What Is Selling Away in Finance and How Does It Work?

Selling away is a term in the financial industry describing brokers selling securities not approved by their broker-dealer. This practice exposes investors to significant risks and legal complications, making it crucial for both investors and professionals to understand its implications.

Common Setups that Involve Unapproved Sales

Unapproved sales often arise when brokers, motivated by higher commissions or personal relationships, conduct transactions outside their broker-dealer’s oversight. These situations frequently involve brokers promoting investments promising high returns but lacking the necessary vetting and approval from their affiliated firms. Brokers may bypass due diligence processes mandated by their broker-dealer when they have personal connections to the issuers of these securities.

One common scenario involves brokers selling private placements or alternative investments that are not registered with the Securities and Exchange Commission (SEC). Marketed as exclusive opportunities, these products attract investors seeking diversification or higher yields. However, the lack of registration and oversight increases risks, including illiquidity and potential fraud. Brokers may present these opportunities as innovative or emerging market investments, but without broker-dealer approval, investors lose the protection of regulatory scrutiny.

In some cases, brokers exploit regulatory exemptions like Regulation D, which permits certain private offerings to bypass SEC registration. Although these exemptions have specific requirements, brokers who fail to comply risk severe penalties. The Financial Industry Regulatory Authority (FINRA) monitors such activities, imposing fines and suspensions on brokers engaging in selling away.

Broker-Dealer’s Role

Broker-dealers oversee the activities of their associated brokers to ensure compliance with regulatory standards and internal policies. They provide infrastructure for trade execution, compliance oversight, and risk management, protecting investors by ensuring that approved securities undergo rigorous vetting.

To deter unauthorized sales, broker-dealers implement robust compliance programs adhering to the Securities Exchange Act of 1934 and FINRA rules. These programs include mandatory training, regular audits, and stringent approval processes for new products. By swiftly identifying and addressing deviations from established protocols, broker-dealers safeguard their reputation and their clients’ interests.

Types of Securities Involved

Securities involved in selling away often fall outside the traditional offerings approved by broker-dealers, including private placements, alternative investments, and unregistered products. Each carries unique risks and regulatory considerations.

Private Offerings

Private offerings, often structured under Regulation D of the Securities Act of 1933, allow companies to raise capital without SEC registration if they meet specific criteria. For example, Rule 506(b) permits sales to accredited investors and a limited number of non-accredited investors, while Rule 506(c) allows general solicitation but restricts sales to accredited investors only. The lack of SEC registration means these offerings are not subject to the same disclosure requirements as public offerings, increasing the risk of inadequate information. Brokers engaging in selling away may exploit these exemptions to bypass their firm’s due diligence. Investors face risks like illiquidity and the absence of secondary markets, complicating exit strategies and valuation assessments.

Alternative Investments

Alternative investments such as hedge funds, private equity, and real estate investment trusts (REITs) are also commonly linked to selling away. These investments promise higher returns and diversification but come with increased complexity and risk, including limited transparency and higher fees. For instance, hedge funds may use leverage and derivatives, amplifying both gains and losses. Brokers may present these investments as exclusive opportunities, but without broker-dealer approval, investors miss out on thorough vetting and compliance checks. Investors must conduct their own due diligence, examining factors like fund performance, management experience, and fee structures.

Unregistered Products

Unregistered products, including promissory notes, viatical settlements, and certain cryptocurrency offerings, are particularly vulnerable to selling away practices. These products are not registered with the SEC, either due to exemptions or the issuer’s failure to comply with registration requirements. The lack of registration heightens risks of fraud and misrepresentation. For example, promissory notes, marketed as low-risk investments with high returns, often lack collateral and carry significant default risk. The SEC has issued warnings about fraudulent schemes involving unregistered products, urging investors to verify the legitimacy of offerings and seek independent legal and financial advice.

Example Scenario

Consider Sarah, a financial advisor at a boutique investment firm, who is approached by a friend launching a tech startup in need of capital. The friend offers Sarah a commission to help sell shares of the startup. Intrigued by the potential earnings, Sarah agrees without informing her firm.

Sarah pitches the startup’s shares to several high-net-worth clients, emphasizing its growth potential. Trusting Sarah’s judgment, these clients invest significant sums. However, the startup lacks a solid business plan and struggles to meet projections, leaving investors exposed to substantial risk.

During a routine audit, Sarah’s firm uncovers her unauthorized actions and reports the incident to authorities, leading to an SEC investigation. Sarah faces disciplinary action, including potential financial penalties and suspension, while her clients grapple with possible financial losses.