16, 2016 -- as in about 17 months ago. What different set of acts underpins FINRA's May 2018 AWC? I see that the Virginia matter involved a $20,000 note and FINRA's matter involved a $200,000 and $300,000 notes. On the other hand, when you read through the state's and FINRA's settlements, they seem largely based on the same underlying conduct. As such, FINRA's settlement looks more like a lazy double-dip that merely takes advantage of the earlier and more timely state investigation and settlement. 

PST Participation?

Finally, I'm not persuaded that the facts as alleged in the AWC constitute Stamm's improper involvement in a private securities transaction ("PST"). 

As alleged by FINRA "Stamm did not receive any compensation as a result of the transaction." NASD Rule 3040 admonished in pertinent that:

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.

Similarly, Rule 3040 also stated in part that:

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.

Rule 3040 did not require that the PST result in compensation but it did require "prior notice" of a person's participation. If you believe that the transactions cited in the AWC were PSTs, then Stamm violated the rule by not providing prior notice of his participation in the PSTs to his firm. Hence, the basis for the settlement. 

Let's concede for argument's sake that the transactions were PSTs -- that prompts the next question as to whether Stamm had participated in the PSTs. The AWC asserts that for the May 2014 PST, Stamm "participated in the purchase by reviewing the promissory note, making corrections to it, obtaining a signature on the note, delivering a check for the investment to the issuer, and providing the executed note to the Customer." Similarly, the AWC asserts that for the April 2015 PST "he participated in the purchase by delivering a check for the investment to the issuer and providing the executed note to the Customer."

Let's think about that. I go online and download a generic copy of an all-purpose promissory note. I give you the copy but you tell me that you broke your hand and can't fill it out. I enter all the information into the note, which is little more than name, address, and whatever terms you and the borrower had negotiated. You then sign the note, which I deliver to the borrower on my way to work, and, thereafter, I return an executed copy to you. Have I participated in your business transaction? I didn't get paid. There is no allegation that I negotiated any terms. About all that I did was fill in the blanks with information that accurately reflected whatever you negotiated. If I have voice-dictation on my computer and I pull up an interactive promissory note form and dictate the data into each field, does that mean my computer has participated in the loan transaction?

Without question, if there was an allegation in the AWC that Stamm had negotiated the terms of the notes, I would cite him for participating in the PSTs. Similarly, if he was paid for his time and effort, I would view that act of compensation as rising to his participation in the PSTs. On the other hand, merely performing a purely ministerial service at no charge doesn't quite strike me as conduct equivalent to participating in a transaction. Also, keep in mind that as extensive as Virginia's Settlement Order is, FINRA's AWC doesn't mention most of the specifics set forth in the state's document.

As I always note with these FINRA AWCs, we should never lose sight of the fact that the Respondent signed off on the settlement and if the outcome was good enough for Stamm, then it's not my place to second guess his decision. Similarly, an AWC is a byproduct of some negotiation and give-and-take and I don't know what I don't know and there may have been facts omitted from the settlement document that would alter my view. All that aside, I don't believe that FINRA has made a compelling case here.