NASD v. Dahmer, Disciplinary Proceeding No. C8A030086 (O.H.O., February 17th 2005)

In 2005, an insurance agent / financial planner / registered rep was suspended for sixty (60) days and fined $5,000 and ordered by NASD to re-qualify by examination for failing to disclose his outside business activities (OBAs). You may read and shrug your shoulders and ask the question, “what’s so unusual about this?”

Unlike the usual OBA case, where the Registered Rep fails to disclose to his broker / dealer that he is involved in more exotic ventures like selling promissory notes issued by car dealerships or equity ownership interests in Mexican real estate ventures or shares in payphone investment contracts, this Rep sold to “non-proprietary insurance products”, many of which were fixed insurance products. Your interest may be piqued, somewhat, but still you ask, “what’s the big deal about this case?”

Consider these facts. This Rep started his “career” of “selling non-proprietary insurance products” when his Division Manager referred two neighbors to this Rep. The Rep interviewed the neighbors and prepared a plan that included both survivorship and term life insurance products that, NASD agreed, were appropriate to the customer’s needs. The problem: The Rep’s BD did not offer the survivorship product, and so the Rep sold the customers a survivorship product offered by an insurance company not affiliated with the Rep’s BD. Significantly, the Rep’s Division Manager attended the customer interview, and actually knew about the sale of this “non-proprietary insurance product” to the customer, and never mentioned to the Rep about the need to complete an OBA form before or after effecting the sale of outside insurance products.

Based on this experience, the Rep repeated this pattern of selling products that he believed were best suited his customer’s needs. If “house products” were suitable, he sold these; if “non-proprietary products” were suitable, he sold these instead. As NASD explained, this Rep “put his clients’ interest ahead of his own, often earning lower commissions on non-[proprietary] products than he would have been paid for selling the client an equivalent [proprietary] product.” This Rep “disclosed fully to his clients the identity of the company whose product he was selling, and the features, benefits, and fees associated with those products.” This Rep [never represented that [his BD] somehow endorsed his sales of non-[proprietary] products or that it approved any of the non-[proprietary] products.” Finally, NASD admits that “none of [this Rep’s] customers was harmed by his sales practices. To the contrary, his clients benefited from his actions by paying lower premiums, and he earned their trust and respect.”

Another interesting fact in this case: This Rep’s first sale of an outside product took place in 1989, but it wasn’t until 1997 that his BD required its reps to disclose outside business activities on a corporate form – the form that required disclosure outside insurance products.

Yet another interesting fact in this case: This Rep never received his BD’s client relations guide or compliance manual, which was supposed to have explained the firm’s policy on outside business activities.

One more interesting fact: In 2001, this Rep’s Branch Manager wrote a letter to the firm’s Field Compliance Director, confirming that the Manager had conducted close review of this Rep’s transactions, client files, and mail logs going back to 1998; and that, as a result of his review, he was aware of the magnitude of this Rep’s sales of non-proprietary products and extent that these sales adversely affected the Rep’s income (meaning, commissions were consistently secondary to the customer’s best interests.)

Notwithstanding all of these compelling facts, this unfortunate Rep found himself having to defend himself in an enforcement proceeding that charged him with violating Rule 3030 – the NASD rule that requires Reps to disclose to their broker/dealers all outside business activities, even if these OBAs are not securities-related.

In reaching its decision, NASD had some very laudable things to say about this Rep. He “never attempted to mislead his supervisors about his outside business activities or conceal them.” Since the inception of his employment with his BD, this Rep’s Division Manager “encouraged him to seek the most appropriate products for each client, regardless of the provider.” This Rep had “mistakenly confused outside business activity with selling away”. (As a former compliance examiner, I can attest to the fact that discussions during annual compliance meetings confirm that reps are often confused about the difference between OBAs and “selling away”.) NASD confirmed that this Rep testified credibly, “accepted responsibility”, and “was contrite”. Above all, none of this Rep’s customers were injured; in fact, these “customers benefited from [his] outside business activities.” And as a kind of testimonial to this Rep’s integrity, NASD pointed out that “his concern for his customers adversely affected his own financial interests”. Equally important, “there is no evidence of financial injury” to the Rep’s company, admitted NASD.

So you ask: Don’t any of these good things count for anything? The short answer is no, at least on the liability side of an enforcement case (they help, somewhat, to mitigate sanctions imposed.) OBA violations come close to being strict liability cases. In other words, if you fail to complete an OBA fully and accurately, NASD can find you liable – even if you are an otherwise exemplary professional in the securities industry. As NASD points out, “the purpose of the Rule is to give the firm a meaningful opportunity to review the representative’s activity and determine the extent, if any, to which it should supervise his involvement.” In other decisions, NASD has pointed out that the purpose of Rule 3030 is, not only to prevent harm to the investing public, but also to limit a firm’s entanglements in legal difficulties that can result from unsupervised outside business activities, especially ones not even related to the securities industry. In other words, to protect a Broker Dealer from having to supervise an activity in which it has no expertise and to prevent the need for the BD to defend itself in a lawsuit that does not even involve its “bread and butter”. Precisely because of these two risks to your Firm, all Registered Reps should take their firms’ OBA policies very seriously. The penalties for not doing so can be severe.

You can read the entire case here.