Selling away occurs when a broker invests a client’s money without going through the brokerage firm that he is employed with. It is one of the most commonly committed violations according to the Financial Industry Regulatory Authority (FINRA). Generally in a selling away case, both parties will agree that the customer lost his money due to misappropriation or fraud by the broker dealer. At that point the focus shifts to whether the firm maintained adequate supervision over the broker dealer. The firm needs to have reasonable level of supervision in place that would prevent or catch most instances of their broker dealers selling away. If there is a finding that the brokerage firm did not conduct adequate supervision, then the firm may be held directly liable for the customer’s losses. The brokerage firm can also be found liable through a theory of respondeat superior.
Many times these types of cases will be Ponzi schemes. Ponzi schemes are the selling of fraudulent investments such as promissory notes, securities that do not exist, partnerships in companies that do not exist, or other imaginary investment products. Generally these schemes are conducted by allowing later investors’ money to pay off early investors with larger returns. Often times the schemer will use these large payouts to entice more investors or to convince former investors to re-invest with a larger sum of money.
To protect customers from brokers running Ponzi schemes and other selling away schemes, FINRA and other regulatory bodies imposed a specific duty upon the brokerage firm to supervise its registered representatives. By creating regulations that place a duty on brokerage firms to supervise their registered representatives, regulatory bodies are attempting to protect the investing public. More specifically the regulations attempt to protect unsophisticated investors and those investors who will trust a broker that appears to be backed by a brokerage firm with their financial and investment decisions. A good example of this type of regulation is NASD Notice to Members 99-45, “NASD Provides Guidance on Supervisory Responsibilities” (June 1999). It states:
The requirement that every registered person be assigned at least one supervisor serves several functions. It provides the person being supervised with a clear line of authority and specifically identifies for the supervisor the persons for which he or she has responsibility. In addition, this requirement recognizes the obvious fact that a supervisory system reasonably designed to achieve compliance with the securities laws does not permit persons to supervise themselves.
Additionally, NASD Notice to Members 86-65, “Compliance with the NASD Rules of Fair Practice” addresses the duty to supervise, detect, and correct or report regulatory and compliance issues of off-site representatives.
When this duty is breached and a customer loses money, a firm may be held directly liable to the customer on a negligence theory. Moreover, if a brokerage firm is grossly negligent in its duty to supervise its broker, the firm may be held liable for punitive damages as well as compensatory damages.
If you suspect that a broker is selling away you can report him to his brokerage firm or to FINRA. If you or someone you know has been the victim of selling away by a broker, contact an attorney immediately.