From: Michael Gibson
Date: Fri, 1 Apr 2011 at 1:29pm
Hello to all. Some of you will have already seen this post, but some may not have, so I am including all and would ask that comments be posted here so that we can keep our discussions on securities related issues confined to one message board. I have listed a series of questions which I feel would be helpful to address in the IIUSA panel discussion in DC and would ask that everyone associated with either the Panel or the Securities Sub-Committee please comment and add any other issues that they feel the panel should address that may be of concern to all here.
Questions that believe the audience would like feedback on and from those who will be speaking and that understand SEC / USA (Blue Sky) regulations and guidance:
1. How are fees paid to unregistered persons in the connection of the sale of a U.S. securities viewed?
2. Do U.S. laws differentiate between fees paid to U.S. versus non-U.S. non-registered persons?
3. What factors would cause an an issuer to grant rescission rights to an investor?
4. What constitutes fraud in the connection with the solicitation and sale of a security?
5. Can non-registered persons (ie. attorneys) have their clients sign disclaimers which waive their clients rights when the seeking relief should advice given by the non-reg. person be misleading or incomplete?
That is, many of our immigration attorney members give advice to their clients on which project to invest in (security to purchase) and then have their client sign a disclaimer that no advice was given and the client looses their right to sue the attorney in the event that the investment fails to produce the results projected on information given. Is this allowed? Can clients loose the ability to sue if they have signed waivers with non-registered persons in the connection of the sale of a security?
some of these issues as addressed in this article:
Consequences of violating Section 29 By Rachael E. O'Beirne, Joseph W. Bartlett and Jonathan G. Kortmansky, Sullivan and Worcester Share E-Mail Return To Full Story
Published May 10, 2010 at 9:55 AM
A "finder" is a loosely defined term for an unregistered intermediary who helps arrange private placements.
Finders bring investors and issuers together using their contact lists, but their services are limited; unlike full service broker-dealers, they do not deal in retail trades, underwrite flotations, handle customer calls, publish analysis or manage investments under federal and/or state laws. However, finders' activities often fall within the Securities and Exchange Commission staff's interpretation of the definition of a broker-dealer in Section 15 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), which requires all persons in the business of effecting transactions in securities to register with the SEC. Using an unregistered broker to facilitate a deal poses significant risks to all parties involved.
Over the past few years, these risks have increased and have now, apparently, reached an inflection point. The three major issues that can arise from using an unregistered broker are: (i) the contract between the unregistered agent and the issuer can be declared void, (ii) the unregistered agent may face regulatory action by the SEC and state authorities and (iii) the issuer may face private actions by investors seeking to rescind their purchases and recover their investments. While the first two issues have been widely recognized, the third issue raises new, unanswered questions that are ripe for discussion.
Advice from regulators and recent court decisions can be read to suggest that the use of unregistered brokers will cause the company to be liable as aiders and abettors of securities laws violations under Section 20(e) and 29(b) of the Exchange Act. Additionally, Form D has for some time required disclosure of the name and CRD number of any person who was paid a fee in connection with the sale of securities, enabling the SEC and state regulators to easily track the use of unregistered brokers; the latest change is that Form D must now be filed online, meaning in turn that all hands, including regulators and potential plaintiffs, can have a bird's-eye view.
In the current economic climate, disappointed investors have increased incentives to bring private actions against issuers to rescind their investments based on a violation of 29(b) of the Exchange Act, arguing the issuer was complicit in the unregistered broker's statutory violation. The broad language of 29(b), along with the three year statute of limitations, creates a window for unsatisfied investors to discover the use of an unregistered broker and rescind their contracts and recover their funds by unwinding the purchase of securities placed by an unregistered person or entity.
Recent SEC enforcement of broker registration raises the intensity of this issue, and the Financial Industry Regulatory Authority has proposed rule 2040, which also addresses payments to unregistered persons. In addition, there has been proposed legislation that would overturn the effects of both Central Bank of Denver NA v. First Interstate Bank of Denver NA, 511 U.S. 164, 191 (1994) and Stoneridge Investment Partners LLC v. Scientific-Atlanta Inc., 552 U.S. 148, 159 (2008). The proposed legislation would extend liability to those who aid and abet violations of securities laws, (who previously did not fall within §10(b)) by amending the Exchange Act to authorize a private right of action for aiding-and-abetting liability. Senator Christopher Dodd, D-Conn., has proposed a similar amendment to the Exchange Act as part of the Restoring American Financial Stability Act of 2009, which would also allow plaintiffs to pursue secondary actors. Each bill can be seen as an implication that the current climate may be ripe for a judge or jury to find for a plaintiff and award rescissionary damages in a case where an issuer knowingly hired and used an unregistered finder.
Furthermore, state securities laws grant investors additional rights. For example, in California, Section 25501.5 of the Corporate Securities Law provides, in part, that a person who purchases a security from or sells a security to a broker-dealer required to be licensed but which has not, at the time of the sale or purchase, secured from the commissioner a certificate authorizing the broker-dealer to act in that capacity, may bring an action for rescission of the sale or purchase or, if the plaintiff or the defendant no longer owns the security, for damages. In fact, six state statutes contain voidability provisions, all of which specifically give a right of rescission to the buyer. Four states make any sale made in violation of any provision of the Blue Sky statutes voidable. Arizona limits its voidability provision to the sale of unregistered securities, transactions by unregistered dealers or specified fraudulent practices; Florida and Illinois grant rescission as a remedy to a violation of registration provisions of the securities dealer, associated person and investment adviser. The growing risks have been highlighted in a series of articles published in VC Experts Buzz of the Week (http://vcexperts.com/vce) written by Sullivan & Worcester LLP of counsel Joseph Bartlett, a member of the American Bar Association Task Force on Private Placement Broker-Dealers. The articles trace a number of events, culminating in the current status, whereby the SEC and state securities regulators are closely monitoring the activities of non-exempt unregistered brokers and are no longer turning a blind eye to their activities. These actions are sometimes connected to the "pay to play" scandals in New York, New Mexico and Illinois, which have highlighted the need for finders to be regulated in order to protect investors' interests. Is rescission the appropriate remedy for a violation under 29(b)? The absence of case law on this issue could be interpreted to mean that the use of an unregistered broker, unaccompanied by fraud, does not directly trigger rescission rights. On the other hand, the topic of unregistered broker-dealers has been attracting attention in a variety of ways recently: the pay-to-play scandals have increased awareness of the negative effects of unregistered finders; the requirement of a CRD number on Form D facilitates enforcement; and the SEC's enforcement proceedings demonstrate an increased push to enforce registration requirements.
The lack of precedent may merely reflect that the tipping point has not yet been reached, but the current environment is ripe for a judge or jury to see the violation under a new light and award rescissionary damages to misled investors. Joseph W. Bartlett, of counsel in Sullivan & Worcester's New York office, is a member of the corporate department. Rachael E. O'Beirne is a real estate associate in the firm's Boston office. Jonathan G. Kortmansky is a New York-based partner in the firm's litigation practice. Do our panel and securities sub-committee members have any comments that they can make to help our educate our members on these issues? Delete Michael Homeier Fri, 1 Apr at 2:34pm The article's definition of a finder as "not dealing, underwriting, analyzing, and managing" is technically accurate, but not "plain English" enough to be really helpful for our regional center principals. We advise folks in more prosaic terms, that bottom-line, a finder makes an introduction, and that's it - she or he does nothing further: doesn't sell, doesn't help cement a relationship, doesn't negotiate terms - just makes the initial intro. Classically, finders cannot be paid on a "success" basis, nor on a transaction-related basis (percentage of money raised) - just lump sum for an introduction or periodic payments (monthly, semi-annually) for marketing services under contract. Just as simply, brokers and dealers must be registered; finders need not. (The article's citation of "unregistered finder" is thus a misnomer.) The crux of determining whether someone was a BD versus a finder is entirely fact-specific and therefore case-by-case (which makes it problematic to predict). Yet all the other points raised in the article, and the conclusion that the current climate leans toward increasing enforcement/litigation, is certainly well-founded. So some abbreviated answers to the questions from my perspective:
1. Fees are paid as with broker/dealers, almost always per a written contract providing for payment per investor successfully sourced and often in relation to the amount raised (even if framed as number of investors sourced). Transaction- and success-based compensation supports a determination of brokering, not finding.
2. U.S. laws don't differentiate, in that they regulate issuers, who are all U.S. persons (artificially created as entities under state law) regardless of the country source for the investors. Hence the focus on the issuer filing Form D and reporting to whom the issuer pays fees. Under Reg D, the SEC is regulating the issuer's conduct.
3. An issuer would grant rescission rights to an investor, not voluntarily, but by "operation of law": the investor(s) would sue claiming the right to recission, and if the issuer loses the case, must then grant recission to the investor. Dangerously, recission is an alternative remedy - if it would not "fix" the investor's injury, the investor could get monetary damages instead (and possibly equitable relief such as an injunction)
4. Fraud in a securities transaction is the misstatement, or omission, of a material fact. "Material" is defined as "anything an ordinarily prudent investor would consider important in making a fully-informed investment decision" - broad enough to drive a house through. Such an objective standard sets up issuers for a very tough defense. Worse, it's an "after-the-fact" determination - Monday-morning-quarterbacking at its worst. This is why PPMs are so important: properly drafted, they convey the disclosure of all material information (the good, the bad, and the ugly) in order to protect the principals from just such attack.
5. I'm confident that a disclaimer would be unenforceable (an investor can't be bound by such a disclaimer), deemed void as against public policy - enforcement would frustrate the securities laws' protective purpose. It's extremely problematic for our immigration attorney friends to hold themselves out as, in effect, investment advisors (unregistered, too - ahem), as they're opening "Pandor'a s Box" - they're just setting themselves up for a damaged (or lost) relationship - and possibly a lawsuit - for involving themselves in an investor's investment decision that goes sour. Broker/dealers are required to register, because they hold themselves out as able to offer expert advise. Which gets us full circle back to the broker/dealer liability issue. Delete John Braddock Fri, 1 Apr at 2:38pm via email Responses to these questions are a bit too varied and lengthy to respond here in writing. But, we can discuss these during our call next week and sort out who us responsible for addressing which topics.
John C. Braddock Managing Partner Broad Oak Group U.S. Mobile: 917-940-6550 Skype: john.c.braddock
www.broadoakadvisors.com www.broadoakmanage.com www.broadoakasiapacific.com
http://eb5info.com/firms/112-broad-oak-management-llc (U.S. securities registrations held by PIN Financial, LLC, a FINRA-member firm, New York City, www.pinfinancial.com) Delete David Andersson Fri, 1 Apr at 2:55pm via email
Excellent points well expressed. While we have been focusing on wayward immigration attorneys over the past year or so – I would also like to see some more focus, especially in May, on regional center issuer liability. Directors and officer’s liability. SEC criminal sanctions against issuers – what is the bright line that must not be crossed? Delete John Braddock Fri, 1 Apr at 3:46pm via email Possible investment banking practitioner “solutions” for RC’s and issuers: 1) due diligence research, improvement, and preparation in order to high grade projects 2) finders fee agreements & consulting agreements 3) steps yo take to back out and cure early non-compliance and get on the right regulatory track 4) RC websites: keep it simple: remove photos of politicians, intellectual property violations, offering details, solicitations 5) avoiding general solicitations 6) proper financial, business, industry, and USCIS risk disclosure 7) comparison: pros & cons of Reg S and Reg D offerings 8) sales practices; tight control of offering and subscription materials and investor meetings/discussions 9) possible mechanisms for paying migration brokers (e.g., segregated funds from investors; consulting fee arrangements; finders fee agreements in limited situations) 10) accessing investors from financial institutions instead of migration brokers; possible only with B-D regulatory compliance in US and compliance with securities laws in foreign markets; lower fees and control of sales process produces better economics 11) the importance of SEC/FINRA compliance to future project monetization event(s): buyout of investor assets after I-829 petition by institutional or other buyer(s) and allow payday to issuer/regional center is facilitated with regulatory compliance from day-1 12) non-EB-5 funding surrounding EB-5 capital raise is big opportunity to build the “capital stack” which is aborted if EB-5 and RC marketing, management, and reporting process is not SEC/FINRA compliant
John C. Braddock Managing Partner Broad Oak Group U.S. Mobile: 917-940-6550 Skype: john.c.braddock
www.broadoakadvisors.com www.broadoakmanage.com www.broadoakasiapacific.com www.jcbraddock.com
http://eb5info.com/firms/112-broad-oak-management-llc (U.S. securities registrations held by PIN Financial,LLC, a FINRA-member firm, New York City, www.pinfinancial.com)
Delete Michael Gibson Fri, 1 Apr at 4:05pm
Good point, after all, this is a trade organization of Centers and I agree that we should focus our efforts and comments on the responsibilities of our Center members. If they follow best practices as outlined by our Panel of experts then that will flow downstream to the practitioners who are also our members.
Delete John Braddock Fri, 1 Apr at 4:24pm (re-posted to committee site)
Possible investment banking practitioner "solutions" for RC's and issuers:
1) due diligence research, improvement, and preparation in order to high grade projects
2) finders fee agreements & consulting agreements
3) steps to take to back out and cure early non-compliance and get on the right regulatory track
4) RC websites: keep it simple: remove photos of politicians, intellectual property violations, offering details, solicitations
5) avoiding general solicitations
6) proper financial, business, industry, and USCIS risk disclosure
7) comparison: pros & cons of Reg S and Reg D offerings
8) sales practices; tight control of offering and subscription materials and investor meetings/discussions
9) possible mechanisms for paying migration brokers (e.g., segregated funds from investors; consulting fee arrangements; finders fee agreements in limited situations)
10) accessing investors from financial institutions instead of migration brokers; possible only with B-D
regulatory compliance in US and compliance with securities laws in foreign markets; lower fees and control of sales process produces better economics
11) the importance of SEC/FINRA compliance to future project monetization event(s): buyout of investor assets after I-829 petition by institutional or other buyer(s) and allow payday to issuer/regional center is Facilitated with regulatory compliance from day-1
12) non-EB-5 funding surrounding EB-5 capital raise is big opportunity to build the "capital stack" which is
aborted if EB-5 and RC marketing, management, and reporting process is not SEC/FINRA compliant
Delete Michael Gibson Fri, 1 Apr at 4:58pm
This article may be of interest to us trying to find a bright line as per Michael and David's comments above,
issued by the ABA in 2005 that addresses the issue of "finders". I have taken out a few sections which may
shed light on the payment of fees to non-registered persons and how that might affect our issuer Center
members. The entire article is attached and gives footnotes and references to cases and SEC regulations and noaction letters:
Briefly stated, the federal law and the law of every state prohibit a person from being engaged in the business of effecting transactions in securities, unless such person is licensed as provided by the applicable laws. At present, this means the person who wishes to engage in such business, i.e., a securities broker or dealer, must be a member of the National Association of Securities Dealers (“NASD”), or hold one or more appropriate licenses that allow him or her to be a representative of a NASD member. Essentially, this means that any person who accepts “transaction based compensation”, i.e., commissions, for bringing capital to a third party securities issuer, must be somehow registered to sell those securities through a member of the NASD. As will be explained in more detail later in this Report, there is an exception for a person who merely introduces a potential purchaser to an issuer and accepts a “finders fee” for that introduction when a sale of securities results.
However, it is the position of the Securities and Exchange Commission (“SEC”), and most state securities
law administrators (“State Administrators”) that a person who accepts a fee for introduction of capital
more than once is probably “engaged in the business of selling securities for compensation” and required
to be registered. Certainly, accepting fees for more than a very small number of transactions will require
registration, and we need not debate whether that number is two, three, six or ten, because the great
majority of the persons with whom this Report is concerned are involved in numerous transactions that
far exceed those numbers.
It is also very important to note that the same laws and regulations govern the activities of those persons whose business is introduction and assistance in consummation of what are regularly referred to as “mergers and acquisitions” transactions (“M&A transactions”). Often the persons with whom we are concerned will engage in both the straight placement of securities as well as advice in mergers and acquisitions. There are many extremely large M&A transactions in which commissions are paid to advisors who specialize in this activity,and who are critical to the success of the transaction. Nevertheless, those advisors are, by the nature of their respective activities, unlicensed securities brokers operating in violation of the federal and applicable state securities laws.
Unregistered securities brokers who raise funds for small businesses or engage in mergers and acquisition
activities on a commission basis are most often referred to as “finders”. Other labels include “merchant
bankers”, “investment bankers”, “financial public relations advisors”, and simply “business consultants”.
The one common thread which ties all of these persons together is that they are compensated, in
substantial part, on the basis of a percentage of the amount of securities their clients sell with the
assistance of the unlicensed broker. Notwithstanding the various labels, and despite the fact that a great
number of the brokers, funded businesses, and even sometimes their attorneys, do not realize that they
are operating in violation of securities laws, simply put, they are unlicensed securities brokers whose fee
contracts are unenforceable and whose activities are, in fact, illegal. For ease of reference, throughout this
Report we refer to these unlicensed persons as Private Placement Broker-Dealers ("PPBDs").
.....The SEC recently addressed the unregistered broker-dealer issue in its revisions to the rules on accountant's independence under Section 201 of the Sarbanes Oxley Act of 2002. Rule 10A-2 under the Exchange Act now states generally that a certified public accounting firm is prohibited from acting as a promoter or underwriter, or making investment decisions on behalf of an audit client, among other things. The amendment expanded the scope of the prohibition to address situations where a CPA firm acts as an unregistered broker-dealer.
In the commentary the SEC notes that selling - directly or indirectly - an audit client's securities presents a threat to independence, regardless of whether the broker-dealer affiliated with the CPA firm was registered as such or not. More importantly for the purposes of the Report is the pronouncement, buried in FN 82 of Release 33-8183 which states that: "Accountants and the companies that retain them should recognize that the key determination required here is a functional one (i.e., is the Accounting firm or its employee acting as a broker-dealer?). The failure to register as a broker-dealer does not necessarily mean that the accounting firm is not a broker-dealer. In relevant part, the statutory definition of 'broker' captures persons 'engaged in the business of effecting transactions in securities for the account of others.'
Unregistered persons who provide services related to mergers and acquisitions or other securities-related transactions by helping an issuer to identify potential purchasers of securities, or by soliciting securities transactions, should limit their activities so they remain outside of that statutory definition. A person may 'effect transactions,' among other ways, by assisting an issuer to structure prospective securities transactions, by helping an issuer to identify potential purchasers of securities, or by soliciting securities transactions. A person may be 'engaged in the business,' among other ways, by receiving transaction-related compensation or by holding itself out as a broker-dealer...." The Commission will undoubtedly apply this same standard whether dealing with a Certified Public Accounting firm or not.
Further, in footnote 86, the Commission notes that broker-dealers provide an array of services that may include certain analyst activities, suggesting that when one provides analytical services to an issuer or investor, the question of broker-dealer registration is raised even beyond the concerns in expressed in footnote 82.
B. Who Are the Unregistered Financial Intermediaries?
Financial intermediaries come from a variety of sources. They include CPAs and to a lesser extent lawyers, M&A specialists, business brokers, local "monied people" (the country club set), consultants (who take a variety of forms), insurance agents and real estate brokers, registered representatives illegally selling away from their firms, individuals who have substantial investor networks or the people that work for such individuals, individuals hired by entities seeking capital, angel networks, retired executives and community leaders. They also include unregistered individuals or entities who hold themselves out as finders or investment bankers and do this for a living by providing business plans, private placement memoranda, and who may remain thereafter as paid consultants.
Members of the Section have observed a significant number of attorneys who provide opinions on transactions for their clients giving comfort to these unregistered financial intermediaries, while ignoring SEC no-action letters and federal and state enforcement actions leading to a different conclusion. Generally these individuals are solo or small firm practitioners with very limited securities experience and either no appreciation for the complexity of the analysis or a willingness to render opinions to accommodate a client.
C. What Problems Does One Confront When Using an Unregistered Financial Intermediary? Unregistered financial intermediaries can cause major problems for an issuer. They can taint an offering by creating the basis for rescission rights, raise enforcement concerns, make fraudulent representations and engage in general solicitation. These issues are discussed in the section on Litigation Issues below. They can be individuals who have been suspended or barred from the securities business or fired by firms for misconduct.
There are those who act in collusion with market manipulators and those who bribe registered representatives to act as touts. Use of these individuals often leads to litigation when the stock prices drop, as they frequently do. These financial intermediaries can provide encouragement to cut legal corners. They often under-price legitimate firms or deter issuers from going to legitimate firms. For an attorney, they are a major concern, since their actions adversely affect our ability to render customary legal opinions in transactions and, therefore, harm our clients.
These individuals often lead the issuer down a primrose path with false promises. They may add to the issuer's existing problems, create significant litigation or raise an enforcement action risk. The unregistered financial intermediaries' contracts can be incredibly over-bearing, significantly hampering future financing for the issuer. After funding, issuers may find themselves faced with very unhappy investors who are angry over misrepresentations by the finders or drop in an artificially inflated price, and who demand rescission or the buyout of their shares. Those investors may also apply pressure to the issuer to make a corporation "go public" or qualify its shares for trading on the NASDAQ Bulletin Board or Small Cap market before the company is prepared to take that step from a financial, compliance, risk management, management sophistication, or regulatory filing capability perspective. Issuers who later desire to go public don't appreciate the difficulties which can be attached to prior offerings that violate securities laws.
The issuer must describe prior securities offerings as part of the registration process. The staff of the SEC’s Division of Corporation Finance may well ask for a rescission, or at a minimum disclosure of contingent liability. Under such circumstances, the firm's auditors will also request disclosure, or perhaps a reserve which would have the effect of destroying the credibility of the balance sheet of the issuer. Further, the matter may be referred to the Enforcement Division at the SEC and states that review of the offering will likewise pick up on the disclosure and may commence investigations. A consistent theme in the SEC proceedings against unregistered broker-dealers has been the lack of disclosure of compensation paid to such individuals or entities. While an issuer may have a belief that their offering complies with Regulation D, Rule 506, the failure to disclose that compensation in the presence of even a single non-accredited investors destroys the exemption for failure to meet the Rule 502 disclosure requirements. Further, almost all state laws contain a prohibition against payment of compensation to unregistered brokerdealers as a condition of their private offering exemption. Some states have gone further and expressly deny compensation to finders. If the finder is acting as an unregistered broker-dealer, that addition is surplusage, but to the extent that a role for finders remains, the prohibition reaches that compensation as well.
The consequence of failure of improper payment is loss of the exemption, and the issuer may face a demand from the state securities agency for rescission, or any investors may be able to take advantage of the "put" that is provided by an illegal sale, and require rescission under Section 410 of the Uniform Securities Act, together with interest at the rate prescribed by the state. Finally, most such state acts provide for attorney's fees to the person seeking rescission. The persons liable under state law include not only the issuer, but its officers and directors, as well as those involved in selling the securities. The entity with these problems is also less likely to be looked on favorably as an acquisition candidate, or the price offered for an acquisition may dramatically decrease. Regulators have a substantial concern over the "finders" who flout the securities laws.
We estimate that the various states bring well over 100 enforcement cases against unregistered finders on an annual basis (and probably a great deal more because statistics are not available from NASAA or the states to identify the full extent of state action). The NASD brings a large number of cases against individuals who are engaged in selling away from their brokerage firms for acting as unregistered financial intermediaries, often barring them from the business or imposing long suspensions. This is the second most frequently cited grounds for sanctioning registered representatives and has been for the past several years.
The NASD asserts that Code of Conduct Rule 3040 includes situations where the associated person's role in a transaction is limited to a client introduction and to eventual receipt of a finder's or referral fee.7 The NASD monthly Notice To Members which lists enforcement actions contains "selling away" allegations in virtually every issue. These actions represent only the tip of the iceberg of that problem. The SEC brings dozens of these cases annually, but the manner of description of the cases circulated to the public focuses almost exclusively on the fraudulent conduct that occurs, and mentions only in passing the unregistered broker or broker-dealer issue without details or explanation of the basis for the charge.
These cases provide a great opportunity for better guidance, but the message is lost in the present descriptions of cases published in Exchange Act Releases.8 However, it is worth noting that among the allegations of fraud in such cases are the failure to disclose compensation paid to the unregistered broker-dealer, misrepresenting the cost of the offering and lying about the amount of commissions paid.9 The SEC has also barred persons from acting as finders.10 In one of its better publicized cases, the SEC alleged that a former Tyco Lead Director and Chairman of the Compensation Committee collected a secret $20 million finder's fee in conjunction with Tyco's 2001 acquisition of the CITI Group, Inc. 11 The illegitimate financial intermediaries, who are really unlicensed broker- dealers, were a direct cause of the SEC action in restricting the scope of Regulation S and Rule 504 in 1999. Regulators are also unhappy to find that the people that they have expelled from the business have resurfaced in a new guise.12 Today, so-called "finders" are active in soliciting investors for a range of products which have been held to involve securities, including pay phone leases, viatical or life settlement contracts, promissory notes, foreign CDs, and "prime bank" scams. These areas of concern appear regularly in NASAA's Top Ten Investment Frauds which is published annually.
A concern expressed to the Task Force is that the unregistered financial intermediary makes it very difficult for smaller registered, reputable broker-dealers to become involved in raising funds. Unscrupulous entities and individuals can make exorbitant promises, enter into exclusionary contracts with unconscionable terms, and abuse the unsophisticated small businessman without much difficulty. Another concern frequently expressed to the Task Force addressed the problem that competent attorneys face when an issuer comes seeking guidance, is told that the financial intermediary who proposes to raise their funds is operating illegally, and recommends not doing business with that financial intermediary. A common lament from these attorneys is that too often the client walks down the street and easily finds attorneys who are willing to advise the issuer that there is no problem in hiring the financial intermediary to actively sell their deal to the public, and pay transaction-based compensation afterwards. 1. Transaction-Based Compensation.
Transaction-based compensation has come under intense scrutiny by the SEC. The SEC's Division of Market Regulation has repeatedly noted that: . . . [T]he receipt of compensation related to securities transactions is a key factor that may require an entity to register as a broker-dealer. Absent an exemption, an entity that receives securities commissions or other transaction-based compensation in connection with securities-based activities that fall within the definition of "broker" or "dealer" generally is itself required to register as a broker-dealer. Registration helps to ensure that persons who have a "salesman's stake" in a securities transaction operate in a manner that is consistent with customer protection standards governing broker-dealers and their associated persons. That principle not only encompasses the individual who directly takes a customer's order for a securities transaction, but also any other person who acts as a broker with respect to that order, such as the employer of the registered representative or any other person in a position to direct or influence the registered representative's securities activities.
Herbruck, Alder & Co., SEC No-Action Letter (June 4, 2002); see also, e.g., Birchtree Financial Services, Inc. (SEC No-Action Letter Sept. 22, 1998) (registered representative's personal service corporations); 1st Global, Inc. (SEC No-Action letter May 7, 2001) (unregistered CPA firms); Wirthlin (SEC No-Action letter Jan. 19, 1999); Richard S. Appel, SEC No-Action Letter (Feb. 14, 1983) (1031 exchange transactions; requiring registration because finder would receive commission-based compensation on sales).
Transaction-based compensation triggered a broker-dealer registration obligation in Mike Bantuveris, SEC No- Action Letter (Oct. 23, 1975), where the company wished to offer a consulting service in which it would identify companies as possible acquisition candidates and assist its clients in negotiating toward a final agreement. The company proposed to base its fees, in part, on the total value of consideration received by the sellers or paid by the buyers. On these facts, the staff indicated that the company would be required to register as a broker-dealer. The staff noted that its opinion was "based primarily on the fact that the consulting firm would . . . receive fees for its services that would be proportional to the money or property obtained by its clients and would be contingent upon such transactions in securities." See also John M. McGivney Securities, Inc., SEC No-Action Letter (May 20, 1985).
The SEC has left open whether a commission-like fee arrangement, standing alone, will always constitute grounds for registration as a broker-dealer. It is this letter which appears to create the greatest uncertainty for counsel and intermediaries. Paul Anka, SEC No- Action Letter (July 24, 1991), provides the unusual case where a commission-like fee has been allowed to stand. The staff's favorable position would appear to be attributable to the uniquely limited duties of the finder involved in the case and to the one-time occurrence of the event. In Anka, the Ottawa Senators Hockey Club retained entertainer Paul Anka to act as a finder for purchasers of limited partnership units issued by the Senators. Anka agreed to furnish the Senators with the names and telephone numbers of persons in the United States and Canada whom he believed might be interested in purchasing the limited partnership units. Anka would neither personally contact these persons nor make any recommendations to them regarding investments in the Senators. It is noteworthy that in Mr. Anka's original proposal letter to the SEC he would have made the initial contact with prospective investors, but the SEC would not issue a no-action letter under those facts. In exchange for his services, Anka would be paid a finder's fee equal to 10 percent of any sales traceable to his efforts. Important factors identified in the Anka letter include: • Mr. Anka had a bona fide, pre-existing business or personal relationship with these prospective investors. • He reasonably believed those investors to be accredited. • He would not advertise, endorse or solicit investors. • He would have no personal contact with prospective investors. • Only officers and directors of the Senators would contact the potential investors. • Compensation paid to the Senators' officers and directors would comply • with 1934 Act Rule 3a4-1 (governing compensation to issuer's agents). • He would not provide financing for any investors. • He would not advise on valuation. • He would not perform due diligence on the Senators' offering. • He had never been a broker-dealer or registered representative of a broker-dealer.
Based on these facts, the SEC indicated that it would not recommend enforcement action if Anka engaged in the proposed activities without registering as a broker-dealer. While the SEC did not comment specifically on the issue, it would appear that the staff was willing to tolerate the commission-like structure of Anka's fee arrangement because his role in finding prospective purchasers␣which was limited to sending a list of names to the Senators—providing no opportunity or incentive to engage in abusive sales practices. See John Polanin, Jr., The "Finder's" Exception from Federal Broker- Dealer Registration, 40 Cath. U. L. Rev. 787, 814 (1991). The SEC staff may be reconsidering whether Mr. Anka's activities sufficiently removed him or others like him from having the opportunity to engage in abusive sales practices that registration is intended to regulate and prevent. Based on staff comments at a recent Business Law Section meeting, the SEC staff may also be reconsidering its position in the Paul Anka letter situation and might not issue such a letter today. Although the SEC's position in the Anka letter was not premised on the 1985 Dominion Resources letter (discussed below and in Section IV), the revocation of Dominion Resources in 2000 seems to demonstrate that the staff is moving to a position where the existence of transaction-based compensation alone may be sufficient to trigger broker-dealer registration. From the SEC staff's perspective, transaction- based compensation creates the incentive for abusive sales practices that registration is intended to regulate and prevent. Many financial intermediaries would rather be sure of their status by being registered, but avoid the burdensome and generally inapplicable process that is found in the present regulatory scheme.
“So what?” In conversations with attorneys this is the most frequently asked question. In essence, what are the consequences of participation by a non-registered broker- dealer in a transaction? This segment of the Report will set forth some of the considerations for counsel in analyzing the consequences of such an involvement. A. Federal Securities Law. The starting place in the analysis is with the potential for action by the SEC. If the Division of Enforcement staff at the SEC identifies an unregistered broker-dealer and there has been no fraudulent act committed, the staff is likely to urge registration and if that is forthcoming, close the matter. If there is fraud, it is far more likely that an enforcement action will be commenced. The SEC Divisions of Enforcement and Market Regulation do not have the staff to conduct the level of surveillance necessary to detect even a remote percentage of financial intermediary activity. An examination of websites for many of the unregistered financial intermediaries clearly discloses the activity, but there has been no sweep aimed at addressing the issue.
Our review of SEC enforcement cases indicates that most relevant cases name the issuer as well as the brokerdealer in the suit. However, these suits rarely deal exclusively with using an unregistered broker-dealer. On the contrary, the lawsuits generally involve multiple counts, including violations of the registration provisions for the securities themselves as well as violating the requirement that a broker-dealer be registered. The results of the lawsuits are driven primarily however, by the allegations of fraud and misrepresentation. Often the cases deal with a situation where an individual creates a scheme, and then sells the idea to unwitting investors. The investor's money is then used to pay off previous investors in a Ponzi scheme or to pay for personal purchases. We found no cases where a finder crossed the line into broker-dealer activity for which the issuer was then punished in the absence of such fraud. Finders and unregistered broker-dealers have been subject to permanent injunctions for failing to register and then selling securities. When fraud is involved, the SEC pursues disgorgement of the funds as well as civil penalties. These civil penalties are allowed pursuant to the 1990 Civil Remedies Act, the point of which was to punish perpetrators of fraud rather than simply putting them back in the position they would have been in had they not committed the fraudulent act. In one case, an individual who was not found to be a part of the fraudulent operations was still required to pay disgorgement on a theory of unjust enrichment. See, e.g. SEC v. Cross Financial Services, 908 F. Supp. 718 (1995). B. Civil Liability Under Federal Securities Laws. Unlike many state limited offering or equivalent exemptions, federal private offering exemptions do not condition the use of the exemption on the absence of payments to unregistered broker-dealers or finders. Thus, the issuer does not automatically lose its exemption pursuant to a violation of the securities registration provisions of federal securities laws. Instead, one must look to a three part analysis in determining potential civil liability. 1. Is the person engaging in the activity a broker-dealer? Section 3(a)(4) of the Exchange Act defines the term "broker."
In the Division of Market Regulation October 1998 Compliance Guide to the Registration and Regulation of Broker-Dealers found on the SEC website, there is ambivalence about "finders." This is surprising in light of the history of no-action letters. The guide suggests that the determination of whether one is or is not a broker depends a number of factors, and suggests that "‘finders,' or those who find buyers and sellers of securities of business or find investors for registered-brokerdealers and issuers need analyze three issues: a. Do you participate in important parts of a securities transaction, including solicitation, negotiation or execution of the transaction? b. Does your compensation for participation in the transaction depend upon the amount or outcome of the transaction? In other words, do you receive transaction-based compensation? c. Do you handle the securities or funds of others? If the answer to any of these is "yes" then the reader is cautioned that you may need to register as a broker. Those who are uncertain are told that they may want to review SEC interpretations, consult with private counsel, or ask for advice from the SEC. This is far more ambivalent than the no-action letters suggest is appropriate. In those letters, as later in this Report, there is little equivocation. We suggest finders should be specifically instructed that they are required to register unless they meet specific safe harbors created by the SEC in recognition of existing no action letters or acceptance of recommendations from this Report or other commentators. We do not believe that it is necessary to review here the case law relating to broker-dealer status. Rather, we are assuming that the presence of transaction-based compensation coupled with any active involvement with the issuer or a broker-dealer, will trigger registration requirements absent an exception or appropriate ruling. We believe that fairly characterizes the Division of Market Regulation's present position. If a person is required to register as a broker-dealer, and fails to do so while having active participation coupled with transaction-based compensation, what are the consequences? Section 29(b) of the Exchange Act provides that "Every contract made in violation of any provision of this title or any rule or regulation thereunder, and every contract . . . the performance of which involves the violation of, or the continuance of any relationship or practice in violation of, any provision of [the Exchange Act] or any rule or regulation thereunder, shall be void: (1) as regards the rights of any persons who, in violation of any such provision, rule or regulation, shall have made or engaged in the performance of any such contract." A maximum three year or one year from date of discovery statute of limitations is applied. This section suggests that in any civil litigation an unregistered agent acting on behalf of the issuer will be compelled to return their commissions, fees and expenses; and that the issuer may justifiably refuse to pay commissions, fees and expenses at closing or recoup them at a later time. It also raises the question of whether the issuer can be compelled to repay these funds to an investor, since the unregistered broker-dealer is acting on behalf of the issuer. The investor may also be entitled to return of his or her investment, since the purchase contract between the issuer and the investor is a contract which is part of an illegal arrangement with the unregistered financial intermediary, and that intermediary is engaged in the offer and sale of the security to the investor. The language to Section 29(b) is broad enough to permit such an interpretation. Our research found little guidance on this type of case. Experience tells us that litigation involving unregistered broker-dealers or agents is often quickly settled. Furthermore, a reference to a state regulatory authority or the SEC will often produce compelling pressure for prompt return of the funds. C. Civil Liability Under State Securities Law. Section 402(b)(9) of the Uniform Securities Act as roughly adopted in most states provides generally that an exemption for a limited offering (usually to a small maximum number of persons) is permitted if no commission or similar remuneration is paid for the offer or sale of the securities other than to a registered broker-dealer or agent of the issuer. Some states have added a specific prohibition for payments to "finders." Thus a multi-state transaction done under Sections 4(2) or 3(b) of the 1933 Act will often require use of the 402 (b)(9) state exemption to meet state law requirements. Thus, the ability of either the state or an investor to sue to recover or prevent payment of commissions is clear. Likewise, many states have adopted the Uniform Limited Offering Exemption (“ULOE”) which applies to offerings under Rule 505 of Regulation D, and the ULOE precludes payments in a manner similar to 402(b)(9). While Rule 505 is rarely used for offerings today, the state animus toward finders is reflected in the rules which incorporate the prohibition. Exemptions are also available under state law for sales to institutional investors (the definition varies somewhat from state to state); existing securities holders (in some states there is a numerical cap on the number of persons to whom sales can be made under this exemption); and in some states under the Model Accredited Investor exemption developed by NASAA. The principal problem for aggrieved investors under state law arises in transactions done under Rule 506 of Regulation D. Since Section 18(b)(4)(D) of the 1933 Act preempts much of state law relating to requiring registration of or an exemption for certain classes of securities, including offerings under Rule 506, the states lack the power to impose the prohibition of the payment of commissions to unregistered persons as a condition of the exemption which is found in several Uniform Act exemptions. The states still have a window under Rule 506 however.
Generally under Section 18(b)(4)(D) the states may receive a form, require the payment of a fee, and continue to police fraud. However, if an issuer fails to comply with the disclosure requirements of Rule 502 where appropriate, the exemption under Rule 506 is lost, and the issuer must then frequently fall back on the Section 402(b)(9) exemption. Hence even in a purported Rule 506 exemption, there is risk of state proceedings for failure to meet the information requirements. Further, the failure to accurately disclose compensation to an unregistered financial intermediary on Form D will almost certainly be found to be a material non-disclosure, and a fraud claim will lie for that omission. As noted previously, states are now examining the Form D's to spot payments to unregistered finders. Another consideration under Regulation D is the issue of establishing a prior relationship with investors. There are several SEC no action letters giving comfort to registered broker-dealers in developing relationships which can serve as the basis for establishing a "pre- existing relationship" with these investors. These letters, however, do not extend to unregistered financial intermediaries. Sales in violation of the registration provisions of Section 101 of the Uniform Securities Act and sales by unregistered broker-dealers or agents are also voidable pursuant to an action under Section 410 of the Uniform Securities Act. ABA Report on PPBD's.pdf 626.7 KB Delete Michael Gibson Sat, 2 Apr at 10:42am
I am moving Peter E.'s comments on the Securities Panel over to this message board to try and keep all of the discussions concerning securities issues in one place: Peter and fellow committee members Thanks for all of the excellent emails. Here are some broad suggestions from your moderator based on the emails as to topics. I have tried to focus on those that are more unique to the EB5 world. Most of these may require some set up in the form of basic explanation of the legal requirements underlying them. Of course, these are just intended to begin framing something out for the presentation based on your input. 1. Consequences of securities noncompliance for issuers/centers What is the potential liability? Who can be held liable in addition to issuers? Nature of the liability Collateral consequences of failure to comply (issues in subsequent financings) 2. Particular EB5 Sales and Marketing issues Avoiding general solicitation under Reg D-best practices Avoiding directed selling efforts in the US under Reg S-best practices Finders Fee issues B/D registration requirement Indicia of a b/d Consequences of using a finder who is an unregistered b/d Finders active in foreign markets in Reg S offerings Best practices 3. Disclosure Issues (this is a very brief attempt to address a very complicated topic) What is required Control of offering materials Use of brochures/summaries Best practices 4. B/D role in the offering process Control sales practices Additional FINRA requirements as to B/D role in non-registered offerings Help to avoid finders fee issues Deal with investor sourcing through institutions/migration brokers Other
Delete Michael Gibson Sat, 2 Apr at 2:05pm
Rather than speaking in generalities I thought that it might be helpful to upload an email sent by an IIUSA member to a large number of immigration attorneys. This email was not solicited, nor did the recipients that contacted me have any prior or existing relationship with the issuer.
I am not completely certain, but I do not know of any immigration attorneys who are also registered persons, so my understanding would be that this email was specifically targeting non-registered persons. This example is not to address the issues contained in this particular email, nor with this issuer, but to give an example of hundreds of similar solicitations which are sent out every year by both members and non-members alike and should illustrate a practice which is common in our industry to those on this panel who may not be familiar with EB-5 Regional Center and project marketing practices. Perhaps this example will be useful to guiding our discussion going forward as I am sure that any investigation into our industry by State or Federal authorities will uncover a multitude of similar communications. ------------------------------------------------------------------------------------------------------------------ From: Sent: Tuesday, August 24, 2010 11:14 AM To: Subject: EB-5 Investment Opportunity. Dear _______________, I am contacting you in reference to my firm’s qualified EB-5 project – the development of at least __________ throughout South Florida. _____ is a publicly listed company (NASDAQ:______) and the fourth largest chain of _________ in the United States; it is a direct competitor of _______ and _______ with __________________ nation wide and growing. Our company – ______________ -– owns the Exclusive Area Development rights to all of South Florida - the largest territory every awarded to a single franchisee. The ________ offering is seeking a total of EB5 eight investors, as you will see from the investment summaries. We offering a Finder’s Fee of $60,000 per investor, for the first five investors identified for this deal, and $30,000 for the last three. For purposes of determining the order in which investors are identified, the definition of “identified” is marked by the date when investor’s monies clear escrow. This will eliminate any ambiguity. The ______________ will be located in a beautiful oceanfront 5,600 Sq. Ft. space in _______________. We have received verification from the State of Florida certifying the location as a TEA zone, which means the investment requirement is at the $500k level. You can view a 3 min video of the ___________ project Documents with details pertaining to our ___________ Project in Fort Lauderdale Beach can be accessed via the links provided below. _______________________________________________________ ________ • Investment Brochure http:// • Summary of Transaction Terms http:// • Executive & Advisory Board Profiles http:// • Rendering Aerial View http:// • Rendering Interior http:// • Virtual Tour http:// Our firm is extremely familiar with the EB5 program; the Chairman of the company, Mr. _________, played an instrumental role in the creation of the original EB-5 legislation in the early 1990’s with Senator Edward M. Kennedy as a solution to the economic distress the United States was experiencing during that time. Our Board of Advisors includes the former Director of the USCIS, the former Director of the Department of Homeland Security and the former Mayor of Miami; we are very well connected, politically. As you will learn from reviewing the documents provided via the links, we have a very attractive, unique and solid EB5 project. ________ offers a mature and stable business model with a proven track record that is supported by more than 50 years of success. Following the Fort Lauderdale Beach _____________, we will be introducing another 11 _______________ to the EB5 market under the same deal terms. Our plan is to develop 12 ____________ per year (each seeking 8 investors), which means we will be looking for a total of 96 investors per year. If you are interested in discussing our project further and the possibility of a working relationship, please email or call me at 786-______________. I look forward to hearing from you. Delete Michael Gibson Sun, 3 Apr at 5:05pm This post may shed light on recent SEC enforcement concerning fraudulent presentations, material misrepresentations, and false allegations (written and oral) which may be of concern to our member issuers (and the agents that they compensate) when marketing their projects to potential investors. The cases described cite specific references to securities laws. SEC ENFORCEMENT: MORE CASES, MORE INVESTEMENT FUND FRAUD ACTIONS March 31, 2011 The retooled SEC enforcement program is filing more cases and securing judgments for more dollars than in prior years according to the statistics (here). A significant component of those statistics is investment fund fraud actions. Once considered difficult to discover these cases have in recent months become a key staple of SEC Enforcement. These cases and the disgorgement and penalties secured typically in settlement represent one of the largest single components of the improved statistical performance. This point is well illustrated by the enforcement cases reported yesterday by the SEC – one new case and three settled actions. All are investment fund fraud actions: SEC v. Aerokinetic Energy Corp., Civil Action No. 8:08-CV-1409 (M.D. Fla. Filed July 28, 2008) is an action against the company and its president Randolph Bridwell. Defendants raised approximately $535,000 from 24 investors between September 2006 and the time the complaint was filed in a fraudulent offering of company shares. Investors were told that the company had developed a new green technology that created inexpensive electrical energy and that it had patents and orders to purchase the finished product. All of these claims were false, according to the Commission. Defendant Bridwell is alleged to have misappropriated much of the investor funds for his personal use. The complaint alleged violations of Securities Act sections 5 and 17(a) and Exchange Act Section 10(b). Each defendant settled, consenting to the entry of a permanent injunction prohibiting future violations of the sections cited in the complaint. In addition, the final judgment imposes, jointly and severally, an obligation to pay disgorgement of $555,000 along with prejudgment interest. The company was ordered to pay a civil penalty of $250,000 while Mr. Bridwell is required to pay $130,000.
IS THE SEC ENFORCEMENT PROGRAM MORE EFFICIENT AND EFFECTIVE? March 28, 2011
For the last two years the SEC has retooled the enforcement program which is critical to its mission. One goal has been more efficient, effective and speedier investigations. Since concluding the reorganization of the division the Commission has touted the success of those efforts, pointing to various statistics and a series of selected cases to suggest that the program in on track to return to its glory years. The statistics are impressive (here). More cases were filed last year than the year before. Some statistics suggest the program is more efficient which, in these days of tight budgets, are sure to please those on Capitol Hill. As even Commission officials admit however, statistics are only part of the story. What is really happening on the ground? A case filed last Friday and a related action brought in 2009 suggest the answer. On Friday the Commission filed SEC v. Frishbert, Civil Action No 4:11-cv-0197 (S.D. Tx. Filed March 25, 2011). The action names as a defendant, registered investment adviser Daniel Sholom Frishberg, a principal of Daniel Frishberg Financial Services (“DFFS”).
The complaint centers on the sale of notes from two issuers to advisory clients. The first involved the sale of notes of Business Radio Network L.P., a private equity fund known as BizRadio, from April 2008 through September 2009. About $5.5 million was raised from DFFS clients. The sales were solicited by Albert Kaleta with the approval of Mr. Frishbert. Note purchasers were not told that Mr. Frishberg is the CEO and Mr. Kaleta is affiliated with the company. They also were not told that both men drew a salary form the company or that is was in poor financial condition and it lacked the resources to repay the notes. The second involved the sale of notes issued by Kaleta Capital Management, Inc. (“KCM”), a company controlled by Mr. Kaleta. Again Mr. Frishbert permitted a solicitation of DFFS clients. All representations regarding the notes were oral – there were no written materials. Again investors were not told about the poor financial condition of the company.
In an earlier actions (described below) the Commission alleged the sales representations were false. The complaint alleges violations of Advisers Act Sections 206(1) and (2). Mr. Frishberg settled by consenting to the entry of a permanent injunction prohibiting future violations of Section 206(2) and from aiding and abetting violations of Sections 206(1) and (2). He also agreed to pay a civil penalty of $65,000. In 2009 the Commission filed SEC v. Kaleta, Civil Action No. 4:09-cv-3674 (S.D. Tx. Nov. 13, 2009). The case names as defendants Albert Kaleta and his company KCM. DFFS and BizRadio, were named as relief defendants. Enforcement: Speaking at the same SIFMA Conference, Enforcement Director Robert Khuzami highlighted recent enforcement efforts. After reviewing the now complete reorganization of the division, Mr. Khuzami cited a series of statistics suggesting what he called a high level of accomplishment for the division. In fiscal 2010 the division filed 681 cases, more than in any of the previous five years. During the same period orders for $2.85 billion in disgorgement and penalties were secured which represents a 17% increase over fiscal 2009 and a 176% increase over fiscal 2008. Finally, the Director cited a series of statistics illustrating the increased speed and efficiency of the division. To bolster the statistics Mr. Khuzami pointed to a series of cases including: Countrywide Financial, Citigroup, Morgan Keegan, Goldman Sachs, Pinnacle Capital Markets and the actions against TD Ameritrade and Charles Schwab. He also cited the recently filed insider trading administrative proceeding against Rajat Gupta, noting that it is the Divisions first under its new Dodd-Frank authority to obtain penalties in such actions against persons not associated with a regulated entity. Investment fund fraud: SEC v. Mike Watson Capital, LLC, 2;11-CV-00275 (D. Utah Filed march 24, 2011) is an action against the named entity along with Michael Watson and Joshua Escobedo. The complaint alleges that the defendants obtained over $27.5 million from October 2004 through February 2009 from 120 investors based on fraudulent representations. Investors were told that their funds would be invested and generate returns from real estate investments. They were also told that the investment fund was backed by substantial equity and had significant cash flow.
In reality the properties never generated sufficient income to cover investment interest or redemptions which were thus paid from new investor funds. The defendants settled with the Commission, consenting to the entry of permanent injunctions prohibiting future violations of Securities Act Sections 5 and 17(a) and Exchange Act Sections 10(b), and, as to the individuals, 15(a).
The company and defendant Watson also agreed to be jointly and severally liable for disgorgement of $16,383,037.83 along with prejudgment interest and a civil penalty of $130,000. Disgorgement and a penalty were waived as to defendant Watson based on his financial condition. Investment fund fraud: SEC v. Spyglass Equity Systems, Inc., Civil Action No. 11-2371 (C.D. Cal. March 21, 2011) is an action against Spyglass, Richard Carter, Preston Sjoblom, Tyson Elliott, Flatiron Capital Partners, LLC, Flatiron systems, LLC and David Howard. The complaint alleges that the defendants cold-called primarily elderly investor and, using false representations about the success of their trading system, raising about $2.15 million from nearly 200 investors. Contrary to the representations made to investors, less than half of the money raised was actually pooled and traded. About $1 million was lost trading. Another $500,000 was used for unauthorized business and personal expenses. By December 2008 the operation was out of money and steps were taken to conceal what had happened.
Investors were told that trading halted to permit an audit. The complaint alleges violations of Securities Act Sections 5 and 17(a), Exchange Act Sections 10(b) and 15(a), Investment Company Act Section 7(a) and Advisers Act Sections 206(1), (2) and (4). The case is in litigation. Offering fraud: SEC v. St. Anseim Exploration Co., Civil Action No 11-CV-00668 (D. Colo. Filed March 18, 2011) is an action alleging fraud in violation of Securities Act Section 17(a) and Exchange Act Section (10) by the company and Michael Zaikroff, Anna Wells and Mark Palmer. According to the complaint the company had few assets. To keep it in operation the individual defendants sold promissory notes to about 200 investors raising about $62 million. The sales were based on false allegations that the company was profitable and able to pay investors from recurring revenue that came from oil and gas production and periodic sales of packages of assets. Eventually the defendants were making Ponzi like payments to some investors.
The case is in litigation. Delete Michael Gibson Wed, 6 Apr at 2:04pm Further to educating our Regional Center Issuer's on issues related to the payment of fees to "finders", here is an article found in "The Blue Sky Bugle" which is published by the ABA Committee on State Regulation of Securities (Volume 2009, Number 3, September 2009 - attached and here: http://www.ngelaw.com/news/ pubs_detail.aspx?ID=1087 . The key argument appears to be concerning the payment of a fee related to the success of the transaction. To my knowledge, agents and "finders" in the EB-5 program are only paid their commission if the I-526 is approved. They are paid other fees which are related to marketing, administrative and promotional activities, but that is not what is under scrutiny by the SEC and State Administrators. The practice of Center's paying very large fees to non-registered persons upon approval of the I-526 appears to be a clear indication of success based compensation (as seen in the above email communication). If the Regional Center were to pay a fee to the "finder" regardless of the success of the investment (regardless of whether the I-526 were approved or not), and only in the case of an introduction, then that might pass SEC and USA scrutiny, but I have never heard of this arrangement in any conversation I have had with Center principals or agents working for Centers.
Here is an excerpt of the article: ...While no single factor is dispositive in determining whether a finder is considered a broker-dealer, the SEC has made clear in its No-Action Letters that it considers the manner in which a finder is compensated to be a critical factor in the analysis. Presumably, the reason for this focus is that if a finder’s compensation is tied to whether a transaction occurs (a “success fee”) or the dollar value of a transaction (a “percentage-based commission”), there may be an inherent incentive for the finder to engage in abusive sales practices to effect the transaction. Potential Consequences of Using an Unregistered Broker-Dealer Many believe that the consequences of a broker-dealer failing to properly register fall on the unregistered broker-dealer only. This is simply not the case. A broker-dealer’s lack of registration will certainly subject the broker-dealer to fines and penalties under federal and state law and make it difficult for the broker-dealer to enforce any related fee arrangements.
The consequences, however, may be even more problematic for the company or fund that engages the unregistered broker-dealer. Section 29(b) of the Exchange Act renders void any contract made in violation of the Exchange Act or its rule and regulations. Arguably, this provision gives the parties to a transaction arranged by an unregistered broker-dealer a right to void the transaction agreements and unwind transactions that have previously closed. In other words, an investor that purchases securities may have the right to unwind the purchase if the company or fund that issues those securities subsequently fails just because the purchase was arranged by an unregistered broker-dealer. In addition, the use of an unregistered broker-dealer in a transaction could cause a company or fund to lose any exemption from the registration requirements of the Securities Act of 1933, as amended (as well as from applicable state law qualification requirements), it may have relied upon in that transaction. Accordingly, the company or fund may have a difficult time obtaining a legal opinion from its counsel in connection with that transaction or a future transaction. It also may subject a company or fund to civil and criminal penalties, including pursuant to Section 20(e) of the Exchange Act on the theory that the company or fund aided or abetted the unregistered broker-dealer.
Additionally, the use of an unregistered broker-dealer may lead to accounting issues because of the contingency arising from any rescission right of investors and disclosure issues in a subsequent public offering. Finally, the SEC may bar the company or fund from conducting private placement offerings in the future, thereby risking its ability to raise capital. State Law Registration Requirements Registration of broker-dealers is no longer solely the domain of the SEC. Increasingly, states are imposing their own set of registration requirements on finders and broker-dealers. Registration requirements, and the implications for failing to register, vary by state. Accordingly, a state-by-state analysis of applicable securities laws must be undertaken. Illinois, for instance, requires the registration of “business brokers,” even if the business broker would have been exempt from registration as a broker-dealer under federal law. While many state statutes (including the Illinois statutes) provide for fining finders for failing to register, other states go further. For example, California law provides that any person who purchases a security from, or sells a security to, an unlicensed broker-dealer may bring an action for rescission of the sale or purchase or, if the security is no longer owned by the party, for damages. Disconnect between Law and Practice; Recent Developments Because the law does not clearly delineate what activities can be undertaken by unregistered broker-dealers, the practice in this area varies considerably. Oftentimes, finders are not registered with the SEC, even when the law suggests they should be. In fact, a “major disconnect” between the law applicable to securities brokerage activities and the practice by which the “vast majority of capital is raised to fund early stage businesses in the United States” has been noted by a task force of the American Bar Association. Many proposals for reform have been advanced as a result of this disconnect, including a vastly simplified registration scheme for finders.
Movement on these reform proposals has been slow, however, and, unless and until adopted, companies and funds should be wary of hiring finders not properly registered with the SEC even if they see others doing so. Indeed, there are indications that regulators may be becoming more stringent in their enforcement of the broker-dealer registration rules. In 2000, the SEC revoked the no-action assurance it had previously granted to Dominion Resources, Inc. In its 2000 No-Action Letter, the SEC noted that because of technological advances and other developments in the securities markets, more and different types of persons were becoming involved in the provision of securities-related services and that the SEC had recently taken a more restrictive view of the finders’ exemption. Additionally, Form D, as amended effective September 15, 2008, requires companies to disclose fees paid to finders, which will make policing these activities far easier for regulators. More recently, on June 19, 2009, the SEC announced a settlement of an administrative proceeding against Ram Capital Resources, LLC (“Ram”) and its two principals for acting as unregistered brokers. Between 2001 and 2005, Ram and its principals engaged in the business of identifying and soliciting investors, a majority of which were hedge funds, to participate in PIPE offerings. Ram also played a role in structuring and negotiating the terms of these PIPE offerings.
The investors compensated Ram by paying it a percentage of the gross amount invested and, in most instances, allocated to it a certain percentage of any warrants received in connection with the investment. In characterizing the violation as “willful,” the SEC noted that the principals of Ram “knew or were reckless in not knowing that Ram’s compensation structure for its services required Ram to register as a broker-dealer.” This settlement is unique in that the only basis for the proceedings against Ram and its principals appears to be the failure to register as a broker-dealer. Few, if any, enforcement proceedings had been initiated by the SEC up until this point unless the failure to register was accompanied by fraud or some other form of misconduct.
The Take-Away: Proceed with Caution Companies and funds should be confident prior to engaging a finder that the finder is either registered with the SEC and under applicable state securities laws or that the SEC and applicable state securities regulators will not view the finder as an unregistered broker-dealer.
A company or fund can quickly determine whether a finder is registered with the SEC by consulting the list of registered broker-dealers maintained by FINRA on its website. If a finder is not a registered broker-dealer, a company or fund should consider consulting with an attorney for assistance in determining whether registration is required and the risks in proceeding without registration.
There are steps a company or fund can take to minimize risk when engaging an unregistered broker-dealer, including by: • Researching the finder’s history of involvement in securities transactions. • Excluding the finder from negotiating or making recommendations regarding the transaction and carefully delineating the scope of the finder’s engagement in an agreement with the finder. • Limiting the finder’s compensation to a flat or hourly fee that is not contingent on the success of the transaction. • In M&A transactions, proceeding with an asset sale rather than a sale of the underlying stock. Given the lack of clarity regarding the registration requirements for finders, companies and funds should proceed with extreme caution when engaging a finder. What may appear to be a good way to identify sources of funding or a willing buyer could result in a company or fund unintentionally assuming long-term risks and liabilities. Securities - Gray, Neal, Gerber, Eisenberg - Unregistered Finders.pdf 286.6 KB
Delete Michael Gibson Wed, 6 Apr at 3:03pm
Another interpretation of transaction based compensation requiring registration.
I am sure that all here are familiar with the BMW denial of no-action letter, but I thought that this interpretation might be helpful to illustrate to those who may not be familiar with the guidance given by the SEC why the distinction between receiving compensation v. success based compensation is important for our members. Success based (post approval of the I-526 application) is how "finder's" and agents are traditionally paid in EB-5 transactions by Regional Centers: For many years, people who assist companies either in finding investors or a purchaser for the business have been advised that, if they only make introductions and do not otherwise participate actively in the transaction, they should be able to avoid registering as a broker under Section 15 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Until a recent no-action letter, this was thought to be true even if the financial intermediary received a percentage of the amount raised as compensation, since the simple act of making introductions did not appear to involve being “in the business of effecting transactions in securities.”
As noted in the 2005 Report of the American Bar Association’s Task Force on Private Placement Broker- Dealers: Although no single factor is dispositive of the question of whether a finder is engaged in the activities of a broker-dealer, SEC no-action letters reveal a variety of factors that are typically given some weight by the staff including: (1) whether the finder was involved in negotiations; (2) whether the finder engaged in solicitation of investors; (3) whether the finder discussed details of the nature of the securities or made recommendations to the prospective buyer or seller; (4) whether the finder was compensated on a transaction-related basis; and (5) whether the finder was previously involved in the sale of securities and/or was disciplined for prior securities activities.
Although all of these factors have played a role in the staff’s interpretations of who is a broker, transactionbased compensation has frequently elicited special concern. The staff has frequently stated that such compensation gives the finder a "salesman's stake" in a securities transaction. However, in most instances where such compensation was present, other factors also seemed to contribute to the SEC’s refusal to grant relief from the registration requirements. Now the SEC has issued a no-action letter, Brumberg, Mackey & Wall, P.L.C., in which it seems to reject in the strongest possible language the possibility that an unregistered finder can be compensated based on the amount raised, even when none of the other factors are present. In a fact scenario that could be considered very typical, the SEC refused to give assurance that it would not take action against the finder, basing its position almost exclusively on the fact that the firm was receiving transaction-based compensation. According to the request for no-action, Brumberg, Mackey & Wall (“BMW”) was a Virginia law firm which did not practice securities law and was not otherwise engaged in activities involving securities.
The firm proposed to assist Electronic Magnetic Power Solutions, Inc., a Tennessee corporation (“EMPS”), in finding financing. Their role “would be limited to the introduction of EMPS to a limited number of its contacts who may have an interest in providing funds for financing the operations and development of EMPS.” The letter recited that BMW would specifically not engage in negotiations with contacts, would not provide them with information about EMPS and would not be involved in advising anyone regarding any agreement to provide funding. Nevertheless, as noted, the staff refused to grant the no-action relief requested. The staff asserted that transaction-based compensation is “a hallmark of broker-dealer activity”. As to BMW’s description of its role as introducing EMPS to a limited number of its potential investors, the staff took the position that these activities implied that BMW was anticipating both “pre-screening” potential investors for eligibility and “pre-selling” the securities to gauge their interest.
Therefore, although this fact situation was very different from the one in Herbruck, Alder & Co., the staff repeated its assertion from Herbruck that the receipt of transaction-based compensation “would give BMW a ‘saleman’s stake’ in the proposed transactions and would create heightened incentive for BMW to engage in sales efforts.” Having earlier stated that “[a] person receiving transaction-based compensation in connection with another person’s purchase or sale of securities typically must register as a broker-dealer or be an associated person of a registered broker-dealer”, the staff concluded that BMW’s proposed activities would require brokerdealer registration. This letter seems to undercut reliance by finders on the very narrow exemption allowed in the staff’s Paul Anka letter. There, Mr. Anka had invested in the Ottawa Senators Hockey Club Limited Partnership and had also agreed to introduce potential "accredited investors" to the Senators. In the original request for no action, Mr. Anka was to contact the potential investor, give the issuer’s name and the price of the securities offered. He would also disclose his interest in the company and the fact that he would receive a finder’s fee. If the investor expressed interest, Mr. Anka would forward the name to the Senators, who would then conduct all further discussions with the investor. The staff, however, apparently refused to confirm that even this limited activity would afford an exemption from registration, because a second request was submitted which indicated that, instead of Mr. Anka’s contacting the investors directly, he would submit to the Senators the names of potential investors “with whom he has a preexisting personal and/or business relationship and whom he thinks may be interested” in the investment. Someone from the Senators would then contact the investor, advising that the contact was at Mr. Anka’s suggestion.
Apparently on the basis of this change, the staff agreed to grant no-action relief. If the specific facts of the Paul Anka letter do not fit, then Brumberg, Mackey seems to mandate that a finder avoid transaction-based compensation if it wants to avoid the risk that registration may be required. In at least one letter, Colonial Equities Corp. the staff agreed to take no action after the compensation payable by a registered broker-dealer to multiple finders was changed from a percentage of the net brokerage commissions generated from sales. Instead, Colonial proposed to pay each finder a flat fee for each questionnaire it submitted from a prospective investor and, if the investor was found by Colonial to be suitable, an additional flat fee for arranging an introduction to the investor. In each case, the fee was payable regardless of whether the investor actually made the investment. The very strong language used in the Brumberg, Mackey & Wall letter may be motivated in part by the increased scrutiny being given to the financial services industry across the board as a result of the recent industry crisis. The staff may be trying to remind finders that the stakes have gotten higher in the current regulatory environment. In any event, it is clear is that the staff continues to view the receipt of transaction-based compensation as a strong indicator that the finder is acting as a broker within the meaning of the Exchange Act and therefore the finder should either affiliate with a registered broker or itself register as a broker. Securities - Transaction Compensation Triggers Registration.pdf 282.1 KB Delete Michael Gibson Wed, 6 Apr at 3:37pm In our last conference call (with the securities sub-committee members) we were not able cite specific cases concerning the issues being discussed. Attached please find a comprehensive guide to the subject of Broker Dealers, "finder's" and compensation to others engaged in the offering, with references to specific case law. § 1A:2.5 Role of Compensation in Analysis In the SEC’s no-action guidance and enforcement actions, receiving commissions or other transaction-related compensation is one of the determinative factors in deciding whether a person is a “broker” subject to the registration requirements under the Exchange Act. Transaction-related compensation refers to compensation based, di- rectly or indirectly, on the size, value or completion of any securities transactions.
The receipt of transaction-based compensation often indicates that a person is engaged in the business of effecting transactions in securities. As a policy consideration, transaction-related compensation can induce high pressure sales tactics and other problems of investor protection often associated with unregulated and unsupervised brokerage activities. Absent an exemption, an entity that receives commissions or other transaction-related compensation in connection with securities-based activities generally would be viewed as a broker-dealer. The rationale for this position is summarized by the SEC as follows: Persons who receive transaction-based compensation generally have to register as broker-dealers under the Exchange Act because, among other reasons, registration helps to ensure that persons with a “salesman’s stake” in a securities transaction operate in a manner consistent with customer protection standards governing brokerdealers and their associated persons, such as sales practice rules. That not only mandates registration of the individual who directly takes a customer’s order for a securities transaction, but also requires registration of any other person who acts as a broker with respect to that order, such as the employer of the registered representative or any other person in a position to direct or influence the registered representative’s securities activities. Whether a person receives transaction-related compensation is often an important factor in the SEC staff’s decision in granting or denying no-action relief to, or bring enforcement actions against, persons providing services to broker-dealers. For example, the SEC staff has denied no-action relief to personal services companies that are established by registered representatives of a broker-dealer and receive commissions earned by the registered representatives from the broker-dealer.60 At the same time, the SEC has granted no-action relief to companies providing payroll processing services to broker-dealers for a flat, pre-determined administrative fee not related to commis- sions earned by the employees of the broker-dealer. In the letter granting no-action relief to e-Media, a company providing communications services for its registered broker-dealer clients, the SEC noted that, among other things, neither e-Media nor its personnel would “receive compensation from its client broker- dealers other than a flat transmission fee and that such fee w[ould] not be made contingent upon the outcome or completion of any securities transaction, upon the size of the offering, or upon the number of prospective investors accessing the [services].”
The SEC has granted noaction relief to investment advisers that did not receive compensation for its activity of assisting securities transactions, but denied no-action relief to investment advisers that proposed to receive transaction-related compensation. The SEC has identified the receipt of transaction-related compensation as a factor in its decision to deny no-action relief to some stock bulletin boards. Although the SEC has previously granted no-action relief under limited circum- stances in which a celebrity acting as finder “sold his rolodex,” and would receive a success-based fee, it has since publicly distanced itself from that precedent.67 The SEC has brought enforcement actions against persons for violation of section 15(a) registration requirements partly based on the fact that they had received transaction-based compensation. Receiving transaction-related compensation, however, is not the only factor that the SEC has considered in its decision to grant or deny no-action relief or bring enforcement actions. For example, even in the absence of commissions or other specific transaction-related fees, the SEC has declined to grant no-action relief regarding the broker-dealer registration of an investment adviser that proposed to locate issuers, solicit new clients, and act as a customers’ agent in structuring or negotiating transactions.69 In addition, the SEC has brought enforcement actions for violation of section 15(a) against persons who had induced and attempted to induce the purchase and sale of securities for the accounts of others. § 1A:2.6 Specific Contexts [A] Finders As noted above, the SEC staff has historically recognized a very narrow exception to the broker-dealer registration requirements for certain “finders.”
A “finder” is a person who places potential buyers and sellers of securities in contact with one another for a fee. There is no “finder exception” in the Exchange Act or SEC rules; instead, the finder analysis is based on SEC no-action letters. The SEC’s decision to grant no-action treatment in some cases to permit finders to engage in limited activities without registration as broker-dealers is presumably based on the idea that certain limited activities in relation to securities transactions do not create risks sufficient to warrant registration. § 1A:8 Doing Business As an Unregistered Broker-Dealer § 1A:8.1 SEC and State Enforcement Absent an exemption, a broker-dealer who engages in securities transactions without proper registration may be subject to enforce- ment actions by the SEC, relevant state regulators, as well as investor actions for rescission. The SEC and the state regulators have authority to enforce respective federal and state securities laws through admin- istrative proceedings, civil court proceedings, and referrals for criminal prosecutions. Exchange Act § 21(a)(1) grants the SEC the authority to make investigations to detect securities laws violations. Once it deter- mines that there is a violation, the SEC can enter a cease-and-desist order which may, in addition to requiring a person to cease and desist from committing a violation, require such person to comply with a rule upon such terms and within such time as the SEC may specify. The SEC can also impose civil penalties and require accounting and disgorgement. The SEC can also bring an action in court and seek permanent or temporary injunction or a restraining order against an unregistered broker-dealer. In addition to an injunction, the SEC may also seek civil penalties and equitable relief for such violation.468 In addition, the SEC may transmit such evidence of securities laws violations to the Attorney General, who may, in his discretion, institute the necessary criminal proceedings under the Exchange Act. In addition to SEC actions, an unregistered broker-dealer may also be subject to state enforcement actions under respective state blue sky laws.
As discussed in section 1A:1, most states have their own registration requirements. Under both the 1956 Uniform Act and the 2002 Uniform Act, as adopted by most states, a state regulator can initiate a civil action in court for a temporary or permanent injunction to enjoin a person’s act in violation of the registration requirement.470 The state regulator may also, under the 2002 Uniform Act, issue a cease-and-desist order or impose civil penalties on the unregistered broker-dealer.471 Under the 1956 Uniform Act, the state regulator can refer evidence to the attorney general or appropriate district attorney who may institute criminal proceedings against the unregistered broker-dealer.472 States have brought numerous enforcement actions against unregistered broker-dealers.473 In cases where fraud is in- volved, states have brought criminal charges against such broker- dealers. § 1A:8.2 Private Actions—Exchange Act § 29(b) Exchange Act § 29(b) provides that contracts made in violation of any provision of the Exchange Act or any rule thereunder are “void” (though, in reality, courts treat such contracts as being voidable rather than void ab initio). The Supreme Court has recognized a private right of rescission under this section. Section 29(b) renders void not only those contracts that “by their terms” violate the Exchange Act, but also those that involve a violation when made or as in fact performed. Although a contract engaging an unregistered broker- dealer in a securities transaction may not be illegal by its terms, the performance of it may involve a violation of section 15 (a) of the Exchange Act. In such cases, some courts have found the contract to be void and have allowed rescission under section 29(b). Courts have held that, under section 29(b), a contract is only voidable at the option of the innocent party, not the unregistered broker-dealer, and that the unregistered broker-dealer is not entitled to any fees as yet unpaid. However, when the services contracted for have been performed by an unregistered broker-dealer, courts have been unwilling to grant restitution of payments made for such services, except for those by which the defendant unregistered broker-dealer has been unjustly enriched.
A plaintiff in a section 29(b) action does not have to prove a causal connection between its harm and the defendant’s violation of the broker-dealer registration requirements. A plaintiff can avoid a contract by showing that: (i) the contract involved a “prohibited transaction;” (ii) he or she is in contractual privity with the defendant; and (iii) he or she is in the class of persons the Exchange Act was designed to protect. The plaintiff must demonstrate a direct relationship between the violation at issue and the performance of the contract; that is, the violation must be inseparable from the performance of the contract rather than collateral or tangential to the contract.485 If an agreement cannot be performed without violating the securities laws, that agreement is subject to rescission under section 29(b). As discussed in supra section 1A:1, states have their own registration requirements for broker-dealers doing business within the state. Many states’ securities laws have provisions modeled on section 29 of the Exchange Act, which allow parties to rescind contracts with unregistered broker-dealers. § 1A:8.3 Concerns for Controlling Persons Section 20 of the Exchange Act imposes liabilities on controlling persons and persons who aid and abet anyone in violation of the Exchange Act. Under section 20(a), every person who, directly or indirectly, controls any person liable under any provision of the Exchange Act or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action. Under section 20(e), any person that knowingly provides substantial assistance to another person in violation of the Exchange Act, or of any rule or regulation thereunder, shall be deemed to be in violation of such provision to the same extent as the person to whom such assistance is provided. Pursuant to sections 21(d)(1), (3) and (5) of the Exchange Act, the SEC can bring enforcement actions against such controlling persons and seek injunction or restraining order, money penalties or equitable relief. The SEC has filed numerous complaints against controlling persons who aided and abetted violations of Exchange Act § 15(a) and sought injunction or restraining order, disgorgement and prejudgment interest, or civil penalties.
Some state laws impose liabilities on controlling persons who materially aid in the acts or transactions constituting violations of the state securities laws. § 1A:8.4 Concerns for Registered Broker-Dealers [A] Compensation Sharing FINRA rules also prohibit FINRA members from engaging in any compensation sharing arrangements with non-members. The form of compensation is not limited to commissions, and can be in the form of concession, discount and allowances. Under NASD Rule 2410, no member shall offer a concession, discount, or other allowances to any person not actually engaged in the investment banking or securities business. NASD Rule 2740 provides the same restrictions in connection with the sale of securities which are part of a fixed price offering. NASD Rule 2420492 prohibits members from dealing with any non-member broker-dealer except at the same prices, for the same commissions or fees, and on the same terms and conditions as are by such member accorded to the general public. Members are not allowed to grant selling concession, discount or other allowances to non-members as they are allowed to grant to members. Rule 2420(d) provides restrictions on payments by or to persons that have been suspended or expelled. NASD Rule 2420(b)(2) also prohibits FINRA members from joining with any non-member broker-dealer in any syndicate or group for the distribution of securities. However, Rule 2420(c) allows members to pay concessions and fees to a non-member broker-dealer in a foreign country who is not eligible for membership subject to certain conditions.
On December 2, 2009, FINRA proposed for public comment FINRA Rule 2040 which would replace several NASD rules including NASD Rules 2410 and 2420.498 Proposed Rule 2040 would prohibit members or associated persons from paying or offering to pay, directly or indirectly, any compensation, fees, concessions, discounts, commissions or other allowances to any person that is not registered with the SEC as a broker-dealer but, by reason of receipt of any such payments, would be required to be so registered.
The proposed rule would be consistent with FINRA staff interpretations under NASD Rule 2420 and SEC rules and regulations under section 15(a) of the Exchange Act. Under the proposal, persons would look to SEC rules and regulations to determine whether the activities in question require registration as a broker-dealer under section 15(a) of the Exchange Act. [B] Participating in Syndicates with Unregistered Persons FINRA prohibits its members from participating in underwriting syndicates with unregistered persons. FINRA Rule 5110(f)(2)(L) forbids FINRA members from participating in underwriting syndicates with unregistered persons hired by the issuer primarily to assist in the public distributions of non-underwritten offerings except associated persons of the issuer who are exempt from broker-dealer registration under Rule 3a4-1 and applicable state law. [C] Aiding and Abetting Registered Broker-Dealers are liable for aiding and abetting operations of unregistered broker-dealers. Exchange Act § 20(e) provides that any person that knowingly provides substantial assistance to another person in violation of a provision of the Exchange Act, or of any rule or regulation issued thereunder, shall be deemed to be in violation of such provision to the same extent as the person to whom such assistance is provided. Pursuant to Exchange Act §§ 21(d)(1), (3) or (5), the SEC has brought enforcement actions against Registered Broker-Dealers for aiding and abetting unregistered broker-dealers in their securities transactions. Some state laws impose liabilities on Registered Broker-Dealers who materially aid in the acts or transactions constituting violations of the state securities laws. § 1A:8.5 Concerns for Issuers [A] Liability for Aiding and Abetting Issuers can face liability for knowingly aiding and abetting an unregistered broker-dealer. Exchange Act § 20 imposes liabilities on persons who aid and abet another person in violation of the Exchange Act and the SEC has brought enforcement actions against such issuers. Some state laws also have provisions that impose liabilities on persons who with knowledge assist another person in violation of state securities laws. [B] State Liability for Engaging Unlicensed Agents Besides liabilities from aiding and abetting, an issuer who engages unregistered broker-dealers can face private actions for rescission from investors. Some states have provided a private right of rescission for innocent parties who buy securities through unregistered broker- dealers. [C] Section 29 As discussed above, section 29(b) of the Exchange Act renders contracts involving a violation of section 15(a) void and provides for a private right of rescission for innocent parties. Securities - What is a BD 711.2 KB Delete Michael Gibson Wed, 6 Apr at 4:12pm more on the interpretation of fee based compensation: http://www.legayelaw.com/legalalerts?id=13 SEC Further Limits Use of Finders Fees The Securities and Exchange Commission’s (SEC) position on the payment of finder’s fees to non-registered broker-dealers has been further clarified in a request for a No-Action Letter, which was denied by the SEC. That clarification bodes poorly for those who are looking for a more expansive interpretation of the finder exemption from broker-dealer registration. Historically...The SEC has stated numerous times that the presence of any one of the factors would not necessarily cause the SEC to conclude that the person is acting as a broker in the transaction. The SEC denial of the No-Action Letter appears to change that presumption. In the SEC’s denial of the request for a No-Action Letter, the SEC stated that: “A person's receipt of transaction-based compensation in connection with these activities is a hallmark of broker-dealer activity”. Impact on Investment Banking Activities In addition to the impact on the payment of finder fees, especially in a “introduce and step away scenario”, the SEC cited a 2003 SEC Release related to auditor independence whereby it asserted that "a person may 'effect transactions’, among other ways … by helping an issuer to identify potential purchasers of securities”. Such activity has been viewed historically as more of an advisory activity, but it appears that when that activity is tied to transaction based compensation, the SEC now believes those activities will in all likelihood require registration as a broker-dealer.
While the activities of finders and subsequent payments to finders for the referral of potential clients have been the subject of numerous decisions and interpretations by the SEC, it appears that the SEC is moving away from its historical reliance on the balancing of the five factors as to whether it will require broker-dealer registration. The denial of the BMW request for a No-Action Letter clearly reflects that the current position of the SEC, at it appears to have transitioned to the payment of transaction based compensation as the primary factor to be considered with respect to the requirement to register as a broker-dealer. To the extent that there is a presumption established that if transaction based compensation is paid, all participants will need to be registered as a broker-dealer, or be subject to a specific exemption from registration, the issue of whether finders fees can be paid may become a moot issue. That will clearly have a significant impact on investment banking and private placement transactions. http://www.martindale.com/securities-law/article_Faegre-Benson-LLP_1071908.htm
The BMW no-action letter is the most recent example of the SEC's trend of narrowly interpreting the finder exception. The SEC's focus on the proposed transaction-based compensation suggests that the other three factors previously identified for determining whether broker-dealer registration is required carry little (if any) weight if transaction-based compensation is involved. The SEC's 1991 no-action letter involving the entertainer Paul Anka still suggests that if there is absolutely no contact between a purported finder and potential investors, the finder may be allowed to receive transaction-based compensation without registering as a broker-dealer. However, given the SEC's increasing focus on investor protection, the age of the Paul Anka letter and the lack of recent SEC responses granting no-action relief for finders seeking to receive transaction-based compensation, the SEC seems to be taking the position that any person who receives transaction-based compensation in a securities transaction is a broker under the Securities Exchange Act. The BMW no-action letter serves as a reminder that issuers seeking financing and finders seeking to comply with the law should be aware of the laws that apply to finders and broker-dealers, the ambiguities that exist in those laws and the potential consequences of non-compliance. http://www.easterntechnologycouncil.org/downloads/etc/eTechTimes/imPACT_dec10/ imPACT_DEC10_Dept_Corporate.html Beware of the pitfalls of engaging unlicensed brokers to raise capital Kathleen M. Shay John W. Kauffman By Kathleen M. Shay and John W. Kauffman, Duane Morris LLP Many companies seeking investment financing engage brokers or finders as intermediaries to assist with fundraising. What many of these companies fail to realize, however, is that the intermediary often must be licensed as a securities broker or dealer to accept payment for fundraising activity. Failure of an intermediary to register as a securities broker or dealer when necessary presents significant risks to both the intermediary and the company. Under Section 15 of the Securities Exchange Act of 1934 (Exchange Act), persons who make use of the mails or interstate commerce to effect any transaction in a security, or to induce or to attempt to induce the purchase or sale of a security, generally must register as a broker or a dealer. Section 3(a)(4) of the Exchange Act defines a broker as “any person engaged in the business of effecting transactions in securities for the account of others.”
The Securities and Exchange Commission (SEC) has increasingly interpreted these sections broadly. Most states regulate broker-dealers as well, and may have different interpretations of conduct that requires brokerdealer registration. For example, the Pennsylvania Securities Commission has unequivocally stated that “Pennsylvania does not allow the payment of finder’s fees for sales of securities to Pennsylvania residents.” The issue arises primarily when the intermediary’s compensation is based on the amount of money raised or is otherwise contingent on the sale of the securities. This is referred to as “transaction-based compensation.” Also relevant are the activities that the intermediary performs during the fundraising process. Activities cited to require registration include: advising on the merits of an investment; drafting or distributing offering materials; assisting in the completion of subscription agreements or securities purchase agreements; providing financing to or facilitating financing for an investor; handling securities or funds; and acting as a finder on a regular basis. Note, however, that employees and other affiliates of a company who participate in offering securities on behalf of the company are not required to be licensed if they are not compensated for their participation in the offering process by the payment of commissions or other remuneration based either directly or indirectly on transactions in the securities. Some SEC interpretations In the past, the SEC took a less restrictive position as to when a finder was required to register as a brokerdealer.
In the 1991 no-action letter issued to Paul Anka (available July 24, 1991), the SEC allowed a “finder’s exemption” notwithstanding a transaction-based compensation arrangement, citing the following representations made by Anka in his no-action request: he had a prior relationship with each prospective investor; he reasonably believed those investors to be accredited; he would not advertise, endorse or solicit investors; he would not directly contact potential investors but simply provide their names to the company; he would not provide financing to the investors; he would not perform due diligence or advise the prospective investors on valuation; and he did not regularly engage in the securities business and had never been a brokerdealer or registered representative of a broker-dealer.
The SEC has since limited the applicability of the Paul Anka no-action letter and has more recently taken the position that the existence of transaction-based compensation alone may be sufficient to require broker-dealer registration. For example, in June 2009, the SEC ordered sanctions against Ram Capital Resources, LLC, and two of its principals for acting as an unregistered broker-dealer in violation of the Exchange Act’s registration provisions. The specific activities cited by the SEC were: identifying potential private investment in public equity (PIPE) offerings; soliciting investors to invest in the PIPE offerings; identifying and engaging issuers to raise capital through PIPE offerings; acting as an intermediary between the issuers and investors, including structuring offerings, negotiating offering terms, and drafting and distributing term sheets; and charging a transaction-based fee equal to a percentage of the dollar amount raised. The SEC ordered Ram Capital and its principals to cease and desist from future violations of the Exchange Act’s broker-dealer registration requirements; censured Ram Capital; suspended the principals from association with any broker or dealer; and ordered each principal to pay a significant disgorgement fee and penalties. In a recent no-action response issued to Brumberg, Mackey & Wall, P.L.C. (available May 17, 2010), the SEC denied no-action relief to a firm seeking to provide finder services to a company because the firm would have received transaction-based compensation for introducing prospective investors who “may have an interest” in providing financing to the company through investments in securities. The SEC considered the firm’s introduction of only persons with a potential interest in investing in the company as “pre-screening” potential investors to determine their eligibility to purchase the securities and “pre-selling” the securities to gauge the investors’ interest.
For these reasons, the SEC believed that the firm would have a “salesman’s stake” in the proposed transactions and a heightened incentive to engage in sales efforts. Adverse consequences As demonstrated by the Ram Capital case, the consequences to an intermediary that fails to comply with the broker-dealer registration requirements can be onerous. Potential consequences include: the issuance of an injunction or cease and desist order; potential civil and criminal monetary penalties; a requirement to return commissions and fees; the refusal of a court to enforce a company’s agreement to pay the intermediary for its services; and denying the intermediary the right to register as a broker-dealer in the future. A company seeking to raise capital may also suffer significant adverse consequences from engaging an unlicensed intermediary. These consequences include: the right of the investors to rescind their purchases and receive the return of the amounts invested, or even to seek damages against the company; the imposition of civil and criminal penalties, including charges of aiding and abetting the unregistered broker-dealer’s securities law violations; and the imposition of sanctions barring the company from conducting private offerings under Regulation D of the Securities Act of 1933. These consequences could adversely affect a company’s ability to raise capital in the future, both privately and publicly, or to be acquired, due to adverse accounting implications and the imposition of future disclosure obligations, such as risk-factor disclosure. A possible solution The American Bar Association’s Task Force on Private Placement Broker-Dealers issued a report in 2005 recommending that the gap between the current regulation of broker-dealers and unregulated, unregistered finders be bridged by establishing a simplified system for the registration of private placement broker-dealers that would permit them to engage in limited activities and receive transaction-based compensation.
Implementation of this proposal could have the benefit of aiding capital formation in private placements while limiting the potential abuses that have raised concerns. Companies seeking to engage an intermediary to assist the company in raising capital should confirm the intermediary’s licensure status. If the intermediary is not registered as a broker-dealer, the relationship between the company and the intermediary should be carefully defined and circumscribed, and the compensation arrangement should be structured so as to avoid transaction-based compensation. Delete Michael Gibson Wed, 6 Apr at 4:30pm note: this article was written in 2002 and offers in more detail a very thorough explanation of the issues involved with the payment of fees to "finders".
This article was written prior to the BMW denial of no-action letter which many consider to be more restrictive in the interpretation of the payment of fees to non-registered persons today. http://www.allbusiness.com/legal/laws/933382-1.html Finder's fee agreements: Potential pitfalls and considerations The rush towards capital formation and strategic alliances often leads companies to engage the services of a "finder" to assist them in locating investors and raising capital. However, unsuspecting finders may become unnecessarily subject to regulation under the federal securities laws. This article examines how finder's fee agreements are treated under New York law generally and what potential pitfalls the drafter of finder's fee agreements should avoid. I. Background New York law recognizes a finder as "someone who finds, interests, introduces and brings parties together for a business transaction that the parties themselves negotiate and consummate." See Moore v. Sutton Resources, Ltd., 1998 WL 67664, *4 (S.D.N.Y. 1998) (citing Northeast General Corporation v. Wellington Advertising, Inc., 82 N.Y.2d 158, 163, 604 N.Y.S.2d 1 (1993)). Unlike a broker, a finder has no duty to bring the parties to an agreement, but instead acts as an intermediary or middleman. See Moore v. Sutton Resources, Ltd., 1998 WL 67664, *4. As one court has explained, "[f]inders find potential buyers or sellers, stimulate interest and bring parties together. Brokers bring the parties to an agreement on particular terms." See Train v. Ardshiel Assoc., Inc., 635 F.Supp. 274, 279 (S.D.N.Y. -- 1986), aff'd without opinion, 805 F.2d 391 (2d Cir. 1986). In the corporate financing context, a finder's compensation is generally based on a percentage of the amount invested by one party or, in circumstances involving mergers and acquisitions, a percentage of the transaction value.
II. Causation Requirement
For a finder to recover under the typical finder's agreement, there must be a causal relation between the introduction of the parties and the ultimate conclusion of the transaction. See Moore v. Sutton Resources, Ltd., 1998 WL 67664, *4; see also Simon v. Electrospace Corp., 28 N.Y.2d 136, 142, 320 N.Y.S.2d 225, 229 (1971); Edward Gottlieb, Inc. v. City & Commercial Communications PLC, 200 A.D.2d 395, 606 N.Y.S.2d 148, 150 (1st Dept 1994); Karelitz v. Damson Oil Corp., 820 F.2d 529, 531 (Ist Cir. 1987) (Breyer, J.) (applying New York law). Moreover, courts have consistently required that the finder show more than that his services was a necessary "but-for" condition. See Moore v. Sutton Resources, Ltd., 1998 WL 67664, *4, see also Karelitz v. Damson Oil Corp., 820 F.2d at 531. Rather, the finder must show that the final deal flowed directly from the introduction. See Moore v. Sutton Resources, Ltd., 1998 WL 67664, *4. Accordingly, the finder typically must establish a continuing connection between the finder's service and the ultimate transaction. See Moore v. Sutton Resources, Ltd., 1998 WL 67664, *4. One commentator has observed that this continuing connection is not dependent upon the finder's participation in negotiations, and a finder's fee may be payable even though a third person brings the party to agreement. Thus, if a finder introduces a prospective investor who enters into negotiations that are abandoned and later resumed, the causation requirement is probably satisfied if the renewed negotiations stem from the original introduction. See B. Fox & E. Fox, Corporate Acquisitions and Mergers, at 30.04(3)(1986). For example, in Simon v. Electrospace Corp., 32 A.D.2d 62, 299 N.Y.S.2d 712 (1st Dep't 1969), reversed as to damages, 28 N.Y.2d 136, 142, 320 N.Y.S.2d 225, 229 (1971), a finder introduced the defendant, Electrospace Corp. ("Electrospace"), to Louis Taxin ("Taxin"), for the purpose of arranging a merger with one of Taxin's companies. The finder had entered into an agreement which provided that "in the event you can effect the sale of the stock of this corporation . . . by introduction to a party or parties with whom a transaction will be thereafter consummated, then 5% of the gross value of the transaction will be paid as a commission to you at the time of closing." Although nothing came of the initial meetings, Electrospace and Taxin resumed their negotiations eighteen months later.
The Court of Appeals, in affirming the Appellate Court's decision that the finder was entitled to a finder's fee, held that the evidence was sufficient to establish a continuing connection between the finder's initial efforts and the merger that came about. See Simon v. Electrospace Corp., 28 N.Y.2d 136, 142, 320 N.Y.S.2d 225, 229 (1971).
III. Chain of Introductions Concept
The rush towards capital formation and strategic alliances often leads companies to engage the services of a "finder" to assist them in locating investors and raising capital. However, unsuspecting finders may become unnecessarily subject to regulation under the federal securities laws. This article examines how finder's fee agreements are treated under New York law generally and what potential pitfalls the drafter of finder's fee agreements should avoid. I. Background New York law recognizes a finder as "someone who finds, interests, introduces and brings parties together for a business transaction that the parties themselves negotiate and consummate." See Moore v. Sutton Resources, Ltd., 1998 WL 67664, *4 (S.D.N.Y. 1998) (citing Northeast General Corporation v. Wellington Advertising, Inc., 82 N.Y.2d 158, 163, 604 N.Y.S.2d 1 (1993)).
Unlike a broker, a finder has no duty to bring the parties to an agreement, but instead acts as an intermediary or middleman. See Moore v. Sutton Resources, Ltd., 1998 WL 67664, *4. As one court has explained, "[f]inders find potential buyers or sellers, stimulate interest and bring parties together. Brokers bring the parties to an agreement on particular terms." See Train v. Ardshiel Assoc., Inc., 635 F.Supp. 274, 279 (S.D.N.Y. -- 1986), aff'd without opinion, 805 F.2d 391 (2d Cir. 1986). In the corporate financing context, a finder's compensation is generally based on a percentage of the amount invested by one party or, in circumstances involving mergers and acquisitions, a percentage of the transaction value.
II. Causation Requirement
For a finder to recover under the typical finder's agreement, there must be a causal relation between the introduction of the parties and the ultimate conclusion of the transaction. See Moore v. Sutton Resources, Ltd., 1998 WL 67664, *4; see also Simon v. Electrospace Corp., 28 N.Y.2d 136, 142, 320 N.Y.S.2d 225, 229 (1971); Edward Gottlieb, Inc. v. City & Commercial Communications PLC, 200 A.D.2d 395, 606 N.Y.S.2d 148, 150 (1st Dept 1994); Karelitz v. Damson Oil Corp., 820 F.2d 529, 531 (Ist Cir. 1987) (Breyer, J.) (applying New York law). Moreover, courts have consistently required that the finder show more than that his services was a necessary "but-for" condition. See Moore v. Sutton Resources, Ltd., 1998 WL 67664, *4, see also Karelitz v. Damson Oil Corp., 820 F.2d at 531. Rather, the finder must show that the final deal flowed directly from the introduction. See Moore v. Sutton Resources, Ltd., 1998 WL 67664, *4. Accordingly, the finder typically must establish a continuing connection between the finder's service and the ultimate transaction. See Moore v. Sutton Resources, Ltd., 1998 WL 67664, *4. One commentator has observed that this continuing connection is not dependent upon the finder's participation in negotiations, and a finder's fee may be payable even though a third person brings the party to agreement. Thus, if a finder introduces a prospective investor who enters into negotiations that are abandoned and later resumed, the causation requirement is probably satisfied if the renewed negotiations stem from the original introduction. See B. Fox & E. Fox, Corporate Acquisitions and Mergers, at 30.04(3)(1986). For example, in Simon v. Electrospace Corp., 32 A.D.2d 62, 299 N.Y.S.2d 712 (1st Dep't 1969), reversed as to damages, 28 N.Y.2d 136, 142, 320 N.Y.S.2d 225, 229 (1971), a finder introduced the defendant, Electrospace Corp. ("Electrospace"), to Louis Taxin ("Taxin"), for the purpose of arranging a merger with one of Taxin's companies. The finder had entered into an agreement which provided that "in the event you can effect the sale of the stock of this corporation . . . by introduction to a party or parties with whom a transaction will be thereafter consummated, then 5% of the gross value of the transaction will be paid as a commission to you at the time of closing." Although nothing came of the initial meetings, Electrospace and Taxin resumed their negotiations eighteen months later. The Court of Appeals, in affirming the Appellate Court's decision that the finder was entitled to a finder's fee, held that the evidence was sufficient to establish a continuing connection between the finder's initial efforts and the merger that came about. See Simon v. Electrospace Corp., 28 N.Y.2d 136, 142, 320 N.Y.S.2d 225, 229 (1971).
III. Chain of Introductions Concept
Some courts have directed the payment of a finder's fee even in situations where the consummation of the transaction at issue culminated not directly from the finder's initial introduction but indirectly from a chain of introductions initiated by the finder's introduction. For example, Defren v. Russell, 71 A.D.2d 416, 422 N.Y.S. 2d 433 (Ist Dep't 1979), involved a finder's fee dispute in connection with a series of introductions that allegedly culminated in the acquisition of BioDynamics, Inc. ("Bio-Dynamics") by IMS International, Inc. ("IMS"). The plaintiff and Thomas Russell ("Russell"), Bio-Dynamic's president, had entered into a finder's agreement that stated that plaintiff would receive $75,000 for the consummation of the acquisition of all of the stock of Bio- Dynamics "with or through" Loeb, Rhoades & Co. ("Loeb, Rhoades"), and/or one of its affiliates. Id. at 435-36. After execution of the finders agreement, plaintiff introduced Russell to Peter Dixon ("Dixon"), a representative of Loeb, Rhoades who, along with plaintiff, was going to assist Russell in his efforts to sell the Bio-Dynamics stock. However, approximately 10 months later, Russell told plaintiff that he was going to sell the Bio- Dynamics stock on his own. Id. at 436. In fact, unknown to plaintiff, Russell continued to work closely with Dixon for the next two years in an attempt to sell the Bio-Dynamics stock.
After plaintiff made the initial introduction of Russell to Dixon, there was a long series of introductions which eventually culminated in the acquisition of BioDynamics by IMS. Id. In addressing whether plaintiff was entitled to a finder's fee pursuant to the finder's agreement, the court recognized that the more narrow question presented was whether plaintiff was entitled to recover on the basis of Loeb, Rhoades' efforts on Russell's behalf. Id. Preliminarily, the court noted that the finder's agreement provided that the consummation of the acquisition "with" or "through" Loeb, Rhoades would fulfill the terms of the agreement with respect to the plaintiffs performance thereunder. Id. The court then recognized that there was not the slightest indication that Russell would have become even aware of the existence of IMS except "through" the diligent services performed by Dixon. Id. Thus, the court held that in view of the fact that the Bio- Dynamics stock was sold to IMS through the efforts of Loeb, Rhoades, the plaintiff was entitled to recover a finder's fee of $75,000. Id. Similarly, in Seckendorff v. Halsey, Stuart & Co., 234 A.D. 61, 254 N.Y.S. 250, 260 (1st Dept 1931), rev'd on other grounds, 259 N.Y. 353 (1932), a plaintiff approached the investment banking firm of Rodgers Caldwell & Co. ("Rodgers Caldwell") to determine if it was interested in arranging bond financing for certain properties located in Washington, D.C. After the plaintiff described the properties, Rogers Caldwell entered into an agreement which provided that the plaintiff would receive a 1% commission on the par value of any securities' distributed to the public and 2% of any securities that Rogers Caldwell may receive as a bonus for handling the transaction. Id. at 254. After signing the agreement, Rogers Caldwell approached the investment firm of Halsey, Stuart & Co. ("Halsey") to inquire whether Halsey would be interested in heading the bond syndicate. Id. at 255. At this time, the plaintiffs agreement was brought to the attention of Halsey. However, Halsey indicated that it was not interested in participating in the bond financing. Id. at 256. Nevertheless, one year later, Halsey and Rogers Caldwell developed a different deal structure and ultimately financed the Washington D.C. properties without the plaintiffs knowledge.
In holding that the plaintiff was entitled to his commission under the agreement, the court recognized that Rogers Caldwell and Halsey were "in reality, partners or, at least, joint adventurers, and that Rogers Caldwell could legally bind its associates Halsey . . ." Id. at 255. Furthermore, the court found that without the plaintiffs introduction, there never would have been any bond issue because plaintiff himself was alone responsible for finding this business and bringing it to the defendants' attention. Id. at 260. Accordingly, the court held that the one year lapse in negotiations and different deal structure did not preclude the jury's finding that the transaction "flowed directly from" the plaintiffs original introduction. Id. at 261. Both the Defren and Seckendorff cases illustrate that drafters of finder's fee agreements should be cognizant of the "chain of introductions" concept. Accordingly, when drafting finder's fee agreements, the drafter may wish to include a provision entitling the finder to a fee if a transaction is ultimately consummated with any party that resulted from the finder's original introduction. Such a provision may, at the very least, clarify the scope of the finder's relationship and may avoid protracted litigation should a transaction be ultimately consummated with a third-party that was not directly introduced by the finder himself.
IV. Finder's Fee Agreements and the Federal Securities Laws
The federal securities laws generally govern whether a finder must register as a broker-dealer, or conduct its activities through a registered broker-dealer. Section 3(a)(4) of the Exchange Act defines "broker" as "any person engaged in the business of effecting transactions in securities for the account of others." Section 3(a)(5) of the Exchange Act defines "dealer" as "any person engaged in the business of buying and selling securities for his own account, through a broker or otherwise." Section 15(a)(1) of the Securities Exchange Act of 1934 (the "Exchange Act") provides that it is unlawful for any broker or dealer to effect any transaction in, or to induce or attempt to induce the purchase or sale of, any security unless such broker or dealer is registered with the Securities & Exchange Commission.
As one commentator has noted, although a pure finder may "induce the purchase or sale of" a security within the meaning of Section 15(a)(1), he or she is not normally a "broker" because he or she effects no transactions. See Louis Loss, Securities Regulation, Volume VI, page 3004, (1990). In addition, the staff of the Securities and Exchange Commission has issued certain no-action letters further interpreting these provisions. For example, in a no-action letter the staff explained: "[A]n intermediary who did nothing more than bring merger or acquisition-minded people or entities together and did not participate in negotiations or settlements between them probably would not be a broker in securities and not subject to the registration requirements of Section 15 of the Exchange Act; on the other hand, an intermediary who plays an integral role in negotiating and effecting mergers or acquisitions that involve transactions in securities generally would be deemed to be a broker and required to register with the Commission." See Henry C. Coppelt d/b/a/ May Pac Management Co., 1973-1974 Fed. Sec. L. Rep. (CCH), paragraph 79,814. In light of the SEC's no-action letter, potential finders should be wary of performing anything more than an intermediary role in bringing parties together for the purposes of consummating business transactions involving the purchase or sale of securities, otherwise they run the risk of being deemed unregistered brokers pursuant to the federal securities laws. In particular, finders should avoid offering investment advice in connection with their services.
Accordingly, finders and drafters of finder's fee agreements, should preliminarily determine what the finder's role will be in connection with any potential finder's arrangement. Furthermore, finders and drafters of finder's fee agreements should explore whether the finder's role will be restricted to merely bringing two parties together for a business transaction or whether the finder will assume a more active role in negotiating and structuring the ultimate financing arrangement. Only by examining the finder's duties can the practitioner determine whether the finder must register as a broker pursuant to the federal securities laws.
While the use of finder's fee agreements have become commonplace, finders and practitioners alike must be wary of potential pitfalls that may arise from such agreements. Before drafting any finder's agreement, the practitioner should first determine the extent of the finder's role in consummating the transaction at issue. In addition, the practitioner should evaluate whether the finder may be subject to regulation under the federal securities law.
Finally, after the practitioner has addressed these considerations, the practitioner may want to include a provision in the finder's fee agreement to ensure that the finder will be compensated from transactions that culminated from a chain of introductions initiated by the finder. Howard S. Meyers, Esq., C.P.A. Meyers & Heim LLP New York, New York Howard S. Meyers, Esq., C.P.A. is a former enforcement attorney with the Securities and Exchange Commission and is currently a partner in the law firm of Meyers & Heim LLP (www.MeyersandHeim.com) in New York City. The firm's areas of specialization include: NASD and NYSE Arbitration, Securities Litigation, Investment Advisor Regulation, Hedge Fund Formation and Compliance, White Collar Criminal Defense, Private Placements and Venture Capital. Mr. Meyers, a graduate of Temple University School of Law, is a member of the American Bar Association, American Institute of CPAs, Public Investors Arbitration Bar Association and the AAA-CPAs Delete Michael Gibson Mon, 2 May at 6:20pm a finding on the issue of compensation from California, where the majority of Regional Centers are located: http://www.primerus.com/news/resources_business/welcome-to-california-watch-out-for-those-speed-bumps/ Welcome to California: Watch Out For Those Speed Bumps! California has some quirky laws that often surprise lawyers from other states who are involved in Californiabased transactions. It is not always clear where some of our laws are going, or which direction a business person is meant to take.
To help you maneuver your way around these speed bumps, this series of articles explores some of the more unusual California laws that trip up or otherwise cause consternation to out-of-state attorneys involved in California transactions. In previous months we looked at California usury laws and country club memberships that could be treated as a securities offering. Introduction Imagine a start-up company trying to raise funds in California. As you would expect, the officers and directors of the company participate in the fundraising efforts as part of their duties. They are successful in selling stock and do not receive a commission for their participation in the sale of their company’s securities. They are not licensed as broker-dealers. They haven’t done anything illegal, right? Wrong! At least according to a recent California criminal case which held that an officer or director who participated in the sale of securities for his or her company without a broker-dealer license, even with no transaction-based compensation, was a criminal. People v. Cole According to the opinion in the 2007 case People v. Cole, an officer, founder, director or employee of an entity who participates in the sale of the entity’s securities, and does not receive commissions or special compensation based upon sales of the securities, is a “broker-dealer” as defined in Section 25004 of the California Corporate Securities Law, and is in criminal violation of the law if he or she is not registered as a broker-dealer under Section 25210. Thus, any person who, as a regular part of his or her employment or other duties to an entity, assists in the sale of its securities without the assistance of a licensed broker-dealer, is a criminal and could face time in prison along with major fines. The defendants in the Cole case claimed they were not selling securities in violation of licensing requirements because they were engaged in the selling activities on behalf of entities of which they were founders, officers and directors. Moreover, they were not receiving commissions or other transaction-based compensation in connection with the sales of the securities involved. They claimed they fit within the exclusion for “agents” in the definition of broker-dealer in Section 25004(a)(2), which provides that “broker-dealer does not include an agent, when an employee of an issuer.” Section 25003 defines “agent” as “any individual, other than a broker-dealer or a partner of a licensed broker-dealer, who represents a broker-dealer or who for compensation represents an issuer in effecting or attempting to effect purchases or sales of securities in this state.” However, Section 25003 goes on to say that an officer or director of the issuer is an agent only if he receives compensation specifically related to purchases or sales of the securities. The California appellate court rejected the defendants’ argument that they were excluded from the definition of broker-dealer because they were corporate officers and directors who sold promissory notes in their own entities.
The court held that the defendants did not fall within the exclusion for “agents” of an issuer because they did not receive commissions for the sale of the securities. The appellate court stated that allowing individuals to set up a corporation and sell securities without registration would conflict with the licensing statute’s purpose of protecting investors. Aftermath of Cole Case The Cole case creates a risk for all early stage California businesses, as well as businesses in other states which try to raise money in California. It is well known that virtually every early stage company must raise its capital without the assistance of a licensed broker-dealer. Therefore, if we believe Cole is good law, it follows that every officer, director, or other employee of such company who assists in that process is in violation of the licensing requirements of Section 25210, subjecting the person to criminal sanctions as exemplified in the Cole case. Furthermore, with the legislation that went into effect January 1, 2005, specifically Section 25501.5 of the Corporate Securities Law, unlicensed broker-dealers are unwittingly made “guarantors” of the success of the investment, no matter how complete and accurate the offering materials, and an argument may be made that the purchaser also has a rescission right against the issuer.
The Cole opinion unveiled a disconnect between practice, reality and law in California–not an unusual event. The problem in the Cole opinion was created by a literal reading of the law that was correct, but totally unintended by the legislature and not what the Department of Corporations believes the law to be or what the law has always been interpreted to be since its adoption in 1968. Gerald Niesar, co-author of this article, brought this disconnect to the attention of the Department of Corporations by a letter to the Commissioner of Corporations in March 2008. In response, the Department issued a release in October 2008 to provide some clarity regarding broker-dealer licensing requirements for officers and directors of issuers who do not receive commissions from effecting securities transactions. The release stated that the Cole decision had limited impact and should not be read to stand for the proposition that an issuer’s officers or directors must be licensed as broker-dealers unless they receive a commission for selling securities. The release stated that an overly broad reading of Cole would create tremendous burdens on businesses without providing corresponding investor protection.
The release stated that an officer or director of an issuer could be excluded from the definition of brokerdealer if he or she does not “engage in the business” of effecting transactions in securities, defined in Commissioner’s Opinion No. 98/1C as “business activity of a frequent or continuous nature.” Thus, an officer or director could fall outside the definition of broker-dealer if the person effects securities transactions on a single or occasional basis. The release went on to state that an officer or director of an issuer could be excluded from the definition of broker-dealer if he or she engages in the business of effecting securities transactions, if he or she does not receive a commission specific to effecting transactions in securities. However, this statement is contrary to the Cole court’s literal reading of the law. Reading the definition of “broker-dealer” together with the definition of “agent” in the Corporate Securities Law leads to the conclusion that an issuer’s officers and directors must be licensed as broker-dealers regardless of whether they receive a commission for selling securities. Conclusion The Department of Corporations’ October 2008 release appears to confirm the generally held position that, consistent with federal broker-dealer regulations, officers and directors who help their companies sell securities in California but do not receive transaction-based compensation are generally exempt from California brokerdealer registration requirements. As a practical matter, California securities lawyers, including ourselves, follow the Commissioner’s guidance in the October 2008 release. But the release does not resolve the uncertainty created by a literal reading of the Corporate Securities Law, as shown in the Cole opinion. According to the release, the Commissioner is considering the adoption of more formal regulations creating a safe harbor for officers and directors who do not receive a commission for selling securities. Such a development would provide sorely needed clarity on this issue to businesses seeking to raise capital in California. Copies of Gerald Niesar’s letter to the Commissioner, the Commissioner’s release, and other information relating to this subject matter may be found on our website nvlawllp.com. Delete Michael Gibson Mon, 2 May at 6:27pm Another post from California: http://jpostlaw.wordpress.com/taking-note/finders-and-unregistered-brokers/
Finders and Unregistered Brokers: Understanding the Limited Exemptions from Registration
While raising capital has always been a challenge for small and emerging growth companies, it is particularly difficult in the current economic environment. As a result, many companies are turning to financial intermediaries known as “finders” to facilitate the identification of potential sources of capital for private placement transactions. Finders make introductions and open up their contact lists for a fee, relying on the socalled “Finders’ Exemption” to broker-dealer registration. The problem with using finders, however, is that many are engaging in broker-dealer activity in violation of the registration requirements of the Securities Exchange Act of 1934 (“Exchange Act”) as well as California’s Corporate Securities Law of 1968 (“California Securities Law”). Often the finders themselves are unaware of the parameters of the “finders exemption” under federal law. Broker-Dealer Registration Section 15(a)(1) of the Exchange Act requires a “broker” to be registered with the SEC or, if a natural person, to be associated with a registered broker-dealer. “Broker” is defined broadly as any person engaged in the business of effecting transactions in securities for the account of others. According to the Securities and Exchange Commission (“SEC”), a person may “effect transactions” in securities by, among other ways, assisting an issuer to structure prospective securities transactions, by helping an issuer to identify potential purchasers of securities, or by soliciting securities transactions. A person may be “engaged in the business” of effecting transactions by, among other ways, receiving transaction-related compensation or by holding itself out as a broker-dealer. California Securities Law substantially mirrors the Exchange Act broker-dealer provisions. California Corporations Code Section 25004 defines a broker-dealer as any person engaged in the business of effecting transactions in securities in California. Under Section 25210, any person acting as a broker-dealer must be licensed by the Department of Corporations unless they are otherwise exempt.
Finders’ Exemption to Broker-Dealer Registration
The SEC has recognized a “Finders’ Exemption” to broker-dealer registration for a person who merely introduces a potential purchaser to an issuer and accepts a “finder’s fee” when a sale of securities results. However, this exemption has been narrowly applied, and it is the position of the SEC (and most state securities law administrators) that a person who accepts a finder’s fee more than once is probably “engaged in the business” of selling securities for compensation and is therefore required to register. Moreover, guidance from both the SEC and the Financial Industry Regulatory Authority (“FINRA”) suggests that very little finder activity would qualify for the Finders’ Exemption to registration, no matter how infrequently it occurs, and regardless of whether compensation is transaction-based. In its December 2005 Guide to Broker-Dealer Registration (“SEC Guide”), the SEC stated: Each of the following individuals and businesses may need to register as a broker, depending on a number of factors:
• Finders, business brokers,” and other individuals or entities that engage in the following activities:
• Finding investors or customers for, making referrals to, or splitting commissions with registered brokerdealers, investments companies or other securities intermediaries;
• Finding investors for issuers, even in a consultant capacity;
• Engaging in, or finding investors for, venture capital or angel financings, including private placements; and
• Finding buyers and sellers of businesses (i.e., activities relating to mergers and acquisitions where securities are involved). The SEC Guide further states that placement agents selling securities exempt from registration under Regulation D are not exempt from broker-dealer registration. In Notice-to-Members 05-18, FINRA cautioned its members against paying referral fees to real estate agents in connection with the sale of tenancy-in-common interests. Citing several SEC No-Action Letters, the Notice listed the following, as the types of activities the SEC has found require broker-dealer registration:
• Receiving transaction-based compensation;
• Participating in presentations or negotiations;
• Making securities recommendations or discussing or presenting the attributes of a securities investment;
• Structuring securities transactions; and
• Recommending lawyers, underwriters, or broker-dealers for the distribution or marketing of securities in the secondary market.
Not surprisingly, receiving transaction-based compensation tops the list of activities that requires broker-dealer registration. In a 1999 No-Action Letter, the SEC stated that receiving transaction-based compensation is “one of the hallmarks of being a broker-dealer.”
Given the stance taken toward finders in the SEC Guide and SEC No-Action Letters, it appears that any Finders’ Exemption to broker-dealer registration that may still be available would be extremely limited in scope. Consequences of Using an Unregistered Broker The consequences to an issuer of using an unregistered broker to assist in funding a private placement can be severe. When an unregistered broker is involved, the issuer can face regulatory action by the SEC and state authorities, and may face private actions by investors for damages. In addition the transaction may be subject to rescission under both federal and California law. Further, using an unregistered broker can compromise reliance on the Regulation D private placement exemption, risking unwinding the entire transaction and jeopardizing future private placement transactions, since a common sanction by the SEC in these circumstances is to bar the issuer from conducting Regulation D offerings in the future. The contingency created through the rescission right may also cause accounting complications and require that a risk factor concerning rescission be included in offering documents and certain public filings. Finally, the issuer may have difficulties in obtaining a legal opinion to close a transaction if investors demand one. The consequences to the unregistered broker can be equally severe. If the person acting as a finder is in fact deemed to be acting as an unregistered broker, the agreement with the issuer will be wholly unenforceable in court (leaving little or no resource to be compensated), and the finder will be susceptible to both civil and criminal penalties under both federal and state laws.
Recommendations Proceed with caution. While the use of finders in California is prevalent, the exemption is very narrow and the risks of utilizing an unregistered broker are not mitigated by the fact that the practice is widespread. Obviously, the least risky move is to use only registered brokers in any financing deal involving securities. An issuer can easily determine the registered status of an individual or entity by consulting the list of registered broker-dealers maintained by FINRA on its website.
If an issuer does decide to use a finder, there are steps it can take to minimize risk, including: • Researching the finder’s history of involvement in securities transactions; • Excluding the finder from negotiating or making recommendations regarding the transaction; • Carefully delineating the scope of the finder’s engagement in an agreement with the finder that would prohibit activities that only a registered broker can undertake; Limiting the finder’s compensation to a flat or hourly fee that is not contingent on the success of the transaction. Jennifer A. Post, Esq. Deanna Whitestone, Esq. Ms. Post has twenty years of experience representing issuers and investors in corporate, securities and finance matters. She is counsel to numerous public companies and acts as outside general counsel for them in all their corporate, transactional and SEC matters. Ms. Whitestone is an associate at the firm and is the leader of the firm’s broker-dealer regulation practice. She also specializes in representing issuers in connection with alternative public offerings, SEC compliance and pipe financings. Delete Michael Gibson Mon, 2 May at 6:34pm This is guidance for our members who are accountants and CPA's: http://www.nmmlaw.com/index.php?option=com_content&task=view&id=166&Itemid=28
ACCOUNTANTS SERVING AS SECURITIES INDUSTRY PROFESSIONALS: SOME CAUTIONARY NOTES Background and Scope
The new rules are the result of a multi-year effort by the American Institute of Certified Public Accountants (AICPA) to expand the permitted revenue base of accountants to encompass the already significant trend towards providing consulting and other business services, some of which are quite removed from the traditional tax and audit functions. The AICPA, functioning as the trade association for the profession, sought to allow accounting firms of all sizes to receive performance-based or transaction-based compensation in connection with this service line diversity. Other states have adopted similar revisions to their professional licensure laws and regulations governing the practice of accounting.... ....In each of these situations, if the accountant expects to receive compensation based on the securities purchase or sale transaction, he or she must be licensed as a registered representative. The SEC, in Rule 2420 the National Association of Securities Dealers (NASD), prohibits the payment of securities brokerage commissions to anyone who is not a licensed, (i.e., registered) securities professional.
Acting as an unregistered broker when registration is required under applicable law can have both criminal and civil consequences. At the least, the accountant would be subject to enforcement action by the SEC or a state regulator seeking an injunction against the wrongful activity and probably seeking a bar on that person becoming a registered broker for some period into the future. The client might well have grounds to recover commissions paid and, worse, the counter party to the client could have a basis to rescind the transaction tied solely to the unregistered status of the accountant, something unlikely to endear the accountant to the erstwhile client. These acts would pose the risk of substantial civil liability, forfeiture or suspension of the capacity to perform those services and the loss of clients. In extreme cases, especially where other abuses are present, criminal sanctions might be sought against the accountant. In order to be a registered broker licensed to sell securities, an individual must be employed by a registered broker/dealer firm (e.g., Merrill Lynch & Co, Inc., Ryan Beck & Co., Inc., Prudential Securities, Inc., etc.). Once employed or retained on a probationary basis, the individual must study and pass an examination, typically the Series 7 (general securities representative) or, if only mutual funds and annuities are involved, the Series 6 (investment company products/variable contracts representative) given by the North American Securities Administrators Association (NASAA) in conjunction with NASD. The examination requirement is imposed and enforced by the state securities regulators in the several states (the Bureau of Securities in the Division of Consumer Affairs of the Department of Law and Public Safety in New Jersey). The broker/dealer firm must have an up-to-date registration statement on Form BD on file with the SEC and with the state securities administrators in the states where the firm does business. In addition, the individual must have completed and filed an up-to-date Form U-4 with the appropriate state regulators. This is usually accomplished by filing the form with the Central Registration Depository (CRD) maintained by NASD. If the accountant wishes to continue to practice as an accountant, he or she must secure written dual employment authorization from both the broker/dealer firm and the accounting firm. The broker-accountant must also comply with significant books and records requirements and be able to pass muster in compliance examinations conducted by federal and state regulators.
Delete Michael Gibson Wed, 4 May at 11:05pm
SECURITIES and EXCHANGE COMMISSION CAPITAL FORMATION MAKING "FINDERS" VIABLE
Hugh H. Makens WARNER NORCROSS & JUDD LLP
Individuals or entities acting as unregistered financial intermediaries, "finders" or "investment bankers" (hereinafter "finders") constitute a major problem in corporate finance transactions and in the area of mergers and acquisitions. The vast majority of these persons are unregistered broker-dealers under federal and state securities laws, and accordingly transactions in which they are involve jeopardize the issuer, its officers and directors, and other investors because of the use of the unregistered/non-exempt person. Further, some of the individuals have adverse regulatory histories or were closely affiliated with those who had, and some even had been barred or suspended from broker-dealer or agent registration by regulators or convicted of financial fraud. The bad ones too often bring financial arrangements that do not work to the advantage of the entity seeking a merger or needing financing, and taint the legality of transactions in which they are involved. The Final Report of the 22nd Annual SEC Government-Business Forum on Small Business Capital Formation (December 2003) recognized the need for a new approach to the regulation of finders.
Their top recommendation stated: • The SEC should work with NASAA and the NASD to undertake the address the regulatory status of finders; • facilitate an appropriate role for finders in the capital-raising process; and • clarify the circumstances under which issuers and others can legally compensate finders and other capital formation specialists who meet minimum standards.
In undertaking this effort, the SEC staff should focus specifically on whether to create an exemption from broker-dealer and/or investment adviser registration requirements for certain finders or instead issue a new regulation enabling these finders to register under a simplified regime aimed at regulating finders engaging in a defined category of activities. Federal and state securities laws prohibit a person from being engaged in the business of effecting transaction in securities unless registered under applicable laws. These persons must attain membership in the National Association of Securities Dealers ("NASD") as well, and the individuals associated with the firm must hold a series of registrations relating to the right to sell, to supervise and to provide financial information.
There is a broad misperception in the market that there is an exception for a person who merely introduces a potential purchaser to an issuer and accepts a transaction-based fee for that introduction. This misperception, to the extent that it is supported by legal research, is usually based on incorrect interpretations of what constitutes doing business as a broker-dealer and certain no-action letters discussed below. There is a further perception that if one does a small number of these transactions, even for separate issuers, it is "okay." While that is true in some states, it is not true at the federal level. Problems relating to unregistered finders have been particularly prominent in the raising of early stage capital for smaller business. I believe that there is a vast "gray market" of unregistered brokerage activity where the funding for these companies, who generally can't access traditional brokerage firms for underwritings, is often obtained through unregistered financial intermediaries.
This opinion is based on discussions with many lawyers, accountants and issuers, as well as my experience with many of these individuals or entities who propose to act as "finders" without broker-dealer registration. Many finders, including accounting firms, law firms, nationally recognized consultants, retired executives from the brokerage industry and major corporations, and a long list of others, have avoided broker-dealer registration, arguing that the examinations they face have little to do with the way that their business is run; that the regulatory structure makes little sense for the nature of their business; that the process for getting registered is slow and arcane; that they may do only one or two transactions a year or even less; and that regulators are unable to adequately differentiate between the obligations of a retail broker-dealer and their activities. Issuers face a dramatic lack of understanding of the interpretive positions taken by the Securities & Exchange Commission (the "SEC" or the "Commission") in no-action letters. Attorneys for unregistered financial intermediaries may extrapolate SEC no-action letters into broad grants of authority and the cases brought by the SEC and the states have tended to focus on the fraud and unregistered status, without commenting on the nuances of the specific acts that differentiate types of conduct. This contrasts with the no-action letters where multiplicities of factors are analyzed in lengthy detail. Cases involving allegations against unregistered brokerdealers are frequent; cases discussing the nuances of finders are few. There is no general guidance on this subject from the SEC.
The perception of many ABA Business Law Section members, representatives of state bar association securities law committees and state regulators with whom I have discussed this issue is that the vast preponderance of finders in private corporate or similar finance transactions are in reality unregistered broker-dealers. Most surprising has been the large number of attorneys who have expressed interest in our project and concern over the frequency with which they encounter unregistered finders in their practices on a routine basis in private offering transactions. They strongly echo the need to take effective action create a system that will "really work" and lament the failure of the present regulatory procedures to competently address the finder problem. In addition to concern for their clients, attorneys often expressed frustration over the ability of promoters to obtain advice by attorneys that finder activity involving negotiation and transaction-based compensation was lawful rendered. These attorneys were either unaware of the SEC's interpretations or chose to ignore them.
PUTTING THE PROBLEM INTO PERSPECTIVE
Often in both acquisitions and business financings lawyers learn that finders are present. They can be both a blessing and a curse. As a source of funds otherwise unavailable to a client, or as the catalyst that leads to a successful acquisition, they are a boon to finance. As a purveyor of bad deals, bad relationships, securities law violations and the potential for rescission, they represent a major threat not only to the client but also to the professionals working with the client. Any system developed must screen out the undesirable individuals and entities while encouraging the legitimate ones. At their worst, unregistered financial intermediaries are the bane of the financing business. They appear at the beginning of an offering (but sometimes aren't discovered until later in the offering) and may have engaged in general advertising or solicitation before the attorneys arrive. They can be making offerings that violate the antifraud provisions of the federal and state securities laws. They can be the purveyors of that most worthless product in the securities industry - the "clean public shell."1 They can bring to the transaction the market manipulators and profiteers whose only interest is the trading profit from dumping their secretly accumulated shares, regardless of the consequences to the company or its investors. They can cause offers or sales to occur without regard to compliance with the very requirements of the securities offering exemptions they purport to rely on when advising an issuer.
The definition of an unregistered financial intermediary characterized as a "finder" is elusive and, indeed, it varies under the circumstances. In Use and Compensation of !‘Finders' To Locate Purchasers in Private Placements,2 the term is defined as "a person, be it a company, service or individual, who brings together buyers and sellers for a fee, but who has no active role in negotiations and may not bind either party to the transaction." In my view, the definition should be expanded to state "that the person should neither offer nor sell the security, nor solicit an offer to buy, but rather act strictly as an intermediary for the purpose of introducing the parties" to underscore this all too common problem of "finders" who are in reality nothing more than salespersons for an issuer. The SEC's Division of Market Regulation views even this suggested limited activity with skepticism when the activity is coupled with transaction-based compensation.
WHO ARE THE UNREGISTERED FINDERS?
Finders come from a variety of sources. They include CPAs and, to a lesser extent lawyers, M&A specialists, business brokers, local "monied people" (the country club set), consultants (who take a variety of forms), insurance agents and real estate brokers, registered representatives illegally selling away from their firms, individuals who have substantial investor networks or the people that work for such individuals, individuals hired by entities seeking capital, angel networks, retired executives and community leaders. They also include unregistered individuals or entities who hold themselves out as finders or investment bankers and do this for a living by providing business plans, private placement memorandum, and who may remain thereafter as paid consultants. Members of the Business Law Section and state bar association business law committees have observed a significant number of attorneys who provide opinions giving comfort to these unregistered financial intermediaries, while ignoring SEC no-action letters and federal and state enforcement actions leading to a different conclusion. They are frustrated with the "opinion shopping" that some issuers use to find an attorney who will give them a favorable opinion after experienced securities counsel has declined to do so. Generally these attorneys providing questionable opinions are solo or small firm practitioners with very limited securities experience and either no appreciation for the complexity of the analysis or a willingness to render opinions to accommodate a client.
WHAT PROBLEMS DOES ONE CONFRONT USING A FINDER?
Unregistered financial intermediaries can cause major problems for an issuer. They can taint an offering by creating the basis for rescission rights, raise enforcement concerns, make fraudulent representations and engage in general solicitation. They can be individuals who have been suspended or barred from the securities business or fired by firms for fraudulent misconduct. There are those who act in collusion with market manipulators and those who bribe registered representatives to act as touts. Use of these individuals often lead to litigation when the stock prices drop, as they frequently do. These financial intermediaries can provide encouragement to cut legal corners. They often under-price legitimate brokerage firms or deter issuers from going to legitimate firms. For an attorney, they are a major concern, since their actions adversely affect our ability to render customary legal opinions in transactions and harm our clients. These individuals often lead the issuer down a primrose path with false promises. They may add to the issuer's existing problems, create significant litigation or raise an enforcement action risk. The unregistered financial intermediaries' contracts can be incredibly over-bearing, significantly hampering future financing for the issuer.
After funding, issuers may find themselves faced with very unhappy investors who are angry over misrepresentations by the finders or drop in an artificially inflated price, and who demand rescission or the buyout of their shares. A consistent theme in the SEC proceedings against unregistered broker-dealers has been the lack of disclosure of compensation paid to such individuals or entities. While an issuer may have a belief that their offering complies with Regulation D, Rule 506, the failure to disclose that compensation in the presence of even a single non-accredited investors destroys the exemption for failure to meet the Rule 502 disclosure requirements. Further, almost all state laws contain a prohibition against payment of compensation to unregistered broker-dealers as a condition of their private offering exemption. Some states have gone further and expressly deny compensation to finders. If the finder is acting as an unregistered broker-dealer, that addition is surplusage, but to the extent that a role for finders remains, the prohibition reaches that compensation as well. The consequence of failure of improper payment is loss of the exemption, and the issuer may face a demand from the state securities agency for rescission, or any investors may be able to take advantage of the "put" that is provided by an illegal sale, and require rescission under Section 410 of the Uniform Securities Act, together with interest at the rate prescribed by the state. Finally, most such acts provide for attorney's fees to the person seeking rescission. The persons liable under state law include not only the issuer, but its officers and directors, as well as those involved in selling the securities.
Regulators have a substantial concern over the "finders" who flout the securities laws. I estimate that the various states bring well over 100 enforcement cases against unregistered finders on an annual basis (and probably a great deal more because statistics are not available from NASAA or the states to identify the full extent of state action). The NASD brings a large number of cases against individuals who are engaged in selling away from their brokerage firms for acting as unregistered financial intermediaries, often barring them from the business or imposing long suspensions.
This is the second most frequently cited grounds for sanctioning registered representatives and has been for the past several years. The NASD asserts that Code of Conduct Rule 3040 includes situations where the associated person's role in a transaction is limited to a client introduction and to eventual receipt of a finder's or referral fee. The NASD monthly Notice To Members which lists enforcement actions contains "selling away" allegations in virtually every issue. These actions represent only the tip of the iceberg of that problem.
The SEC brings dozens of these cases annually, but the manner of description of the cases circulated to the public focuses almost exclusively on the fraudulent conduct that occurs, and mentions only in passing the unregistered broker-dealer issue without details or explanation of the basis for the charge. These cases provide a great opportunity for better guidance, but the message is lost in the present descriptions of cases published in Exchange Act Releases. However, it is worth noting that among the allegations of fraud in such cases are the failure to disclose compensation paid to the unregistered broker-dealer, misrepresenting the cost of the offering and lying about the amount of commissions paid.9 The SEC has also barred persons from acting as finders.10 In one of its better publicized cases, the SEC alleged that a former Tyco Lead Director and Chairman of the Compensation Committee collected a secret $20 million finder's fee in conjunction with Tyco's 2001 acquisition of the CITI Group, Inc.
The illegitimate financial intermediaries, who are really unlicensed broker- dealers, were a direct cause of the SEC action in restricting the scope of Regulation S and Rule 504 in 1999. Regulators are also unhappy to find that the people that they have expelled from the business have resurfaced in a new guise.12 Today so-called "finders" are active in soliciting investors for a range of products which have been held to involve securities, including pay phone leases, viatical or life settlement contracts, promissory notes, foreign CDs, and "prime bank" scams. These areas of concern appear regularly in NASAA's Top Ten Investment Frauds which is published annually. Unregistered financial intermediary make it very difficult for smaller registered, reputable broker-dealers to become involved in raising funds. Unscrupulous entities and individuals can make exorbitant promises, enter into exclusionary contracts with unconscionable terms, and abuse the unsophisticated small businessman without much difficulty.
So what if one uses a finder? What are the consequences of participation by a non-registered broker-dealer in a transaction? A. Federal Securities Law. The starting place in the analysis is with the potential for action by the SEC. From the case law to date, it appears that if the Division of Enforcement staff at the SEC identifies an unregistered broker-dealer and there has been no fraudulent act committed, the staff is likely to urge registration and if that is forthcoming, close the matter. If there is fraud, it is far more likely that an enforcement action will be commenced. The SEC Divisions of Enforcement and Market Regulation do not have the staff to conduct the level of surveillance necessary to detect even a remote percentage of financial intermediary activity. An examination of websites for many of the unregistered financial intermediaries clearly discloses the activity, but there has been no sweep aimed at addressing the issue. A review of SEC enforcement cases indicates that most relevant cases name the issuer as well as the brokerdealer in the suit. However, these suits rarely deal exclusively with using an unregistered broker-dealer. On the contrary, the lawsuits generally involve multiple counts, including violations of the registration provisions for the securities themselves as well as violating the requirement that a broker-dealer be registered. The results of the lawsuits are driven primarily however, by the allegations of fraud and misrepresentation. Often the cases deal with a situation where an individual creates a scheme, and then sells the idea to unwitting investors. The investor's money is then used to pay off previous investors in a Ponzi scheme or to pay for personal purchases. I found no cases where a finder crossed the line into broker-dealer activity for which the issuer was then punished in the absence of such fraud. Finders and unregistered broker-dealers have been subject to permanent injunctions for failing to register and then selling securities. When fraud is involved, the SEC pursues disgorgement of the funds as well as civil penalties. These civil penalties are allowed pursuant to the 1990 Civil Remedies Act, the point of which was to punish perpetrators of fraud rather than simply putting them back in the position they would have been in had they not committed the fraudulent act. In one case, an individual who was not found to be a part of the fraudulent operations was still required to pay disgorgement on a theory of unjust enrichment. See, e.g. SEC v. Cross Financial Services, 908 F. Supp. 718 (1995). B. Civil Liability Under Federal Securities Laws. Unlike many state limited offering or equivalent exemptions, federal private offering exemptions do not condition the use of the exemption on the absence of payments to unregistered broker-dealers or finders. Thus, the issuer does not automatically lose its exemption pursuant to a violation of the securities registration provisions of federal securities laws. Instead, one must look to a three part analysis in determining potential civil liability. This section suggests that in any civil litigation an unregistered agent acting on behalf of the issuer will be compelled to return their commissions, fees and expenses; and that the issuer may justifiably refuse to pay commissions, fees and expenses at closing or recoup them at a later time. It also raises the question of whether the issuer can be compelled to repay these funds to an investor, since the unregistered broker-dealer is acting on behalf of the issuer.
The investor may also be entitled to return of his or her investment, since the purchase contract between the issuer and the investor is a contract which is part of an illegal arrangement with the unregistered financial intermediary, and that intermediary is engaged in the offer and sale of the security to the investor. The language to Section 29(b) is broad enough to permit such an interpretation. My research found little guidance on this type of case. Experience tells us that litigation involving unregistered broker-dealers or agents is often quickly settled. Furthermore, a reference to a state regulatory authority or the SEC will often produce compelling pressure for prompt return of the funds. C. Civil Liability Under State Securities Law. Section 402(b)(9) of the Uniform Securities Act as roughly adopted in most states provides generally that the exemption for a limited offering (usually to a small maximum number of persons) is exempt if no commission or similar remuneration is paid for the offer or sale of the securities other than to a registered broker-dealer or agent of the issuer. Some states have added a specific prohibition for payments to "finders." Thus a multi-state transaction done under Sections 4(2) or 3(b) of the 1933 Act will often require use of the 402(b)(9) state exemption to meet state law requirements. Thus, the ability of either the state or an investor to sue to recover or prevent payment of commissions is clear.
Likewise, many states have adopted the Uniform Limited Offering Exemption which applies to offering under Rule 505 of Regulation D, and the ULOE precludes payments in a manner similar to 402(b)(9). While Rule 505 is rarely used for offerings today, the state animus toward finders is reflected in the rules which incorporate the prohibition. Exemptions are also available under state law for sales to institutional investors (the definition varies somewhat from state to state); existing securities holders (in some states there is a numerical cap on the number of persons to whom sales can be made under this exemption); and in some states under the Model Accredited Investor exemption developed by NASAA. The principal problem for aggrieved investors under state law arises in transactions done under Rule 506 of Regulation D. Since Section 18(b)(4)(D) of the 1933 Act preempts much of state law relating to requiring registration of or an exemption for certain classes of securities, including offerings under Rule 506, the states lack the power to impose the prohibition of the payment of commissions to unregistered persons as a condition of the exemption which is found in several Uniform Act exemptions. Further, the failure to accurately disclose compensation to an unregistered financial intermediary will almost certainly be found to be a material non- disclosure, and a fraud claim will lie for that omission. As noted previously, states are now examining the Form D's to spot payments to unregistered finders. Sales in violation of the registration provisions of Section 101 of the Uniform Securities Act and sales by unregistered broker-dealers or agents are also voidable pursuant to an action under Section 410 of the Uniform Securities Act. SEC Finders 2004.pdf 431.2 KB Delete Michael Gibson Thu, 5 May at 9:02am Along with issuers, immigration attorneys, and accountants here may be a note of caution for securities attorneys and others who help prepare the offering documents for the issuers: September 2, 2009 1:09 PM Holland & Knight Sued Again in Nadel Ponzi Case Posted by Zach Lowe Holland & Knight has been hit with a second malpractice suit over its allegedly incomplete work in preparing offering documents sent to investors who put their money into funds that turned out to be part of an alleged Ponzi scheme, according to the Daily Business Review, an Am Law Daily sibling publication.
In the new suit, the court-appointed receiver for investors who lost money with alleged swindler Arthur Nadel accuses H&K lawyers of preparing documents that failed to disclose key information to investors--including the fact that Nadel was disbarred in New York in the 1980s for allegedly dipping into client escrow funds. That echoes allegations a group of investors aimed at the firm in a separate malpractice suit filed in state trial court in Florida in March, as we reported then. The new suit seeks $50 million in punitive damages. The original suit also faulted H&K for signing off on offering documents between 2003 and 2006 that failed to clearly note that the accountant for Nadel's funds was not a certified public accountant. (Some offering documents did state that fact clearly, however).
Holland & Knight has vowed to vigorously defend itself against both suits, according to the Daily Business Review. And in March, Peter Henning, a white-collar crime expert who teaches at Wayne State University, told us plaintiffs would have a difficult time winning a malpractice case against the firm. To do so, he said, plaintiffs would have to prove they became direct clients of Holland & Knight through their investment with Nadel. (Henning said plaintiffs might have an easier time proving negligent representation, though their fate on that claim would rest primarily on whether Holland & Knight prepared the offering documents or simply reviewed them.) The suit filed this week also accuses the firm of breach of fiduciary duty and aiding and abetting both breach of fiduciary duty and fraud, the Daily Business Review reports. Ruling in Sarasota lawsuit against Nadel's lawyers By Michael Pollick Published: Thursday, March 11, 2010 at 1:00 a.m. Florida’s most powerful law firm, Holland & Knight, came into Sarasota Circuit Court this week in an all-out effort for dismissal of a lawsuit that attempts to tie the firm to wrongdoing at Scoop Management, the hedgefund- operator-turned-Ponzi scheme run from downtown Sarasota until a year ago. The lawsuit — alleging conflicts of interest and lack of due diligence on the part of the firm — will be allowed to proceed on behalf of the receiver who is working to recover money for investors, Circuit Court Judge Rick DeFuria ruled. But, after listening to the lengthy Holland & Knight pleading backed up by 50 relevant cases, DeFuria threw out three of the six plaintiffs: three funds for which Arthur Nadel acted as both general partner and trader. Through their court-appointed receiver, the remaining plaintiffs are the three funds for whom the general partners were the father-and-son team of Neil and Chris Moody: Valhalla Investment Partners, Viking Fund, and Viking IRA Fund.
The defendants remain unchanged: Holland & Knight, plus partner Scott R. MacLeod, who spearheaded the firm’s work on behalf of Scoop and its hedge funds. It is still unclear how the judge’s ruling affects the potential for monetary awards, should Holland & Knight lose the case. In a report to the U.S. Securities and Exchange Commission, receiver Burton Wiand said last fall that the damages from the malpractice suit could be about $50 million. After a year in a holding cell in Manhattan, Nadel last month pleaded guilty to the 15 felony fraud counts against him. The 77-year-old faces sentencing June 11. Earlier in February, Neil and Chris Moody consented to civil fraud charges filed by the SEC. Separately, Holland & Knight is the defendant in a proposed federal class-action lawsuit in Tampa that claims the firm failed to protect investors. Guy Burns, the same Tampa lawyer who represents the receiver in the Sarasota case, is suing the firm on behalf of the victims in the federal case. The grounds in the two cases are similar but rely on differing statutes — federal and state. Holland & Knight is being taken to task in both cases for preparing prospectuses for the Scoop hedge funds without informing investors that Nadel had been disbarred in New York state for stealing money from a client’s escrow fund. The way the three Nadel funds were removed from the circuit court case was surprising, and occurred after courtroom observers thought the judge’s ruling was finished.
Holland & Knight hired a team of lawyers from Miami to argue a multi-faceted motion asking for the case to be dismissed. The Miami law firm of Kenny Nachwalter P.A. presented DeFuria with a 3-inch-thick legal binder containing judicial decisions it said supported its position. The Miami lawyers argued the case was “a poorly camouflaged attempt by plaintiffs, a group of investment funds, to blame their law firm for their own fraudulent, and, indeed, criminal conduct.” Another argument was that the funds and Nadel were virtually synonymous. It was irrational for the funds, over which Nadel appeared to exercise near-complete control, to be able to sue Holland & Knight for not outing Nadel, the defense attorneys argued. After more than two hours of legal fencing, DeFuria took a break to study the paperwork. When he returned, he issued what at first appeared to be a ruling that was completely in favor of the plaintiffs, allowing the whole case to proceed against Holland & Knight. DeFuria said that when considering a motion to dismiss, Florida law directed him to look at the case in the light most favorable to the plaintiffs, and to assume that all their allegations were true. He went through his thought process out loud, so that it could be recorded by the court reporter for later use. When it seemed like the judge had finished his oral ruling, finding completely in favor of the plaintiffs, Guy Burns, the Tampa attorney who presented the plaintiffs’ arguments, began casually addressing the court reporter and requesting a transcript. That is when Richard H. Critchlow, the Miami lawyer who did the talking for Holland & Knight, asked a question: Was the judge’s ruling intended to apply to all six of the funds, even the ones for which Nadel was the “sole actor.”
DeFuria thanked Critchlow for reminding him of that aspect of the motion, then said that he would dismiss those three funds as plaintiffs, adding, “I felt he really did have sole control.” The court was scheduled to entertain a separate motion on behalf of the receivership to expedite the case, owing to the advanced age of many of the Scoop victims. But because it took roughly three hours to get through the motion to dismiss, DeFuria told the lawyers that he would take the other motion on another day. This story appeared in print on page D1 Copyright © 2011 HeraldTribune.com — All rights reserved. Restricted use only. Judge Lets Stand Nadel Receiver's Lawsuit Against Holland & Knight Julie Kay 03-17-2010
A Sarasota, Fla., judge dismissed some counts but let stand malpractice and breach of fiduciary duty charges in a lawsuit filed against Holland & Knight by the receiver in a $168 million Ponzi scheme. The rulings by Circuit Judge Rick DeFuria keep alive a suit filed last year by Burton Wiand against the law firm and one of its partners, Scott MacLeod. Wiand of Wiand Guerra King of Tampa was appointed receiver in January 2009 to try to recover funds from indicted Sarasota hedge fund manager Arthur Nadel. Nadel, 77, pleaded guilty last month to 15 counts of operating a Ponzi scheme in Sarasota from 1999 to 2009. In a case that has been compared to Bernard Madoff's, Nadel's investors thought they were investing in a variety of hedge funds under Nadel's control or association. He is awaiting sentencing in a New York prison and faces up to 300 years. Wiand hired the law firm Johnson Pope Bokor Ruppel & Burns of Tampa to sue Holland & Knight for allegedly preparing disclosure documents for investors that failed to mention Nadel was a disbarred New York attorney who had drained a client's escrow account. The suit also accuses Holland of conflicts of interest for representing Nadel and his investment funds simultaneously. Wiand is seeking up to $168 million from Holland, equal to the amount of the Ponzi loss.
A separate class action suit brought by investors is pending in Tampa federal court with motions to dismiss filed by Holland & Knight. Last week, Holland & Knight's team of lawyers from the Miami law firm of Kenny Nachwalter argued to dismiss the state suit. DeFuria agreed to dismiss counts alleging Holland aided and abetted the fraud but let stand counts alleging malpractice and breach of fiduciary duty. The dismissals were without prejudice, and Wiand said he is considering whether to file amended pleadings on those counts. "The major portion of the case is still in place," he said. "The case will proceed." Holland & Knight spokeswoman Olivia Martinez referred calls to the firm's outside counsel. Attorneys at Kenny Nachwalter declined comment. Previously, Karen McBride, a spokeswoman for Holland & Knight, told The Daily Business Review, "the firm's position remains unchanged. We've done nothing wrong, and we intend to vigorously defend this."
In an unusual twist, DeFuria also verbally agreed to throw out three of the six hedge funds named in the suit, then restored them in a written order issued two days later. The original ruling occurred when, in an offhand remark after the hearing, lawyers for Holland & Knight asked DeFuria whether the judge's ruling applied to all six of the hedge funds, even the ones over which Nadel had complete control. DeFuria noted he would dismiss those three hedge funds -- Scoop Real Estate, Victory Ira Fund and Victory Fund -- and thanked Holland's lawyers for pointing out the distinction. "There was some confusion at the end of the hearing, and the judge indicated he realized he misspoke," Wiand said.
Knocking three of the hedge funds out of the case "would have had some impact on the case, but it still is a very significant case one way or another." The case is being closely watched in Sarasota, where many of the wealthy, elderly investors live. Wiand rejected any notion that pressure was brought to bear on DeFuria by angry citizens. "I would say that's absurd," he said. "I know of no basis of thinking that of any kind. If you read his analysis, you will see he just misspoke at the end. That is nonsense." No trial date has been set for the case. Asked whether he is negotiating with Holland & Knight, Wiand said, "I wouldn't tell you even if I was."
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