After passing the appropriate licensing exams, filing the U-4, and FINRA confirming registration as effective, a person is considered a registered representative. Working in the finance industry comes with many rules and responsibilities. We’ll discuss the following in this section:
A representative’s license goes into an inactive state when they leave the industry. As long as the person re-associates with another firm within 2 years, all licenses will stay intact and become active again once effective registration is gained (after filing the new U-4). However, a person’s licenses begin lapsing if out of the industry for 2 or more years. In this scenario, it’s possible a previously fully-licensed individual must re-take several exams once re-entering the industry.
Specifically, any NASAA exam (like the Series 63) or FINRA exam other than the SIE exam will lapse after 2 years. The SIE does not lapse unless a person stays out of the industry for 4 or more years. Also, firms cannot “park” licenses of former employees. When an individual leaves the firm, the countdown begins!
Registered representatives must inform their employer if they’re making money outside of their firm, known as an outside business activity (OBA). This ensures representatives are not engaging in conflicts of interest that may harm the firm or its customers. Unpaid volunteering efforts and lottery or casino winnings are not OBAs. Any other circumstance involving payment, including working for a family member’s business or being paid tips for creative endeavors (e.g. playing in a band on the weekends) are considered OBAs. FINRA recently has been cracking down on the enforcement of OBA rules.
To take a job or money-making opportunity outside the firm, representatives must notify their firm in writing. If the employer feels they’re engaging in activity detrimental to the firm, they have the right to deny the OBA. Although firms have the right of denial, representatives are not technically asking for their permission when they notify their employer in writing. It’s only a problem if they hear back after submitting the OBA notice!
Along the same lines as OBAs, registered representatives must follow similar procedures if planning on performing a private securities transaction. A number of different scenarios fall into this category if performed outside the employing firm, including:
In a nutshell, a private securities transaction occurs when a registered representative facilitates a securities transaction of any form outside of their employing firm. If these requirements are met, the transaction is compliant with FINRA rules:
*No written approval is required if the representative is not being paid to facilitate the transaction.
The representative is selling away if they do not fulfill these obligations, which is a FINRA violation subject to penalties.
FINRA is concerned about “pay for play” within the financial industry, so they limit gifts made to business partners. For example, if your broker-dealer does business with a mutual fund company, the firms cannot give gifts worth more than $100 per person, per year to the other firm’s employees. However, this does not include business entertainment, which is not considered a tangible gift. Business entertainment includes tickets to sporting events and dinners. As long as it’s not excessive, these activities can exceed $100.
Registered representatives are subject to limitations when borrowing from or lending to customers. Generally speaking, representatives are prohibited from engaging in loans of any form with most customers. This should make sense; do you really want to owe money to your client?
Regardless, some exceptions exist. If the customer is in the business of lending money (for example, if the customer is a bank), then a representative may borrow money from them. Additionally, exceptions to borrowing and/or lending rules apply to customers that are family members or individuals in personal relationships (e.g. a partner or fiancé).
A guaranteed security is a security with backing from a third party in relation to interest, dividends, and/or principal. A security is considered guaranteed when a third party (usually an insurance company) pledges to cover any unpaid interest, dividends, and/or principal. However, this doesn’t mean an investor can’t lose money on a guaranteed security. Market value is not considered if third-party insurance kicks in. For example, let’s assume an investor purchases a $1,000 principal (par) bond* for $1,200. If the bond defaults (meaning the issuer is unable to pay back the borrowed funds), the insurance would only cover the $1,000 principal and any unpaid interest to that point. The $200 premium the investor paid for the bond would be uncovered.
Outside of guaranteed securities, the term ‘guaranteed’ is usually related to unethical activities. In particular, financial professionals must never guarantee a security will perform in a certain manner. This includes:
One of the defining characteristics of a security is the possibility of loss. Performance guarantees and securities simply don’t mix. As nice as it might be being provided a guarantee against loss, it’s not feasible for broker-dealers, agents, investment advisers, or investment adviser representatives (IARs) to offer them. What if a registered person guarantees more than they’re able to handle? Guarantees pose a threat to the financial health of securities firms, especially in the event of a significant bear market (e.g. the Great Recession). Therefore, all financial professionals should avoid performance guarantees.
If a registered representative has any issue with their employer, they must follow specific procedures. With the exception of workplace discrimination or sexual harassment, employees are unable to sue the firms they work for. However, they are able to bring them to binding arbitration facilitated by FINRA, which is similar to court (but more efficient and quick). Hopefully, this never happens!
It’s a fairly common practice for broker-dealers to maintain “networking arrangements” with financial institutions (e.g. banks) in order to offer securities to the customers of those institutions. For example, a broker-dealer rents an office at a local bank and sends one of their representatives there to discuss investing in securities with bank customers. FINRA rules require member firms and their registered representatives to follow strict protocols in this setting, as banks typically offer safe and virtually risk-free products (e.g. certificates of deposit that are FDIC insured). And as you already know, the securities offered by broker-dealers always involve some form of risk.
FINRA institutes three primary rules for these networking arrangements. The member firm must:
Be clearly identified as providing broker-dealer services and distinguish its services from the services of the financial institution
The firm and the representative must be 100% clear - their products and services are NOT offerings of the bank.
Conduct its broker-dealer services in an area that displays clearly the member’s name
The member firm and their representative’s name and identification cannot be hidden from sight. The more hidden it is, the more likely a bank customer may wonder if they’re part of the bank or not.
Maintain its broker-dealer services in a location physically separate from the routine retail deposit-taking activities of the financial institution
This rule is simple - keep the broker-dealer’s operations away from the bank tellers.
In addition to these general business practice requirements, FINRA requires specific disclosures to be made to customers engaging the broker-dealer in the bank setting. Known as the “not-not-may” rule, a statement must be made clarifying the products offered by the broker-dealer:
There are some circumstances where the “not-not-may” disclosure is not required to be made:
“Fool me once, shame on you. Fool me twice, shame on me.” As the saying implies, securities regulators generally assume firms and their representatives act in good faith until proven otherwise. If a firm employs a number of registered representatives that previously worked for firms that have been barred from the industry (revoked registrations), they will be required to tape (record) their phone calls with clients.
One of the most significant penalties a registered firm or person can face is revocation of their registration. This means they are no longer registered, generally disallowing any professional participation in the securities industry. Rules or regulations must be broken in a particularly unethical or egregious way in order for FINRA to implement a revocation.
FINRA is concerned the representatives of former firms with revoked registrations have been trained improperly and are more likely to commit future offenses. Firms hiring specific thresholds of representatives from former “offending firms” must record their phone calls. Those thresholds are:
| # of employed reps | # of reps from offending firms |
|---|---|
| 5 - 9 | 40% or more |
| 10 - 19 | 4 or more reps |
| 20 or more | 20% or more |
FINRA does not implement taping requirements for firms with 4 or fewer registered representatives.
To better understand this rule, let’s explore a few examples.
A member firm employs 8 registered representatives. Three of the representatives previously worked for a firm that had their registration revoked due to continually breaking FINRA rules. Is the firm required to record phone calls with clients?
What do you think?
Answer: no
Three out of eight (3/8) employees represents 37.5% of their registered employees. For firms with 5 - 9 registered representatives, phones only must be recorded if 40% or more of their registered representatives previously worked for “offending firms.” Therefore, phone calls need not be recorded.
Let’s do another!
A member firm employs 18 registered representatives. Five of the representatives previously worked for a firm that had their registration revoked due to continually breaking FINRA rules. Is the firm required to record phone calls with clients?
What do you think?
Answer: yes
For firms with 10 - 19 registered representatives, phones must be recorded if 4 or more of their representatives previously worked for “offending firms.” With 5 of these representatives on staff, calls must be recorded.
One last one!
A member firm employs 30 registered representatives. Six of the representatives previously worked for a firm that had their registration revoked due to continually breaking FINRA rules. Is the firm required to record phone calls with clients?
What do you think?
Answer: yes
Six out of 30 (6/30) employees represents 20% of their registered employees. For firms with 20 or more registered representatives, phones must be recorded if 20% or more of their registered representatives previously worked for “offending firms.” With exactly 20% of the registered staff meeting this threshold, phone calls must be recorded.
Firms required to tape their phone calls must retain these files for at least three years, with calls taped within the first two years readily available (meaning they can be quickly turned over to FINRA if requested). FINRA does not require the phone calls to be sent to them, but they do require periodic reports related to the taped calls to be filed quarterly. Additionally, FINRA can request access to these taped conversations if they deem it necessary (usually in response to a complaint filed).
If a member firm is notified by FINRA that they meet “taping firm” thresholds, they have 60 days to implement a recording system with written supervisory procedures. Once implemented, all phone calls with clients (both current and prospective) must be recorded. If the firm wants to avoid the taping requirement, they have 30 days to terminate the required number of representatives previously employed by “offending firms.” Any terminated representative cannot be rehired for a period of 180 days.
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