What is Selling Away?
Selling away refers to a situation where your broker or financial advisor offers you investment products that are not approved or even known by their firm. For example, let’s say you have an account with one of the big brokerage companies like Charles Schwab. Your broker there, let’s call her Ann, recommends that you invest in some new cutting-edge blockchain company through a private sale. This opportunity is not one that Charles Schwab officially offers to its clients. If you went ahead with Ann’s recommendation, that would be a case of her “selling away” from what her company approves.
Selling away violates internal compliance rules at most financial firms. According to FINRA rule 3040, registered brokers cannot sell securities away from their member firm unless explicitly authorized to do so. Essentially, selling away happens when your broker bypasses all the due diligence and vetting processes that their company normally requires. This exposes you to higher risks since the investment could be something sketchy that is being peddled to score quick commissions.
Now that we know what selling away entails, let’s look at some motivations that could prompt financial advisors to sell away and what that means for investors like yourself. This will help you make more informed decisions if such situations ever come up.
Why Selling Away Occurs
There are a few reasons why a broker may sell away despite company policies forbidding it:
Bypassing Compliance Requirements
Every brokerage firm and investment company maintains an internal compliance team whose job is to vet investment products before allowing advisors to sell them to clients. The compliance team checks for red flags around returns being promised, transparency of holdings, regulatory issues, etc. This process can sometimes stop advisors from selling certain products that may pay them higher commissions. Selling away allows brokers to bypass compliance requirements and sell clients products directly that the company would likely not approve.
Generating Higher Commissions
Many alternative investments like private equity offerings tend to come with higher fees and payouts for the selling broker. Your trusted Charles Schwab advisor Ann may come across one such private real estate fund not available on the Charles Schwab platform. By selling you units privately outside of her company oversight, Ann stands to gain higher personal commissions.
Pleasing High Net Worth Clients
Large private banking clients often demand access to exotic investment opportunities that a standard wealth management firm cannot offer. For such high net worth individuals, brokers sometimes breach internal rules in order to please them and retain their business. This still constitutes selling away though and exposes the client to undue risk.
Hiding Activities from the Firm
Dishonest brokers engaging in fraudulent behavior often sell away to avoid detection. Many Ponzi scheme cases reveal that the perpetrators used selling away to hide their activities and avoid leaving a money trail inside their brokerage firm.
These reasons provide context on what drives the selling away phenomenon. Now let’s look at why it is dangerous from an investor’s perspective.
Risks and Issues with Selling Away
Selling away comes with several risks for retail investors:
No Due Diligence on Investment Products
When your brokerage firm signs off on an investment product, it is because their analysts have researched the product thoroughly first. This “due diligence” provides assurance that your advisor is not peddling some scam investment just to make commission dollars. By selling away, your broker removes this layer of protection and exposes you to riskier investments. In some cases, clients have lost life savings when brokers sell fraudulent or failing products away without telling them the truth.
Lack of Transparency and Oversight
Investments sold away often happen without documentation or disclosure since the selling broker wants to avoid detection. In such cases, you may struggle to find out basics like what fees were charged or where your money was sent for the investment. This lack of transparency makes it much harder to track issues and seek accountability later if things go south.
Investments Can Be Misrepresented
Unethical brokers selling away have incentives to mislead clients about the risk and return profiles of the products they peddle. Many clients report only realizing after massive losses that the investments were far riskier than originally communicated by the broker. Internal compliance helps reduce misrepresentations since advisors know their claims will be verified. But in selling away scenarios, such protections are missing.
Facilitates Fraud
Selling away has been closely linked to brokerage fraud in many court cases that led to client losses. Fraudsters use it as a technique to cover their tracks so that their employer’s monitoring systems don’t catch shady account activity associated with the external investment scheme. Typically, selling away schemes collapse at some point, leaving clients high and dry. According to FINRA arbitration data, selling away violations have been consistently on the rise in recent years.
Hopefully you now have more insight into what selling away means and the mechanics and motivations behind it. Now let’s move on to understanding consequences brokers face and how investors can best protect themselves.
Consequences and Reporting in Selling Away Cases
Brokers face stern penalties, including legal prosecution, if regulators find they have engaged in selling away:
- Disciplinary action or being fired: Financial firms maintain an ethical code and standards that prohibit selling away due to its risks. Brokers who breach this can face internal disciplinary proceedings and even termination of employment depending on case severity.
- Fines and sanctions: Industry regulators like FINRA maintain rules explicitly forbidding selling away practices unless disclosed properly to all parties. Rule 3280 superseded the older Rule 3040. Financial advisors caught violating these rules can face steep fines starting from $5,000 and going up based on scope of infractions. Serious or repeat offenders may also be temporarily sanctioned or barred from practicing.
- Firm liability due to inadequate supervision: According to Rule 3040, firms must formally approve or at least document that an advisor notified them of intentions to sell an unapproved product. Without this paper trail, firms can face charges that they failed to supervise advisor activities adequately. FINRA 4530 mandates reporting of all advisor rule violations to regulators within 30 days. Intentional selling away schemes often point back to deficiencies in how firms govern advisor conduct.
So adequate deterrence does exist to discourage widespread selling away malpractice. But what can you do as an investor to avoid falling prey yourself?
Is Buying a Country Considered “Selling Away” in Investment?
When it comes to investment, the cost to buy a country can be a significant consideration. However, it’s important to understand the legal and ethical implications. While buying a country may not be considered “selling away” in investment, it’s crucial to navigate the complexities of such a substantial purchase carefully.
How Investors Can Protect Against Selling Away
The simplest protections include:
- Conduct advisor background checks: Look into your financial advisor’s employment history, credentials, regulatory record, online reviews from other clients etc. before establishing a relationship. Dubious red flags include switched jobs frequently, past sanctions on record or client accusations around selling away previously. Routine background verification makes it less likely you choose an unethical advisor.
- Avoid recommendations for outside investments: Stick to investment products offered through your advisor’s firm platform for account. If they push you to invest into opportunities from external contacts not formally approved or offered by their company, be very wary of those recommendations. Politely decline such proposals.
- Seek legal assistance immediately if fraud occurs: If you unfortunately already lost significant capital after your broker sold you away on what turned out to be a fraudulent vehicle, consult an investor attorney right away. Lawyers can help determine if grounds and precedent exist to recover some portion of lost investments. Time is of essence usually, so engage qualified legal counsel quickly after discovering losses from potential selling away violation involving your financial advisor.
Final Thoughts
Selling away constitutes any investment recommendations you receive from an employed financial advisor directing you beyond what their own company allows them to sell officially. While sometimes done only to generate higher commissions or please prized clients, selling away has also facilitated some of history’s worst Ponzi schemes and frauds within the retail investor brokerage ecosystem.
As the classic saying goes, an ounce of prevention beats needing a pound of cure. This is why learning the intricacies around this risky concept is important even though likelihood of experiencing it firsthand seems slim. Forewarned is forearmed when next your broker tries convincing you to trust their hot new private stock tip or crypto project. Stay vigilant for red flags and steer clear of advisors attempting to sell away. Your hard-earned capital deserves that prudence always.