Section 15(a)(1) of the Exchange Act of 1934 makes it unlawful for a broker or dealer to “effect any transactions in, or induce or attempt to induce the purchase or sale of any security” without registering with the SEC and joining FINRA. As a baseline, the law requires you to register if you are a part of securities changing hands or if you help facilitate a securities transaction. The prohibited activities are broad, and regulators enforce the requirement accordingly.
This page provides an in-depth look at the broker registration requirement. For an even deeper dive, download our complimentary e-book.
Under SEC guidance, a person may need to register as a broker if they do any of the following:
Many securities issuers attempt to avail themselves of Rule 3(a)4-1, a safe harbor afforded under SEC regulation commonly called the issuer exemption.
The issuer exemption acts as a safe harbor from broker-dealer registration otherwise required under Section 15(a) for a select group of associated persons related to a securities issuer. Ambiguities in the rule can cause individuals to falsely believe they fall under this safe harbor. As a result, these individuals choose not to register or affiliate with a registered broker-dealer. This failure to register can open a person to civil and criminal liability as well as SEC investigation and penalties. As a result, it remains paramount for individuals to carefully analyze the meaning of the issuer exemption and its implications for registration as a broker-dealer.
Although commonly called the issuer exemption, the 3(a)4-1 safe harbor applies specifically to activities of associated persons of an issuer—and not to the issuer itself.
In order to fall under the exemption, an associated person must meet a number of preliminary and substantive requirements as outlined in our Issuer Exemption Whitepaper.
Issuers relying on the federal issuer exemption often fail to consider parallel state requirements. Each state has its own structure and regulations. These can be complicated and can change at the will of the state legislature or administrative agency, or through enforcement action or judicial review without notice.
Therefore, there is ambiguity on what constitutes sufficient activity in a state to trigger the registration requirement. A conservative view would be that an issuer making an offering generally available online should, together with its employees and agents, meet the registration requirements of all 50 states or engage with a broker-dealer that does.
There are extremely adverse implications of breaching Section 15(a), including incorrectly relying on the issuer exemption. First, the SEC can pursue action against issuers who have not correctly registered under Section 15 of the Exchange Act. The Commission can seek injunctive relief, disgorgement, and civil penalties. If the SEC seeks injunctive relief, the issuer must shut down all securities-related operations to protect investors from future harm and to prevent future violations.
Here are a few helpful links to cases we've written about that highlight some recent enforcement actions:
Conducting a securities transaction can be a very complicated undertaking, but a broker-dealer with expertise in the industry is a good investment towards a successful offering. Broker-dealers can assist companies with structuring offerings, determining appropriate valuations and consummating investment closings. With general solicitation offerings in particular, broker-dealers work with the company and the company’s counsel to avoid the regulatory pitfalls imposed by the SEC in connection with the JOBS Act. A seasoned broker-dealer will be familiar with these requirements and can guide the company through the capital raising process.
Broker-dealers can serve as a trusted and neutral third-party to facilitate transactions between the company and investors. The involvement of a broker-dealer behind an offering gives more credibility to the company and its offering, since investors know that the broker-dealer has conducted due diligence before commencing general solicitation. Some broker-dealers may also host their own online fundraising platform for use by their clients.
Unless you have an established relationship with each and every investor that is going to invest in your offering, you are probably going to want to sell your offering to new investors through the use of sales representatives.
Broker-dealers have the ability to sponsor sales reps, who can become registered upon completion of licensure examinations and are then eligible to actively sell your offering.
Registering representatives with a broker-dealer brings a number of other benefits as well:
The real estate industry adopted the provisions of the JOBS Act, particularly general solicitation using Regulation D 506(c), earlier and more broadly than nearly any other industry. However, many market participants don’t even realize that they are selling or helping to sell securities, as opposed to real estate interests—and the line is often blurred between the two.
The distinction, though sometimes difficult to make, is a vitally important one. Luckily, the outcome of a hallmark U.S. Supreme Court case – SEC v. Howey – provides a test for real estate developers to determine when their activities could be considered securities transactions.
Out of that case, the four-part Howey Test emerged to determine whether a transaction was an investment contract and, therefore, a security. In order to be considered an investment contract, the following conditions must be met:
Despite the Court’s guidance in Howey and its continued application today, significant gray areas remain. For further discussion of real estate securities regulation, download our E-book, Am I Selling a Real Estate Security?