The 9% Notes in the Bottom Drawer
Dana R. is a seven-year registered representative in your Cleveland branch. Over the past eight months she has sold three-year promissory notes issued by her brother-in-law's equipment-leasing LLC to six of her retail customers, in amounts from $40,000 to $150,000, roughly $520,000 in total. The notes pay 9%, are personally guaranteed by the brother-in-law, and are not rated. Dana received a 1.5% "marketing fee" from the issuer on each sale. She told no one at the firm, and the notes never appeared on the firm's books or blotters. Yesterday a customer called the branch saying he had not received his last interest payment and asked whether the firm "stands behind" the notes. Dana told the branch manager it was "a family thing, not firm business." The branch manager forwards the call to you, the designated principal.
1. Is Dana's note-selling within FINRA's private securities transaction rules? What facts determine whether it could ever have been approved?
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Start with whether the instrument is a security. A promissory note is a security unless it fits a statutory exclusion - typically short-term, high-quality paper under the Section 3(a)(3) exclusion. A three-year, 9%, unrated note personally guaranteed by an affiliate does not fit; treat it as a security.
Next, FINRA Rule 3280 covers private securities transactions: any transaction in a security outside the regular course of the member's business, and it expressly reaches a rep's participation "for compensation or otherwise." Dana is squarely in it - she sold to firm customers, earned a 1.5% fee, and the firm had no role.
The rule's gate is prior written notice to the firm describing the transaction, her role, and any compensation. The firm then either (a) prohibits the activity, or (b) approves it and records the transactions on its books and supervises them as if they were firm business. Because she took selling compensation and sold to firm customers, the record-and-supervise branch is the only viable approval path - and she never gave notice, so neither happened. Separately, Rule 3270 requires notice of the outside business activity, and Rule 2010 supplies the general standard. The missed interest payment means the analysis cannot stop at registration: assess whether the issuer is solvent or the scheme is fraudulent.
2. What are your immediate supervisory steps in the first 72 hours - with respect to Dana, the six customers, and the records?
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Sequence matters, and the safety of customer assets outranks protecting the rep.
Dana. Immediately instruct her in writing to stop soliciting or accepting any further note purchases and to make no unilateral contact with the six customers about the notes. Do not let her review her own book or email during the inquiry. Pull her firm email, outside account statements, and any calendar or texts available under firm policy, and preserve everything. Do not tip her off to a regulatory referral.
Scope. Build a written list of every purchaser - including non-customers and anyone whose money came from a firm account. Ask the issuer for a full investor list, and compare. Identify whether the missed payment is isolated or the first of many.
Customers. Have a principal, not Dana, call each one with a scripted conversation: confirm what was purchased, where the money came from, what was said about firm backing, and whether they want to file a complaint. Log every call. Evaluate whether reimbursement is warranted.
Escalate. Notify compliance and counsel the same day; consider whether a SAR is required (and if so, keep it confidential), whether state adult-protective or elder-exploitation reporting applies, and whether the firm must self-report.
3. What reporting obligations are triggered, and what determines whether Dana stays employed?
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Reporting follows the facts, not the calendar - and several obligations run on short clocks.
Form U5. If Dana is terminated for cause, or permitted to resign while under investigation, the firm must file a U5 disclosing the circumstance within 30 days of the termination. The reason language should be factual, not conclusory, because it will be tested in arbitration.
Form U4. Any answer that becomes inaccurate must be amended promptly - generally within 30 days of learning the facts - so if she is charged, enjoined, or becomes the subject of a regulatory action, the U4 changes too.
Rule 4530. Reportable events include certain findings and violations and, notably, customer complaints alleging theft, misappropriation, or forgery. A suitability or "where is my interest payment" complaint ordinarily is not itself reportable, but confirm the current text of Rule 4530 and the firm's WSPs, because FINRA has amended the rule's reporting categories over time.
Employment decision. Selling away with compensation is typically a terminable offense - the firm's own WSPs almost certainly prohibit unapproved private securities transactions. Document the investigation before acting, and let counsel confirm whether immediate suspension or termination best protects customers. Continue supervising her if she remains registered.