Q: My wife and I are starting a business unrelated to the securities industry. It’s really my wife’s business but I’m helping her out mostly with the financial aspects. I received permission from my compliance department to participate in the business, so everything is fine as far as that goes. I happened to be speaking to a client of mine, and he liked the idea so much he offered to invest in the business. I didn’t ask him to do so, nor did I solicit him in any way to invest. I had no expectation that he’d want to invest when we began speaking about the business. It really did just start out as small talk and progressed from there. Can we accept his offer to invest?
A: I’m surprised I have to even say it but there are three words that define your scenario: “Conflict of interest.”
I’ve previously discussed
Since the first part of the rule requires that your firm have policies in place permitting borrowing from customers, and since most brokerage firms have policies specifically prohibiting that, you probably don’t even need to look any further into the rule to know that you can’t avail yourself of the exception.
Putting the rule aside, however, let’s consider the conflict of interest itself. Were you to accept your client’s offer to invest in your OBA, you would have a financial incentive to treat that client differently (i.e., better) than you would other clients. You’d probably go out of your way to keep that client happy, even at the expense of other clients, no matter how hard you’d try to treat everyone the same. It’s that incentive that creates the conflict.
Additionally, you would not be able to provide this client with any sort of investment advice with any objectivity. Consider what would happen if your business begins to struggle. Could you really advise him to divest himself of the investment? Even if you’re not providing him with investment advice and only act as an order-taker, you’d be engaging in a securities transaction with him, which opens a whole other can of worms. If we assume he would not be participating in the day-to-day running of the business, the investment would have to qualify as a private securities transaction and you’d need to retain a securities attorney to ensure that transaction was done properly, which brings up FINRA Rule 3280 — Private Securities Transactions of an Associated Person.
All of that said, there is a path through which you might be able to accomplish this. First, and perhaps most importantly, the client should move his account to another brokerage firm entirely so he would no longer be a client of your firm. Second, speak with your compliance department before proceeding. Complying with Rule 3280, you’ll have to give written notice to your employer of the personal securities transaction and make sure they have no objections. Assuming they don’t, you can then retain a securities attorney who can prepare the necessary documents (a subscription agreement, Reg D filing, etc.).
If, after all that, if the individual is still interested, you’ve got yourself an investor.
