Some recent Securities and Exchange Commission (SEC) actions should be carefully reviewed by issuers, funding platforms and portals as they provide stark warning to those who sell securities over the internet but who do not comply with the federal securities laws.

Unregistered Broker-Dealer Sanctions, Yet Another Example

In my last regulatory action update, I discussed SEC Chair Mary Jo White’s keynote address at the 47th Annual Securities Regulation Institute on October 28, 2015.  Chair White alerted the industry that unregistered broker-dealer activity is a top priority for the SEC’s Division of Enforcement.

On December 7, 2015, her assertion was verified when the SEC announced that it had charged lawyers and law firms involved in EB-5 transactions with acting as unregistered broker-dealers.   (See, Press Release, Lawyers Offered EB-5 Investments as Unregistered Brokers, 2015-274, at ).  While not specifically involving the JOBS Act industry, the SEC analysis and the lessons to be drawn from it are instructive.  Notably, while one case did involve outright fraud, the bulk of the actions did not, thus highlighting that unregistered broker-dealer activity even without fraud is a priority area for the SEC. Indeed, if individuals like lawyers can be adjudged to be unregistered broker-dealers, it seems relatively easy for the SEC’s analysis to be applied to funding platforms and other internet offerors of securities.

The SEC action was largely based upon the fact that the lawyers, in addition to their legal fees, were receiving remuneration for selling EB-5 securities which constituted transactional based compensation, and was paid only when the attorney successfully sold securities to an investor.  Transaction based compensation has always been clear cut unregistered broker-dealer activity.  But the SEC found other troubling facts too, including that the attorneys were recommending securities to their clients, acting as liaison between the investment offeror and their client-investors, and facilitating the transfer of investment funds, all without a broker-dealer license.

Section 3(a)(4)(A) of the Exchange Act generally defines a broker broadly as any person engaged in the business of effecting transactions in securities for the account of others. Individuals or entities who participate in important parts of a securities transaction, including solicitation, negotiation, or execution of the transaction, or who are otherwise engaged in the business of effecting or facilitating securities transactions, may be required to register as a broker-dealer.  Receiving transaction based compensation, or compensation that is related to the outcome or size of the transaction, is clear cut indicia of broker-dealer activity.  As the respondents and practitioners did not comport their activities to the securities law, they were deemed to have acted as unregistered broker-dealers in violation of Section 15(a)(1) of the Exchange Act.

They were ordered, without admitting or denying the SEC’s findings, to cease and desist from acting as unregistered brokers, together with disgorgement of the money they earned (aka “profits” in regulatory-speak), prejudgment interest and a monetary penalty.  An Austin, Texas-based attorney and his law firm were jointly and severally ordered to disgorge $30,000, the amount of commissions earned, prejudgment interest of $2,965, and a penalty of $25,000.  (See )  A Florida-based attorney and his law firm, were ordered to pay disgorgement of $228,750, together with prejudgment interest and a monetary penalty.  (See ) Five other lawyers and their law firms were also charged and received similar penalties.  The SEC noted these penalties included consideration that each party cooperated and agreed to enter into early discussions with staff to resolve the SEC investigations, thus suggesting perhaps much higher penalties were in store for those who choose not to cooperate and are found to have violated Section 15 of the Exchange Act.

Conculsion: As internet platforms and other offerors of securities can be construed to be functioning as unregistered broker-dealers, take appropriate steps to protect yourself, including using a registered broker-dealer such as FundAmerica Securities to execute the securities transactions, and structuring your compensation in manner that is not tied to the size or success of a securities transaction or offering.

Does this mean that funding platforms have to become broker-dealers or employ registered representatives directly? Not necessarily, see my previous article on “Do funding platforms under Title II of the JOBS Act have to become broker-dealers?

An SEC investigation and enforcement action against a small business is frequently a harbinger of the end. Even if you’re right, the costs of defending yourself and complying with endless legal requests is usually more than enough to shutter a small company.  Plan ahead and make sure you comply with the law to protect the company you are dedicating yourself to build.

About Scott Andersen:
Scott is principal at and General Counsel of FundAmerica.  He was most recently the Deputy Regional Chief Counsel at FINRA, and prior to that was the Enforcement Director at FINRA and the NYSE, Co-Chief of the Securities Prosecutions Unit of the NY Attorney General’s office, and Asst. Attorney General for the State of NY.  He investigated, prosecuted and supervised criminal, civil and regulatory enforcement actions for over 19 years.  He concentrates his practice on SEC and FINRA regulatory defense and securities regulatory counseling.

The information and materials in this article are provided for general informational purposes only and are not intended to be legal advice. The issues discussed include complicated areas of law and legal advice should be obtained from a securities attorney about your specific circumstances.