By Joshua Horn
(Joshua Horn is a partner and co-chair of the Securities Industry Practice at Fox Rothschild in Philadelphia)
A frequent ploy that fraudsters use to perpetrate their deceptive ways is through the use of an outside business of which the member firm was made aware. Although the rules only require a broker-dealer to be made aware of an outside business, broker-dealers should do more when such activities are disclosed, and not stick its head in the sand.
A frequent ploy that fraudsters use to perpetrate their deceptive ways is through the use of an outside business of which the member firm was made aware.Although the rules only require a broker-dealer to be made aware of an outside business, broker-dealers should do more when such activities are disclosed, and not stick its head in the sand.
Of course, any company policy regarding the review and/or approval of outside businesses will be ineffective in uncovering a fraud when the fraudster decides not to reveal the outside business. In that circumstance, a robust compliance program may be the only avenue of protection.
In the event that an outside business is disclosed, however, you need to do more than merely provide a rubber stamp approval when the proposed outside business does not compete or appear to compete with your business. For one, when your registered representatives disclose an outside business, you have to take action to ensure that the outside business is what it was disclosed to be and doing what it was disclosed to be doing.
As part of this process, you must try to determine if the outside business is going to involve firm clients. If so, you will need to do more to ensure that the business is on the up and up.
The safest course would be to forbid the outside business in this scenario, but that may not be practical, especially where a valued representative is engaging in that activity. So what is a firm to do?
Due diligence is the key. The firm must investigate the legitimacy of the disclosed outside business and document that due diligence. If things go south, you have that fully documented and reasonable due diligence to which you can direct your regulator.
There may be no sure fire way to prevent a fraudster from being in your midst, but having a strict policy regarding the review of outside businesses is an effective tool to prevent a fraudster from using this tactic to perpetrate the fraud. Such a strategy may discourage a fraudster from trying to use your firm as the cover for the fraud, altogether. The absence of such a policy, however, could make your firm a tool in a fraud.