It’s None of FINRA’s Business – Or is it?


August 25, 2020

By: Jonah A. Toleno, Partner

Financial advisors registered with the Financial Industry Regulatory Authority (FINRA) generally are well aware of their obligations when engaging in securities activities.  But some advisors may not know that FINRA’s jurisdiction extends beyond traditional commission-based transactions, which could render them subject to FINRA investigation. Advisors sometimes mistakenly believe activities they deem “non-securities” or “outside business activities” are none of FINRA’s business.  If a financial advisor acts as a “broker”, however, FINRA can enforce jurisdiction over these transactions.

How do advisors know if they are acting as “brokers”? The Securities and Exchange Commission (SEC) defines a “broker” as “any person engaged in the business of effecting transactions in securities for the accounts of others.” 15 U.S.C. § 78c(a)(4)(A).  Federal courts interpret this definition broadly.  In determining whether someone is acting as a “broker”, courts analyze whether the person: “1) is an employee of the issuer; 2) received commissions as opposed to a salary; 3) is selling, or previously sold the securities of other issuers; 4) is involved in negotiations between the issuer and the investor; 5) makes valuations as to the merits of the investment or gives advice; and 6) is an active rather than passive finder of investors.”  See Legacy Resources, Inc., v. Liberty Pioneer Energy Source, Inc., 322 P.3d 683,689-90, citing to S.E.C. v. Martino, 255 F. Supp. 2d 268, 283 (S.D.N.Y. 2003).

The Legacy court found “involvement at key points in the chain [of] distribution is a key indicator of broker activity.”  Legacy, 322 P.3d at 689, citing to S.E.C. v. Bravata, No. 09-12950, 2009 WL 2245649, at *2 (E.D. Mich. 2009).  These “key points” include: (1) advertising for clients, and (2) receiving and possessing client funds and securities. Id.  The Legacy court also held “[t]ransaction-based compensation, i.e., payment on commission, is ‘one of the hallmarks of being a broker-dealer.’” Id. at 688.

The court carefully examined the terms “engaged,” “business,” and “effecting transactions” as defined by the SEC. Id. at 690.  “Engaging” in a securities transaction, according to the court, implies an active participation by the broker in a transaction or series of transactions. The court’s interpretation of “business” typically involves a commercial activity, usually for profit, such as selling other issuers’ securities.

As for “effecting” a securities transaction, the court focused on activities that bring the transaction to fruition. Examples include: (1) involvement in negotiations between the issues and investor; (2) advice regarding the merits of an investment, and (3) the pursuit of investors. Id.  In analyzing these components of the SEC’s definition, the Legacy court issued this interpretation of the term “broker”:  

A “broker” is one who is actively committed to or employed in the regular pursuit of bringing about a securities transaction, as evidenced by transaction-based compensation, the sale of securities of other issuers, involvement in negotiations between issuer and investor, advice or valuation of the merits of an investment, and active pursuit of investors.


Many advisors are unaware that FINRA views some Mergers and Acquisition (“M&A”) consulting work as “broker” activity. In M&A work, advisors typically enter into arrangements compensating for various “consulting” activities which, at first blush, appear to be outside FINRA’s purview.  For instance, while an M&A advisor may not directly sell a security to an investor, the advisor may participate in negotiations, provide advice, or engage in financial advisory meetings.  Under Legacy, FINRA could find that advisor acts as a “broker” under 15 U.S.C. § 78c(a)(4)(A) and therefore regulate the M&A activity – especially if the advisor receives a transaction-based commission.

There is, of course, significant grey area in these analyses.  Here’s the bottom line: If you’re an advisor engaging in possible broker activity, whether you disclose it or not, and irrespective of how you characterize your compensation, you must tread carefully.  Don’t assume it’s none of FINRA’s business just because it’s an “outside business activity.”  If FINRA gets wind of the activity and determines your compensation is a broker-based commission, FINRA likely will make it its business to regulate yours.  We know this firsthand, because FINRA recently determined in one of our matters that an advisor’s undisclosed M&A compensation was subject to FINRA review and jurisdiction.

Our firm regularly represents financial professionals in matters such as these and other industry-related issues, including broker and advisor transition, Broker Protocol, SEC and FINRA investigations, trade secret disputes, and employment matters.  If you have a situation you’d like to discuss, feel free to contact us for a confidential initial consultation. We can help you take necessary steps to protect yourself and your livelihood.

Partner Jonah A. Toleno is based in our San Diego, California office. She practices in securities and financial services law and acts as trial counsel and outside corporate counsel for numerous financial, business, and individual clients. She can be reached at (619) 696-9500 or [email protected] with questions.


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