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6 Factors to Determine if You Are an Unregistered Broker

Post on: September 17, 2018 | Brandy Brown | 0

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Last year, the SEC reported 53 standalone enforcement actions in its “Broker Dealer” category. As a matter of public policy, indemnification for securities violations is generally prohibited. As a result, a person found to have acted as an unregistered broker may be personally liable. No illegal or criminal mindset is required for violating these regulations, and many people may not even realize they qualify as a “broker.”

Under the Securities Exchange Act a broker is “any person engaged in the business of effecting transactions in securities for the account of others.” In determining whether a person meets this broad definition, and thus is subject to the act’s prohibition against acting as unregistered broker, most jurisdictions consider six factors[i]:

  • Regular participation in securities transactions;
  • Employment with the issuer of the securities;
  • Payment by commission as opposed to salary;
  • History of selling the securities of other issuers;
  • Involvement in advice to investors; and
  • Active recruitment of investors.

No single factor is determinative, and most courts do not require the SEC to establish all six factors to prove that a party is acting as an unregistered broker. The primary consideration is whether some combination of the Hansen factors demonstrates involvement at “key points in the chain of distribution,” including participation in negotiations, analysis of the issuer’s financial needs, discussion of transaction details, and recommendation of an investment.[ii]

In one exemplary case[iii], the defendant conclusively met each of the Hansen factors except employment with the issuer of the securities. Instead of disputing analysis of these factors, the defendant unsuccessfully argued that he acted as a “finder” rather than a broker. The Eighth Circuit, unimpressed with this distinction, refused to recognize a “finder defense” to those who are otherwise considered brokers under the Securities Exchange Act.

An extremely limited so-called “finder’s exception” has been interpreted as allowing an individual to engage in a narrow scope of activities without triggering the Act’s broker registration requirements. For example, simply bringing together the parties to the purchase and sale of securities does not require registration. In a series of “no-action” letters, the Commission advised that there is also no need for registration merely because a “finder” receives a percentage of the total payment rather than a flat fee. However, industry actors should note that payment of a flat fee is no guarantee that the payment will be regarded as non-commission compensation under the Hansen broker analysis.

In one case, the Sixth Circuit easily concluded that the defendant was acting as a broker despite receiving no compensation at all. He was not employed by the issuer, but was “regularly involved in communications with and recruitment of investors for the purchase of securities.”[iv] Similarly, defendants “plainly acted as brokers” although they were not employed by the issuers because they affirmatively solicited investors, acted as “middlemen” between the investors and issuers, received transaction-based commissions, participated in the sale of stock of multiple issuers over a period of several years, and assisted in negotiations.[v]

In sum, the distinction between a finder and a broker is still largely unexplored due to the highly fact-specific nature of both relevant case law and the Commission’s “no-action” advice letters. Despite implicit references to the narrow finder’s exception, the courts have thus far declined to expressly assert whether finders are necessarily also brokers under the Securities Exchange Act. The broad terms of the Hansen factors render an expansive range of activities likely to trigger broker registration requirements. With potential consequences including a forced right of rescission allowing investors to demand their money back on an offering, disgorgement of earned commissions, and prohibitions on raising future capital, industry actors should take care to continually assess whether the court would consider them unlicensed brokers under the six factors outlined above.

 

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[i] SEC v. Hansen, S.D.N.Y. No. 83 CIV. 3692, 1984 WL 2413, at *10 (S.D.N.Y. Apr. 6, 1984)
[ii] Massachusetts Fin. Services, Inc. v. Sec. Inv'r Prot. Corp., 411 F. Supp. 411, 415 (D. Mass. 1976), aff'd, 545 F.2d 754 (1st Cir. 1976).
[iii] United States Sec. & Exch. Comm'n v. Collyard, 861 F.3d 760 (8th Cir. 2017),
[iv] S.E.C. v. George, 426 F.3d 786, 797 (6th Cir. 2005).
[v] S.E.C. v. Martino, 255 F. Supp. 2d 268, 283-84 (S.D.N.Y. 2003).

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About author

Brandy Brown

Brandy is part of the legal team at WealthForge, where she focuses on GDPR cybersecurity compliance and handles tasks ranging from corporate governance and regulatory matters to intellectual property management. Brandy earned a bachelor’s degree from the University of Central Florida and is currently a law student at the University of Richmond, where she researches securities litigation and serves as both Secretary and Hospitality Chair to the Client Counseling and Negotiation Board.
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