Broker-Dealer Registration

The SEC recently announced that an equity advisory firm and its owner agreed to pay more than $3.1 million to resolve charges that they improperly engaged in brokerage activity, as well as charging fees without registering as a broker-dealer.  In other words, the firm acted like a broker-dealer but never bothered to register as one.

The SEC’s investigation demonstrated that the firm performed brokerage services in-house, instead of using investment banks or broker-dealers to handle the acquisition and sale of portfolio companies for a pair of equity funds they advised.  Interestingly, the firm disclosed to its customers that it would provide brokerage services and charge customers a fee for doing so.

The problem is that the firm provided those services itself even though it was not registered to do so.  This action should serve as warning, particularly for firms who may be engaged in Reg. D offerings.

money and calculatorIf part of the offering you find yourself engaged in the sale of securities, you better be registered as a broker-dealer to be doing so.  Alternatively, you could have retained the services of a broker-dealer to sell interests in the fund.  The law is clear; you need to do one of the two.

Another point of interest is that the SEC uncovered this improper conduct through an ordinary examination of the investment advisory firm.  In other words, there was no customer complaining that it suffered any harm.  So what lessons are to be learned?

For one, only broker-dealers can engage in brokerage services.  Second, the SEC in its exam process is looking for such activity and going after it.  Don’t make the same mistake; register as a broker-dealer or retain one to provide those services for you.

Over the years that I have defended broker-dealers and investment advisors, a more robust overview of outside business activity (OBA) disclosures would have gone a long way to disprove a number of claims. So where did these firms go wrong?

The biggest issue that I have seen is a firm’s willingness to take the OBA of a representative or IAR at face value and not do any more due diligence. In one instance, that due diligence could have unraveled a Ponzi scheme at its inception, instead of years after the facts and millions of dollars and calculator

In that case, the representative disclosed a beneficial interest in another business and that certain of his clients used that other business for tax preparation services. Although that other entity was not subject to the firm’s authority, the firm could have done more than nothing.

For one, the firm could have conditioned its approval of the OBA on the representative providing bank account statements for the other firm so that the FINRA-regulated firm could have assessed the scope of its clients using that other firm. By doing so, the firm could have uncovered that its clients were transferring money in not insignificant sums from their brokerage accounts to this third-party.

Conversely, if the representative refused or unable to get these statements, the firm could have denied approval of the OBA. Although this extra step may not have exonerated the firm from its representative’s use of the OBA to perpetrate a fraud, it would have provided a solid argument that it should have no liability because the representative acted outside the scope of his authority.

The moral of the story is that there is no perfect system for assessing OBAs. The important thing, however, is to take nothing at face value. Ask questions and push for information. If your employee is unwilling or unable to get that information, then the best thing is to not approve the OBA and lay the foundation for a defense if you are ever questioned about your employee’s outside business activity.

As you may know, FINRA, last April, launched a senior helpline to address issues pertaining to senior investors. According to recent reports, FINRA received calls on many different issues such as how to read an account statement up fraud targeted to senior investors.

FINRA has reported that some of these calls resulted in follow-up calls from FINRA and ultimate referral to federal and state authorities. So what is the take away from the hotline?

For one, senior investors are actively seeking FINRA’s assistance on issues from the mundane to the serious. With respect to those more serious issues, FINRA, in turn, is showing how serious it takes them.

If you have not already done so, it is critical that you revisit your policies and procedures for senior clients. If you do not have policies and procedures, you need them.pointing.jpg

At a minimum, you should consider placing all accounts of anyone 65 years old and over on some form of heightened supervision. By doing so, you are in a better position to learn about issues before they become a problem and, worse yet, get reported to FINRA through the hotline.

From my perspective, one of the biggest issues you face will be suitability of investment recommendations to seniors. By having policies and procedures that demand your attention to this issue (such as heightened supervision), you may avoid liability and regulatory issues in the future. Many issues can be avoided by simply improving the lines of communication with your senior clients.

Do nothing, and you have already set your boat down a rough course.

* photo from

As of December 12, 2015, FINRA will release Form U-5s within three business days of a member firm’s submission, instead of the fifteen days currently provided for under Rule 8312. The current version of the rule was meant to provide the departing registered representative ample opportunity to comment on the disclosure either though a Form U-4 or submitting a comment directly to FINRA. So why shorten the time period?money and calculator

BrokerCheck, FINRA’s on-line resource, makes certain information on Forms U-5 available to the public. In its never-ending effort for more transparency in the financial markets, FINRA wants this information available to the public faster than in the past, but at the same time providing the departing representative the opportunity to comment on the disclosure event.

Ideally, the representative left voluntarily to seek another opportunity such that the expedited comment period will make no difference. For those who are leaving a firm under less than ideal situations, they will have to move much faster to get “their side” of the story to FINRA.

In this day and age, more and more of the consuming public is using BrokerCheck. If you leave a firm, don’t dawdle responding to the Form U-5. Seek assistance where necessary to make sure your side of the events are accurately portrayed; otherwise, your “good name” may be forever impacted without you having a meaningful opportunity to comment.

FINRA has released for comment its proposed amendment to Rule 8312, otherwise known as the BrokerCheck Disclosure rule. As it currently stands, FINRA waits for 15 days before it releases information reported on Form U5. This delay was meant to give a registered representative adequate time to comment.

FINRA has proposed to change the waiting period to three business days. In those circumstances where a representative submits a Form U4 from a new firm before the expiration of the three business days, the Forms U5 and U4 will be released simultaneously under the amended rule. So what does this mean practically speaking?confusion.jpg

FINRA thinks that three days is more than enough time to comment to avoid potential customer harm that may arise if the registered representative files his Form U4 before the Form U5. In that situation, FINRA wants to avoid a customer only seeing the information on the U4, which may not accurately reflect the facts and circumstances of the departure.

Even if a registered representative could not submit comments within the proposed three day window, that person could still file a Form U4 through a new firm and state in it that he/she intends to respond more fully in an amended Form U4 to the information in the U5.

FINRA also noted that a registered representative could always sue his/her prior member firm if it releases inaccurate information on the Form U5. In my experience, even if that suit is successful, the best you will likely get is an amended U5. In other words, the bad stuff is still out there, just clarified or softened.

Considering that the underlying premise for this rule change is to avoid customer harm, it is safe to assume that this rule change will happen. When faced with the decision (whether yours or not) to leave one firm and go to another, try to reach an agreement on the Form U5 language. If not, use your three days wisely.

* Photo from

New FINRA Rule 2040 became effective late last month, requiring broker-dealers who sell EB-5 securities disclose to investors the amount of finder fee payments to non-registered foreign persons and receive written acknowledgement from the investors that they are aware of the fees paid.

Additionally, FINRA only permits member firms to pay transaction-related compensation to non-registered foreign finders where the finders’ sole involvement is the initial referral, and the member firm complies with the following conditions:

  1. the member firm has assured itself that the finder who will receive the compensation is not required to register in the United States as a broker-dealer nor is subject to a disqualification as defined in Article III, Section 4 of FINRA’s By-Laws, and has further assured itself that the compensation arrangement does not violate applicable foreign law;
  2. the finder is a foreign national (not a U.S. citizen) or foreign entity domiciled abroad;
  3. the customers are foreign nationals (not U.S. citizens) or foreign entities domiciled abroad transacting business in either foreign or U.S. securities;
  4. customers receive a descriptive document, similar to that required by Rule 206(4)-3(b) of the Investment Advisers Act of 1940, that discloses what compensation is being paid to finders;
  5. customers provide written acknowledgment to the member firm of the existence of the compensation arrangement and such acknowledgment is retained and made available for inspection by FINRA;
  6. records reflecting payments to finders are maintained on the member firm’s books, and actual agreements between the member firm and the finder are available for inspection by FINRA; and
  7. the confirmation of each transaction indicates that a referral or finders fee is being paid pursuant to an agreement.

Michael Gibson believes that this rule “could transform the EB-5 visa industry from one of non-disclosure and non-transparency concerning agent compensation agreements if complied with” and suggests that investors may be “very upset when they learn how much their agents are being compensated”.  Despite this risk, however, FINRA member firms should make every effort to comply with Rule 2040 to prevent even greater consequences from federal regulators, including having to possibly rescind the offering, refund investor’s capital, civil and criminal penalties.

At least one New York City official would answer that question in the negative. The city comptroller released a proposal that would require a financial advisor to clearly state whether he or she must act in the investor’s best interests.

In other words, do what the SEC has yet to do through a uniform fiduciary duty for all advisors who provide retail investment advice. Under the city comptroller’s proposal, an advisor would have to provide the following disclosure at the beginning of the relationship and frequently thereafter:

“I am not a fiduciary. Therefore, I am not required to act in your best interests, and am allowed to recommend investments that may earn higher fees for me or my firm, even if those investments may not have the best combination of fees, risks and expected return for you.”confusion.jpg

A concern raised by this proposal is that it is not neutral, but instead unfairly focuses on broker dealers. That concern could be addressed by adding to the statement a message about the suitability standard that broker dealers must follow.

Although it is unclear whether this proposal will ever make it to the legislature, it shows a growing impatience with the SEC’s failure to adopt a uniform fiduciary duty standard. Maybe this proposal will send a message that the SEC has to finally take action on the long promised uniform standard.

* photo from

Starting July 1, member firms are required to have written procedures to verify the accuracy and completeness of the information in a registered representative’s U-4 within 30 days of the U-4 being filed with FINRA.  The question that arises is whether the expense of this new type of “investigation” is worth it.pointing.jpg

In short, member firms will have to do more than a simple internet search of a potential hire, particularly if the firm finds something on the new hire.  For example, what do you do if the new hire was sued in the past?

Under this new requirement, it is fair to say that you will have to do more than just look at a docket.  Instead, it is likely that, in order to comply, you will have to review documents filed in the case to see if there were allegations against the new hire such as for fraud or other things that would present cause for concern.

This heightened analysis will certainly take time and money to complete.  If you are hiring a big producer, then the analysis is probably only a minor inconvenience, but what about if the new hire is not a big producer?  How much is enough?

Undoubtedly, firms will likely need to have bright line tests for when they will keep reviewing, as opposed to declining to hire a person with a complicated past.  There will certainly be a market for other firms to conduct this analysis for you.  Either way, member firms have to do more than a passing glance at a new hire’s U-4.

There is likely going to be a fair amount of question regarding how much is enough of a review.  Nevertheless, get your written procedures in place and have a game plan for how you will review the veracity of a new hire’s U-4.  Otherwise, you face the risk of suit for negligent hiring and the wrath of your regulator.

* Photo by

The SEC’s Division of Trading and Markets stated that it would not recommend enforcement action if a “mergers and acquisitions broker” were to engage in the sale or purchase of a privately held company without registering as a broker-dealer under Securities Exchange Act of 1934 Section 15(b). Lee M&A Brokers, SEC, No-Action Letter, avail, 1/31/14,

An “M&A broker” is a broker in the business of effecting securities transactions solely in connection with the transfer of control and ownership of a privately held company via transactions involving securities assets of the company, to a buyer that will actively operate the company.  A private company does not have its securities registered with the SEC, and is not subject to Exchange Act reporting requirements.  Further, if the transaction were structured as an asset sale not involving the sale of securities, a person would not be required to register as a broker-dealer.

The Staff granted the request for no-action relief.  The Staff noted in particular, the following representations:

  • the M&A broker will not have the ability to bind a party to an M&A transaction;
  • the M&A broker will not provide financing for an M&A transaction;
  • the M&A broker will not handle funds or securities issued or exchanged in connection with an M&A transaction;
  • no M&A transaction will involve a public-offering and no party to an M&A transaction shall be a shell company, other than a “business combination related shell company”;
  • if an M&A broker represents both buyers and seller, it will provide clear written disclosure and will obtain written consent from both parties;
  • an M&A broker may facilitate an M&A transaction with a group of buyers only if the group is created without the broker’s assistance;
  • the buyer will actively control the company with the assets of the business;
  • an M&A transaction shall not result in the transfer of interests to a passive buyer;
  • any securities received by the M&A broker or the buyer will be “restricted securities” under Securities Act of 1933 Rule 144(a)(3); and
  • the M&A broker has not been barred from association with a broker-dealer; and is not currently suspended.

The staff said its position is limited to the registration requirements of Exchange Act Section 15(a).

In short, this is a very limited departure for the SEC, and is consistent with prior no-action relief.

Usually, we spend a fair amount of time advising our American broker-dealer clients, who do business overseas, that they have to follow the rules of those countries as well.  However, the “shoe” may sometimes be on the other “foot.”  See

Recently, a foreign broker-dealer was forced to pay a 9 figure judgment to resolve an action brought by the SEC.  This foreign broker-dealer solicited and serviced thousands of American clients and made 8 figures in annual revenue over a 5 year period.  However, a slight detail was ignored.  The foreign broker-dealer never bothered to register as an American broker-dealer or investment adviser.

Sadly, some will never learn especially in this case where it seemed the foreign br0ker-dealer could have easily become registered.  In any event, this is a good example of what happens when you believe you can avoid the rules if you do not speak the “language.”