The Securities and Exchange Commission (“SEC”) has disciplined firms and individuals for broker-dealer registration issues for private fund marketing activities and more recently in June 2016 the SEC took enforcement actions against Blackstreet Capital Management.[1] [2] [3] We would expect the regulatory focus to continue in light of general solicitation and general advertising in Rule 506 private offerings permitted by the Jumpstart Our Business Startups (JOBS) Act. However, President Elect Trump has stated that his administration may rollback regulatory initiatives that occurred under the Obama Administration. While we cannot predict how the SEC will change under the new Administration, we think it is important to bring this issue to your attention.
Potential broker-dealer registration issues arise when private funds raise capital from investors in private (unregistered) securities offerings using its own employees or third party “finders” to locate investors. When these individuals solicit investors on a regular basis or are specifically compensated for their efforts, they may be required to register as a broker or to be associated with a registered broker-dealer.
A company or individual acting as an unregistered broker-dealer in violation of registration requirements faces possible SEC enforcement action, monetary penalties and investor lawsuits seeking rescission of the investment. Registering as a broker-dealer subjects a firm to SEC, Financial Industry Regulatory Authority (“FINRA”) and/or state securities regulators.
Broker-Dealer registration requirement is primary based on whether the person:
The Issuer Exemption: Issuers are generally not “brokers” because they sell securities for their own accounts and not for the account of others. Issuers generally are not “dealers” because they do not buy and sell securities for their own accounts as a part of a regular business. However, the “issuer exemption” does not apply to the personnel of a company who routinely engages in the business of effecting securities transactions for the company or related companies (such as general partners seeking investors in limited partnerships)[4].
Rule 3a4-1 provides a safe harbor from broker registration and exempts people associated with an issuer who participate in the sale of the issuer’s securities. Under the safe harbor, an associated person will not be deemed a broker if, among other things, the person:
“Finders” who do nothing more than introduce prospective investors to the issuer, do not participate in negotiating the transaction, and who receive compensation but not dependent on or related to the purchase of a security are “finders,” not “brokers,” and are not required to be registered[5].
The SEC has cautioned that persons who find investors for issuers, even in a “consultant” capacity, may need to register as a broker if the finder:
The federal securities laws do not specifically define the term “finder” or outline what finders can do. Instead, finders must avoid being deemed a broker or dealer under the federal securities laws unless they register as such with the SEC and FINRA. The following facts are typical of finders who would not need to register as a broker-dealer:
State law under the Uniform Securities Act, adopted by many states; issuers selling their own securities are exempt from broker-dealer registration. An employee or other individual who represents an issuer is exempt if no commission or other remuneration is paid for soliciting investors.
The JOBS Act, among other things, directed the SEC to revise its rules to permit general solicitation and general advertising in offerings under Rule 506 of Regulation D, provided all purchasers in the offering are accredited investors. The JOBS Act also added a new exemption from broker-dealer registration for online platforms that are used to market securities in Rule 506 offerings (so-called “Regulation D portals”). This exemption is separate from the JOBS Act exemption for crowd funding portals.
The new online platform exemption permits a person, in a Rule 506 offering, to (1) maintain a platform or mechanism that permits the offer, sale, purchase, negotiation, general solicitations, general advertisements, or similar activities by issuers, whether online, in person, or through other means, (2) co-invest in the offering, or (3) provide ancillary services (due diligence services or standardized documents), if certain condition are met.
Online platforms relying on the exemption:
The SEC staff has stated that persons associated with an issuer in a Rule 506 offering may rely on the exemption to maintain an online platform, but that employees or other persons who receive a salary or other compensation to promote the issuer’s securities cannot.
Conclusion
RIAs must be cautious in monitoring their activities for compliance with SEC Rules and general advertising in Rule 506 offerings to accredited investors permitted by the JOBS Act including broker-dealer registration issues relating to private fund marketing activities using employees or other unregistered persons to solicit investor capital.
http://www.ncsregcomp.com/team/doug-kamin/
[1] SEC: Private Equity Fund Adviser Acted As Unregistered Broker https://www.sec.gov/news/pressrelease/2016-100.html
[2] Ranieri Partners LLC http://www.sec.gov/News/PressRelease/Detail/PressRelease/1365171513172
[3] SEC v. Banc de Binary Ltd., et al. https://www.sec.gov/litigation/litreleases/2016/lr23481.htm.
[4] https://www.sec.gov/divisions/marketreg/bdguide.htm
[5] No-action letters support this position, however, the SEC has not created a “finder’s exemption.”