In recent news, several cases have emerged where the SEC has taken action further revealing a common issue we continue to observe in the marketplace—the involvement of unregistered individuals in securities transactions.
We’ve addressed this topic previously in our blog posts on Why It's Important to Understand Section 15 of the '34 Act and Private Markets Experience Another Influential SEC Action. Unfortunately, this is an ongoing issue. Let's take a look at some recent cases from the SEC.
Portfolio Management by a Serial Issuer
On June 1, 2016, the SEC instituted a cease-and-desist proceeding against Blackstreet Capital Management LLC (“BCM”) and its owner.1 Of the several violations at issue in the case, including misappropriation of investor funds, is BCM’s collection of transaction-based compensation for taking fees for brokerage services. “Rather than employing investment banks or broker-dealers to provide brokerage services . . . BCM performed these services in-house, including soliciting deals, identifying buyers or sellers, negotiating and structuring transactions, arranging financing, and executing the transactions.” Notably, the illegal compensation was permitted by applicable partnership agreements for placing investments into funds constructed as affiliated special purpose vehicles.
The SEC has pursued several actions against online private security "exchanges." In October 2015, the SEC instituted administrative and cease-and-desist proceedings pursuant to Section 15(a)(1) against an online securities services provider.2 The order points out that although they were not “associated with a registered broker-dealer . . . they have offered and agreed to effect securities transactions for customers over the Internet” and they “held themselves out as broker-dealers that provide broker-dealer services and other ‘issuer services.’” Although the order also mentioned the illicit transaction-based compensation for these services, the order separately calls out that the respondents conducted certain activities without appropriate registration as broker-dealers. In this case, the site also made several false representations to prospective securities issuers and investors regarding its capabilities.
Enforcement action on the registration requirement is not limited to companies or platforms. On May 18, 2016, and May 5, 2016, respectively, the SEC took action against Salvator Rinaldi and James Trolice for misappropriating investor funds and omitting material facts.3 Renaldi “solicited investors directly and through sales agents, to whom he paid commissions and provided offering materials for investors, at a time when he was neither registered as nor associated with a broker-dealer,” and Trolice “was not associated with a registered broker or dealer while soliciting investments for the LLCs and handling investors’ funds.”
While the facts in each of these cases mentioned above is extensive, there are commonalities to the allegations. Specifically, the defendants:
- Engaged in providing blatant misinformation to investors and misappropriated investor funds completely for personal use; and
- Solicited investors without being registered or associated with a registered broker-dealer.
The first is avoidable (and you would think a no-brainer): do not knowingly lie about an offering and do not misuse investor funds for your own personal spending. The second is often not as intuitive. Enforcement actions are often tied to blatant misuse of investor funds. However, the SEC remains keen on ensuring emerging industries, such as internet-based private placement transactions, follow registration requirements. The registration requirement is easy to run afoul of, easy for enforcement to spot, and extremely unforgiving: if you're required to be registered, the guidelines are clear whether you're registered or not.
The Registration Requirement
Section 15(a)(1) of the Exchange Act, which makes it unlawful for an unregistered broker or dealer to “effect any transactions in, or induce or attempt to induce the purchase or sale of any security.”
Thus, Section 15(a) is invoked not only when securities change hands but also when a party is facilitating or inducing the securities to change hands.
Think of the services being provided: if a person or entity sells, or helps to sell a security, Section 15(a) applies. Stated differently, if you answer “yes” to the following question: “Am I helping to facilitate a securities offering?” in even the broadest sense, you should seek legal advice on whether you're required to register as a broker.
Often, the requirement is invoked when an affiliated person of an issuer runs afoul of the non-exclusive safe harbor afforded under Rule 3a4-1, often called the Issuer Exemption Safe Harbor. Our whitepaper on the Issuer Exemption provides an in-depth look at this rule .
New technology coupled with new regulations has fueled the appetite for private securities. The pervasiveness of - and resulting attention on - start-ups, tech companies, and new and complex capital raising models have created a plethora of big ideas in the marketplace. Unfortunately, some of those big ideas have come from not only bad actors, but also the uninformed who haven't been proactive with regulatory compliance. It's important to keep in mind the emphasis of activities relating to a securities offering as they pertain to the Section 15(a) requirement.
Top 4 Things to Keep in Mind
- Receipt of transaction-based compensation isn't the only factor giving rise to the registration requirement—your role in the offering matters.
- Unless the specific requirements of the Issuer Exemption Safe Harbor are met, the registration requirement under Section 15(a) applies to individuals and intermediaries that:
(a) Solicit investment in private offerings, including issuers; and
(b) “Effect” securities transactions as broadly construed by the SEC.
- Entering into a contract to perform certain types of offering services doesn't make your provision of those services or payment for those services legal according to the SEC.
- The SEC is keenly monitoring activity of unregistered individuals and entities.
Learn about the regulatory process, how much it costs, and when you should outsource. Download our "Building a Broker-Dealer" E-guide.
1 See Blackstreet Capital Mgmt., Exchange Act Release No. 77959, Investment Advisers Act Release No. 4411, 2016 WL 3072131 (June 1, 2016).
2 See Steven J. Muehler, Exchange Act Release No. 75996, 2015 WL 5692555 (Sept. 28, 2015).
3 See Salvatore Renaldi, Exchange Act Release No. 77852, 2016 WL 2894685 (May 18, 2016); Complaint, SEC v. Trolice, No. 2:16-cv-02513, 2016 WL 2347068 (D. N.J. May 4, 2016).
Disclaimer: WealthForge provides this information to our clients and other friends for educational purposes only. It should not be construed or relied upon as legal advice.