Overview

Selling away occurs when a financial advisor sells an investment that his brokerage firm does not approve.

FINRA rules require brokerage firms to perform due diligence on all the investments they offer to customers. These rules require broker-dealers to have a reasonable basis to believe that every investment they sell could be suitable for someone (known as “reasonable basis suitability“).

If a financial advisor sells an investment that the broker-dealer did not approve, and the investor loses money, the financial advisor and/or the broker-dealer could be responsible for the investor’s losses in a FINRA arbitration.

Why is selling away a problem?

Brokerage firms have a responsibility to ensure that they vet the investments they offer their customers. This review process helps protect investors because it provides an additional layer of assurance that they receive accurate information about the investment and its risks.

Brokers who sell away cannot provide this assurance. For that reason, unapproved investments that rogue brokers sell often carry substantial, undisclosed risks. And in many cases, substantial undisclosed fees and kickbacks to the broker who sells unapproved investments.

Importance of disclosing and monitoring outside business activity

Broker-dealers must monitor, and brokers must disclose all outside business activities to help prevent selling away. An outside business activity is any business activity that falls outside the scope of what the broker does as part of his employment with his member firm. Disclosure of outside business activities helps broker-dealers confirm that the outside business activity does not conflict with the broker-dealer’s securities business. Or create a risk of selling away.

Warning signs of unapproved investments

Identifying unapproved investments can be difficult to spot. But consider the following warning signs.

Investments that don’t appear on monthly statements

If a broker solicits a customer to invest in something that the brokerage firm does not approve, it typically will not appear in the monthly statements. Monthly statements provide detailed information about the investments held in brokerage account(s). This generally includes (among other things):

• The name of every investment held;
• Every investment’s value (as of the statement date); and
• Every investment’s cost basis (i.e. the date the investor purchased the investment).

The inability to locate an investment their broker solicited on their monthly statements is a substantial red flag.

Non-traditional, private investments

Brokers who sell away typically solicit customers to invest in something non-traditional and private, as opposed to a tradition, public investment. A private investment is one that is not publicly-traded and unavailable on a traditional, public exchange. Examples of private investments include:

• Start-ups- Investment in small, unknown companies.
• Real estate- Direct investment in commercial buildings, or residential properties.
• Private placements- Investment made in securities that are not publicly traded, such as shares in a private company.

Non-traditional, private investments generally have less liquidity than public investments. They carry greater risk because they lack the transparency of public investments. Greater risk and limited transparency makes private investments less likely to gain brokerage firm approval. And for that reason, private investments almost always are at the heart of cases that involve selling away.

Brokers who operate in the shadows

When a broker sells away, they do not want their employing brokerage firm to catch them. Accordingly, brokers might encourage customers to communicate with about the investment on an obscure device. Consider the following examples:

Example:

A broker attempts to sell an investor an unapproved, investment. The broker sends the investor information about the investment from a private email as opposed to the email that the broker’s firm approved. He then instructs the investor not to email him about the illicit investment on his approved email. And to instead send inquiries to his personal email.

Example:

A broker wants to communicate with an investor about an unapproved investment. He instructs the investor to text and call him on a cell phone different from the approved cell phone his employing brokerage firm provided him.

Can broker-dealers be held responsible for losses attributable to selling away?

Broker-dealers commonly claim that they did know, or have reason to do know about an unapproved investment a broker sold. Therefore, they argue, they cannot be responsible for the losses an investor sustained because they had no way of knowing about it.

But broker-dealers can, and often do get held responsible for investor losses caused by selling away. Broker-dealers have duty to supervise the activities of their brokers, and takes proactive steps to prevent selling away. Failure to adequately supervise a broker who sells away, therefore can make the broker-dealer responsible for the investors losses.

*The Law Offices of Patrick R. Mahoney is a full service law firm with extensive experience litigating cases involving a host of securities-related issues. This page is for information purposes only and does not constitute legal or investment advice; nor is it a comprehensive explanation of all selling away issues. If you believe you have a claim, you should speak to competent counsel to better understand your options. Or, contact us.*