March 17, 2020
A stockbroker invests his own money in a real estate deal. His money. No customers involved whatsoever. How does that get him in trouble with his employer? How does that rise to the level of a FINRA fine and suspension? Great questions. Read today's blog for the answers.
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, William Blake McGowan submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of William Blake McGowan, Respondent (FINRA AWC 2019064384101)https://www.finra.org/sites/default/files/fda_documents/2019064384101
The AWC asserts that McGowan was first registered in December 2016 with FINRA member firm MML Investors Services, LLC.
The Pooled Real Estate Investment
As alleged in pertinent part in the AWC:
In July 2017, McGowan purchased securities totaling $55,000 in a pooled real estate
investment; specifically, McGowan purchased shares in an Arkansas limited liability
company formed to purchase and manage a vacation rental property in Florida. The
purchase, which McGowan made on his own behalf, was outside the scope of his
employment with MML, and McGowan did not provide prior written notice to MML of
the transaction or of his role in it. To the contrary, McGowan signed and submitted an
annual compliance attestation to MML in August 2017, in which he falsely represented
that he had not made "any personal investments (e.g., . . . pooled investments in real
estate)" that he had not disclosed to the Firm.
FINRA Rule 3280: 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 3210, transactions among immediate family members (as defined in FINRA Rule 5130), 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.
The AWC asserts that on June 12, 2018, MML filed a Uniform Termination Notice for Securities Industry Registration ("Form U5"), disclosing that McGowan had voluntarily resigned, and that the firm was conducting an internal review pertaining to "potential inadequate disclosure of outside activities[.]" Further, on December 17, 2018, MML allegedly filed an Amended Form U5 disclosing that the concluded internal review confirmed the previously noted concerns.
In consideration of the terms of the AWC, FINRA found that McGown had violated FINRA Rules 3280 and 2010, and imposed upon McGowan a $7,500 fine and a 30-business-day suspension from association in any and all capacities with any FINRA member firm.
Bill Singer's Comment
So . . . we got an associated person taking $55,000 out of his own pocket and buying shares in a company. That company is a "pooled real estate investment," which was formed to buy and manage Florida vacation rental property. The shares that McGowan bought were for his own investment. And what, exactly, in that fact pattern presents a compliance or a regulatory problem?
As MML and FINRA would argue, FINRA Rule 3280 prohibits an associated person from participating in a private securities transaction ("PST") unless that associated person provides written notice to his member firm detailing the proposed transaction, his role therein, and disclosing any compensation he may receive. If compensation is involved, the member firm shall advise the associated person in writing whether it approves/disapproves the proposed transaction. If no compensation is involved, the member firm will provide written acknowledgement of its receipt of the requisite notice and may impose certain conditions upon the associated person's participation in the transaction. In a nutshell: First you let us know what you wanna invest in; and, second, we let you know if it's okay with us.
Somewhat lost in the shuffle in the AWC is the fact that McGowan was only first registered in December 2016 and that the cited investment took place about seven months into McGowan's registered career -- not exactly a ton of time in service to become fully familiar with industry rules and regulations. Similarly, as of the June 2018 date of McGowan's resignation, he was only registered for about 18 months in total. Also somewhat glossed over in the AWC is the important issue of whether McGowan was compensated by the pooled real estate investment -- and I'm inferring from the absence of such an allegation in the AWC that McGowan did NOT receive any compensation attendant to the cited PST.
Why the hell did McGowan get hit with the double-whammy of a $7,500 fine and a 30-business-day timeout?
No customer was involved.
No customer's money was involved.
McGowan invested his own money in the purchase and management of rental property.
What snagged McGowan is that he failed to provide MML with prior written notice of his personal investment. As far as that failed notice goes, okay, sure, MML and FINRA are well within their rights to jump up and down and wag a disapproving finger. To that extent, have at him. On the other hand, c'mon, $7,500 and 30 business days for making a private investment with your own money in rental properties? I dunno -- strikes me as a bit steep given the facts.
As I often acknowledge with AWCs, it's not my place to question McGowan's decision to settle on the terms that he did. I don't know what I don't know. I don't know what was omitted from the AWC per the give and take of settlement negotiations. That being said, solely based on what I know, no more than a $5,000 fine and maybe 30 calendar days in the penalty box would seem to have been more than adequate.