FINRA Sanctions and Findings of Violations For Selling Away Set Aside

James W. Browne, Kevin Calandro, Exchange Act Rel. 58916, November 7, 2008

Time since appeal - 9 months 24 days
Time since last brief - 6 months 15 days
Pages - 16
Footnotes - 41

Summary

Browne and Calandro were registered representatives who were charged with engaging private securities transactions without giving prior notice to or obtaining permission from their firm. NASD suspended Browne for six months and fined him $25,000. Calandro was suspended for three months and fined $5,000. The Commission set aside the findings of violations and sanctions.

Discussion

Browne and Calandro sought permission to purchase stock in a private placement. They consulted their manager who advised them to make a written request to their firm. When Browne became concerned the offering would close before the purchase was formally approved, his manager suggested that the purchase be made by Browne's wife in her name and advised that no permission would be required. In addition, Browne and Calandro told various friends, family, and customers about their purchases of the stock. Some of those persons also purchased in the private placement. Browne also was given permission from his firm to serve as a director of the company on condition that he not discuss the merits of the company with any clients of his firm. Browne and Colandro also bought stock in a later private placement offering of the company. Various friends and family of Browne's and Clandro also bought stock in this later offering after he discussed the offering with them. There was no evidence that Browne solicited or recommended the investment. Browned and Calandro were paid a finders fee in the form of shares of the company. They claimed they had not expected to be paid the finders fee. Browne claimed he understood the stock was in payment for his services as a director and Calandro argued it was in payment for his general efforts to assist the company. Neither informed their employer of the receipt of this free stock.

NASD found that Browne had "participated" in private securities purchases by nine investors and Colandro in purchases by five.

FINRA rule 3040 prohibits persons associated with member firms from participating in "any manner" in a private securities transaction without written notice to the firm and written permission if the person may receive any compensation. The Commission has long given the phase "participate in any manner" a very broad construction. The Commission construes "participation" to mean taking specific actions to effect a transaction or profiting from referring an investor's purchase after making a referral. Here, the Commission found that the evidence did not establish a nexus between Browne's and Calandro's conduct and the specific customer purchases. Several of the purchasers were referred to the company for purposes other than making an investment such as attempts by them to establish a business relationship with the company. The purchasers in the second offering were previous investors in the company who were solicited by the company to participate in that offering. FINRA's theory of liability was that Browne and Colandro should have known that start up companies often seek investments from business vendors and that by referring people to the company for business purposes they should have known that the company might attempt to get them to invest in the company at a later time. The Commission ruled that this places too broad a scope on the rule which requires a direct nexus between the initial referral by the associated person and the investment purchase. As to the free stock that Browne and Calandro received the Commission ruled that there was no evidence that the stock was tied specifically to any purchases of stock by investors. No evidence contradicted their claim that the stock was in payment for their general efforts in assisting the company.

Comment

FINRA clearly was over-reaching here. It changed its theory of the case in mid-stream. Referring someone to a company who is seeking to do business with the company and who later invests does not violate the selling away rule. To constitute a violation, the associated person must make the referral knowing it to be for investment purposes.

FINRA Sanctions Upheld Including Restitution and Consecutive Suspensions

Michael Frederick Siegel, Exchange Act Rel. 58737 (October 6, 2008)

Time since appeal filed - 9 months 3 days

Time since last brief - 5 months 13 days

Pages - 25

Footnotes - 66

Summary

Siegel, formerly a registered rep appealed a NASD disciplinary action.  NASD found he made unsuitable recommendations to two customers and failed to give his firm written notice of private securities transactions (selling away).  He was fined $30,000, ordered to make restitution of $400,300, assessed $7,900 of costs, and ordered to serve consecutive six month suspensions from all association with a member firm.  The Commission sustained the sanctions.

Discussion

Siegal became a director of a private company in late 1997.  He requested permission from his firm to be a director and represented that he would not recommend the company's securities to his customers. Permission as granted subject to a condition that he not effect transactions in the company's securities. Siegal then entered into a written agreement with the company to sell the company's securities for compensation.  The agreement was sent to Siegel's home address, not his business address at the BD which opened all incoming mail.  Siegel also loaned the company $42,000.  He was never paid for his services as a director and the loans were never repaid.

Siegel had discretionary authority over the account of a married couple.  Their account had fixed income products, mutual funds, and stocks. Their primary investments were bank CDs. They had a net worth of $1.5-$2 million excluding their home.  The husband was a lawyer and the couple's total income was about $150,000.  Siegel in late 1997 sold the customers $300,000 of debentures in the company of which he was a director.  Even though the company offered the investors an opportunity to rescind shortly after the purchase Siegel advised them to stick with the purchase which they did.

Siegel also had discretion over another couple's $1 million account.  In early 2008 Siegel sold them $100,000 of debentures in the company of which he was a director.  

The company lost the rights to sell its primary product in in 2002 and its corporate charter was revoked in 2004.  Both investors suffered a total loss.

Siegel admitted at the hearing that one couple invested because he told them he was personally going to invest in the company.  He also admitted that the sales documents he used with both couples were deficient because they had contradictory or confusing information about the details of the investment terms such as maturity dates, interest rates, and repayment terms. He admitted that these deficiencies made the investment unsuitable for any investor.  Amazingly he testified "[t]his is one of the worst set of offering documents I have ever seen in my life." His defense was that he had not studied the offering documents before discussing the investment with his customers.

Siegel did not dispute his violation of NASD rule 3040 that prohibits "selling away" without obtaining written permission from the firm he was registered with.  NASD rules require that securities recommendations to customers be suitable.  Whether or not a recommendation has been made must be determined on a case by case basis. The standard is whether the communication with the customer was a "call to action" and "reasonably would influence an investor to trade . . . ." The Commission found Siegel's defense that he orally advised his supervisor of his selling away was unavailing because his claimed verbal notice insufficiently described the investment and sales activities.

The Commission found that Siegel indeed did recommend the investments based on an analysis of: 1) the relationship between Siegel and his customers; 2) their reliance on him; 3) the specific content of the conversations between them; and 4) Siegel's initiation of the subject of investing in the company.

The Commission rejected Siegel's defense that one couple were extremely sophisticated investors, noting in the process that sophistication alone does not mean that a communication is not a recommendation.

Also, the Commission found the recommendations to be unsuitable. Here Siegel admitted that due to the deficient offering documents the investments were not suitable for any investor. He also admitted he had not read the documents before discussing the investment with his clients. Thus it was impossible for him to reasonably evaluate the potential risks and rewards of the investment.  

The Commission upheld the sanctions.  One of the primary factors that supported this conclusion was Siegel's conflict of interest due to the fact that he was a director of the company and had disclosed that to only one of the couples.  In addition he violated a directive from his firm that prohibited him from selling investments in the company after he became a director.

The Commission upheld the consecutive suspensions imposed by NASD. NASD rules allow such sanctions when the violations involve "different kinds of misconduct and raise separate and serious regulatory concerns."

Siegel argued that while he caused the customers to invest, he did not cause the loss and therefore restitution was inappropriate.  The Commission rejected this claim, noting that restitution is appropriate where the investor loss is a result of the misconduct.  It noted that here the investor loss was the result of Siegel's inappropriate recommendations.  It also noted that the fact that Siegel did not profit was no bar to restitution.

Comment

The obvious recent trend is for Commission decisions to be entered much more quickly than has been the pattern in recent years.

The Commission continues to find that selling away is a very serious violation as it lessens the protection of investors inherent in firm compliance procedures and threatens firms with potential liability.

In an interesting footnote (39), the Commission used the "prudent man" definition of recklessness found in Restatement (Third) Of Torts.

The Commission also ruled that selling away and unsuitable recommendations are sufficiently distinguishable violations to justify separate consecutive suspensions.  

Finally, restitution is appropriate even if the violator received no personal gain from the conduct.