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SEC Reverses Finra in ‘Selling Away’ Case
November 11, 2008
The Securities and Exchange Commission, in a highly unusual move, has set aside a decision by the Financial Industry Regulatory Authority (Finra) involving “selling away,” or engaging in private securities transactions in violation of NASD Conduct Rule 3040.
In its Nov. 7 opinion, the SEC reversed Finra predecessor NASD, explaining that the self-regulatory organization (SRO) had presented a “new theory of liability” that amounted to a novel interpretation of Rule 3040, which requires registered representatives to obtain approval before engaging in business activity away from their firm. It concluded that the record “provides insufficient support” that either James Browne or Kevin Calandro, the reps involved, participated in transactions in violation of the rule. “In sum, we … dismiss those charges,” said the commission. Finra spokesperson Herbert Perone declined to comment on the decision.
For conduct dating to 1998, NASD had ordered that Browne be suspended for six months and fined $25,000, and Calandro three months and $5,000; because they were appealed, the suspensions never went into effect. The representatives allegedly engaged in private deals without first providing written notice or obtaining approval from their member firm. The stock involved was that of e2 Communications, a software provider that filed for bankruptcy in 2002.
Subsequent to e2’s bankruptcy filing, NASD filed a complaint alleging that between 1999 and 2000, Browne and Calandro referred a number of investors to the vendor and received compensation in the form of shares. In its explanation of liability, NASD said that “the receipt of selling compensation alone constitutes participation in the transactions for purposes of Rule 3040.”
In its ruling, the SEC countered that NASD had created a new interpretation of Rule 3040 without providing prior notice to the applicants. “This lack of notice alone raises sufficient concerns to warrant dismissal of the charges,” said the commission, adding that the SRO also failed to establish a connection between the reps’ referrals and the e2 stock transactions.
“There was no proof that they were making introductions for investment purposes. Plus there was a significant time period between the introductions and the purchases,” said Brian Rubin, a Washington D.C.-based partner in law firm Sutherland Asbill & Brennan who represented Browne in the appeal. Rubin added that he has been unable to find another instance of the SEC reversing an NASD ruling for at least a decade.
Rubin, a former NASD deputy chief counsel of enforcement, said it is not unusual for reps that are selling away to avoid telling their firms because they are selling questionable products. However, “In this case,” he said, “the representatives knew people at the firm, e2, and introduced friends and clients to persons involved at e2, for the purposes of networking and for potential business between the two sides--but not for investment reasons.”
In upholding the NASD hearing panel’s 2006 decision, the NASD National Adjudicatory Council in December 2007 agreed that the case presented “uncommon and unusual” facts, added Rubin. “In our view, NASD pushed the envelope too far with respect to this type of violation,” he said. “And the SEC agreed with us.” As a result, “Individuals and firms should think long and hard before they decide to settle with Finra.”
