Prohibited Activities

Let's look at the industry from a regulatory perspective, starting with the conduct of registered representatives.

Outside Business Activities
Many students seem shocked to learn they'll need to notify their employing broker­ dealer before doing any type of work outside the firm. As this rule stipulates:

No person associated with a member in any registered capacity shall be employed by, or accept compensation from any other person as a result of any business activity other than a passive investment outside the scope of his relationship with his employer firm unless he has provided prompt written notice to the member. Such notice shall be in the form required by the member.

Although the rule does not require permission be granted, it functions the same way. Member firms can restrict or reject any plans to work outside the firm for compensa­tion. Therefore, associated persons must give their employing firm notice, and then wait to see if the firm has questions or concerns before engaging in that activity.

The rule covers any work for compensation, not just work in the financial services industry. Giving golf or piano lessons for compensation are examples of outside busi­ness activities subject to disclosure to the firm. The rule does not cover volunteer work, since that is not for compensation.

Private Securities Transactions
FINRA wants all activities of a registered representative monitored, so if the regis­tered representative is sitting in his office offering investors a chance to invest in his sister's new LLC without telling his firm, there is no way the firm could monitor his sales activities, which poses a threat to investors.

That could even be the answer to a question that asks why selling away is a violation because it gives your principal/ firm no opportunity to supervise your activities?. So, principals and registered repre­sentatives cannot offer securities to investors that their firm knows nothing about. As this rule makes clear:

 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

Once the associated person has provided written notice to the employing member firm, the firm can either approve or disapprove the activities. If they disapprove, the associated person would be subject to disciplinary action by FINRA and termination by the firm if he went ahead and sold the securities, anyway.

The member firm must follow different procedures based on whether the associated person will receive selling compensation. If the transactions involve compensation and the firm approves the activity, the member must record the transactions on their regular books and records as well as supervise the registered representative (or princi­pal) as if the transactions were being done on their behalf.

On the other hand, if the transactions will not involve selling compensation, the employing firm must provide the associated person prompt written acknowledgment of receiving notification. The member firm may then, at its discretion, require the person to adhere to specified conditions.

However, if the associated person fails to provide prior written notice, this violates the rule above whether any selling compensation is received or not. For purposes of this rule, FINRA defines selling compensation as, ''Any compensation paid directly or in­ directly 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."

Customers' Securities or Funds

c) Authorization to Lend
No member shall lend, either to himself or to others, securities carried for the account of any customer, which are eligible to be pledged or loaned unless such member shall first have obtained from the customer a written authorization permitting the lending of securities thus carried by such member.

Margin customers sometimes sign a loan consent, which allows the broker-dealer to use the securities when lending to short sellers. The above rule requires the firm to have the customer's consent first. But, FINRA does not require separate forms here. As a recent notice to member firms states, ''FINRA Rule 4330(a) requires a firm to obtain a customer's written authorization prior to lending securities that are held on margin for a customer and that are eligible to be pledged or loaned. Supplementary Material .02 permits a firm to use a single customer account agreement/margin agreement/loan consent signed by the customer as written authorization under Rule 4330(a), provided such customer account agreement/margin agreement/loan con­sent includes clear and prominent disclosure that the firm may lend either to itself or others any securities held by the customer in its margin account."

The firm must keep their assets separate from the assets that clearly belong to the customer, and their books and records must make it clear which securities belong to which customers. A failure to do so is a violation called commingling:

d) Segregation and identification of Securities
No member shall hold securities carried for the account of any customer which have been fully paid for or which are excess margin securities unless such securities are segregated and identified by a method which clearly indicates the interest of such custo1ner in those securities. 

FINRA rules require members to segregate and identify by customers both fully paid and "excess margin" securities. ''with regard to a customer's account which contains only stocks, it is general practice for firms to segregate that portion of the stocks hav­ing a market value in excess of 140% of the debit balance therein.''

So, if the "Dr" or "debit register" in a margin account is $5,000, 140% of that would be $7,000, and anything above that would be considered "excess margin" securities.
So, the broker-dealer pledges $7,000 of the securities as collateral to the bank, and the rest is/ are ''excess margin securities.''

Agents and broker-dealers do not guarantee customers against losses:

Prohibition Against Guarantees

No member or person associated with a member shall guarantee a customer against loss in connection with any securities transaction or in any securities account of such customer.

Some securities are guaranteed, but neither broker-dealers nor agents may guarantee customers against investment losses. A Treasury Bond is guaranteed against default by the US Treasury. But, agents and broker-dealers cannot shield customers against investment losses should they purchase T-Bonds just before interest rates rise.

Treasury securities are safe, but they are not the only debt securities that may be guaranteed. A corporate bond may be guaranteed as to interest and principal by a third party. This means if the issuer is unable to pay, the third party has promised to at least try to make good on the interest, principal or both. Often, the issuer is a sub­sidiary of the guarantor in these cases.

Paying Commissions to Unregistered Persons
Broker-dealers and associated persons are prohibited from paying individuals and entities not registered or associated with a member firm referral fees or any form of compensation for helping them increase their sales efforts.

The same prohibition applies to unregistered employees of the broker-dealer. An assistant without the appropriate license cannot share in any revenues connected to securities transactions with a registered representative.


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