Selling Away: Understanding Conflicts of Interest in Investing

Selling away is an inappropriate practice by an investment professional – such as a financial adviser or stockbroker – who sells or solicits a client to purchase securities not approved by the brokerage firm with which he/she is affiliated.

Generally, brokerage firms keep a list of approved securities products that their stockbrokersStockbrokerA stockbroker is a regulated representative of the financial market who enables the buying and selling of securities on behalf of financial can sell to clients on the firm’s behalf. The list of products offered comprises different types of investments analyzed during the due diligence process and with the appropriate risk and compliance approvals.

In the case of selling away transactions, the securities in question are not on the firm’s list of approved products, and when a stockbroker engages in such a practice, they violate securities regulations. Such activities are dangerous for investors since they are exposed to the risk of securities fraud, theft, and other losses.

Before marketing securities, stockbrokers operating in the United States are required to have obtained the required securities licenses before engaging in brokerage activities. For example, they must obtain a license by passing the FINRA exams such as the Series 6 and Series 7Series 7 ExamThe Series 7 Exam is formally known as the General Securities Representative Examination, and it is administered by the Financial Industry Regulatory exams.

Summary

• Selling away occurs when a stockbroker sells or solicits a client to purchase securities or investment products that are not approved by the associated brokerage firm.
• Brokerage firms have a list of approved products that have been analyzed, screened for due diligence, and identified as solid products that can be offered by their brokers to the firm’s clients.
• If a broker sells products that are outside the firm’s list of approved products, he/she is in violation of securities regulations.

Understanding Selling Away

Selling away transactions often involve non-public investments such as private placements and promissory notesPromissory NoteA promissory note refers to a financial instrument that includes a written promise from the issuer to pay a second party – the payee –, though it may vary. While such transactions may not be intended to deceive or defraud an investor, they occur when a broker solicits a client without the approval of the brokerage with which they are associated. Most often, the transactions are conducted with the broker’s external business activities that are separate from the brokerage activities of their associated firm.

Brokers sometimes engage in selling away transactions with the goal of hiding their commission earned from their associated firm on an investment that a solicited client is willing to buy. The broker may also be eager to earn a commission for non-public security and keep the client happy.

Non-public securities are subject to limited oversight compared to public securitiesPublic SecuritiesPublic securities, or marketable securities, are investments that are openly or easily traded in a market. The securities are either equity or debt-based., and brokers may be tempted to pursue such transactions as separate transactions from the brokerage firm’s activities.

How Selling Away Works

Selling away takes place when a financial advisor or stockbroker sells investments that are outside those that his/her associated firm has analyzed and approved for sale to the public. As a result, such transactions are excluded from the account records of the brokerage firm. Such investments are sold as private deals that an investor may be unaware that the brokerage firm is not aware of such a transaction, and there is no risk disclosure material as is the case with products in the list of approved products.

In addition, the firm’s risk and compliance departments, which are required to perform due diligence on an investment before it is approved, have not reviewed or approved the products recommended by the broker.

Selling away violates FINRA Rule 3040, which prohibits registered representatives from selling away from the member firm unless they’ve been formally authorized to carry out the sale. The rule also required such persons to provide a written note of the proposed transaction to the member firm to receive approval before the sale is executed. They must also disclose any compensation received from the transaction.

Brokerage firms are required to supervise their affiliated brokers to ensure they comply with the applicable laws. If the brokerage firm does not perform its supervisory roles, they violate FINRA Rule 3110, which requires broker-dealers to adopt written supervisory procedures to enforce compliance.

Securities Frequently Linked With Selling Away Transactions

1. Private placement

Private placements are risk securities transactions that are only sold to a small class of qualified investors. Usually, such transactions are required to go through a standard public offering. Ordinary retail customers do not qualify to participate in private placements due to their perceived high risk.

2. Promissory notes

A promissory note refers to a type of loan product that businesses use to raise funds for a specific project. They are generally private investments that carry considerable risks, and the material risks and other important details may not be available to the ordinary retail investor. If such investments do not go through the due diligence of a brokerage firm’s compliance department, they may be used inappropriately as a conduit for fraud.

3. Real estate deals

While real estate-related investments are considered to be safer than other investments, real estate deals in sell away transactions may not involve the level of security represented at the time of sale.

For example, a real estate investment trustReal Estate Investment Trust (REIT)A real estate investment trust (REIT) is an investment fund or security that invests in income-generating real estate properties. The fund is operated and owned by a company of shareholders who contribute money to invest in commercial properties, such as office and apartment buildings, warehouses, hospitals, shopping centers, student housing, hotels or other real estate deals sold without the oversight of the brokerage firm may expose potential investors to a high risk of theft and even fraud.

4. Unusually high returns

If an investment product appears too complex to comprehend and promises unusually high returns that are above the market rate of returns, it should raise a red flag. If a brokerage firm’s not reviewed and approved the securities transaction, the transaction is too good to be true.

5. Guarantee

There is no legitimate investment product that guarantees investors a return on their investment. If a product is marketed as a guaranteed winner with no chance of loss, then it should sound an alarm.

Additional Resources

CFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™Program Page - CBCAGet CFI's CBCA™ certification and become a Commercial Banking & Credit Analyst. Enroll and advance your career with our certification programs and courses. certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

• Commercial Insurance BrokerCommercial Insurance BrokerA commercial insurance broker is an individual tasked with acting as an intermediary between insurance providers and customers.
• Financial Industry Regulatory Authority (FINRA)Financial Industry Regulatory Authority (FINRA)The Financial Industry Regulatory Authority (FINRA) acts as a self-regulatory organization for securities firms operating in the United States.
• Due DiligenceDue DiligenceDue diligence is a process of verification, investigation, or audit of a potential deal or investment opportunity to confirm all relevant facts and financial information, and to verify anything else that was brought up during an M&A deal or investment process.  Due diligence is completed before a deal closes.
• Fraud TriangleFraud TriangleThe fraud triangle is a framework commonly used in auditing to explain the reason behind an individual’s decision to commit fraud. The fraud