4/28/2011

Introduction

This blog will host a series of articles I have written (and am still writing) which discuss both the necessity and the desirability of SEC oversight of finder’s fee payments in the EB-5 field. The first article, below, is a summary of the research I undertook in the summer of 2010, since updated, to determine whether I, as someone who contemplated accepting finder’s fees from regional centers in future, was obligated to first take the General Securities Representative Exam, commonly referred to as the “Series 7 Exam”, and to become a Registered Representative of a broker-dealer firm, before I could accept finder's fees from the centers.

As I began my research I was very well disposed to concluding that I did not have to take the exam. The Series 7 is a difficult six-hour exam: fully a third fail, and the average grade is just 3 or 4 points above the passing grade of 70. The exam requires 100 to 200 hours of study; a near impossibility for a busy, practicing attorney. Nonetheless, I concluded that I had no choice but to become licensed if I wanted to provide investment advice for my EB-5 clients while being compensated by regional centers rather than by my clients.

Inasmuch as I am not a securities law attorney, I cannot claim that the opinions expressed below are authoritative. I merely offer them to start a conversation wherein my views will perhaps be challenged at points and refined by my more learned brethren and sistren in the SEC bar. The persons I most wish to engage in the conversation, however, are the principals of the regional centers, who thus far seem to regard the SEC attorneys speaking at recent EB-5 seminars as so many officious intermeddlers offering advice where it is neither wanted nor needed. I shared this view myself to some extent until I conducted a careful examination of the law and then understood the extent to which the finder’s fee problem is a ticking bomb that threatens the integrity and even the very future of the EB-5 Pilot Program.

Article 1

FINDER’S FEES & SECURITIES REGULATION - THE CURRENT STATE OF THE LAW

The question of whether an immigration attorney may properly accept a finder’s fee from an EB-5 regional center for a client referral has occupied a prominent role in all recent attorney discussions of the EB-5 Pilot Program. Initially, the concerns centered on 1) whether ethical rules commanding attorneys to give advice only in areas where they are competent preclude the possibility of most attorneys, given their limited financial training, from accepting finder’s fees, and 2) whether accepting finder’s fees may be, or appear to be, a conflict with the attorney’s overriding obligation of complete loyalty to the client, and 3) on a more practical level, whether the financial gain of the finder’s fee is worth the long-term risk to the attorney being named in a law suit by a client unhappy with the results of the regional center investment. A new concern was added to the debate in July 2009 when two prominent EB-5 attorneys and two securities law attorneys published the article The Relevance of U.S. Securities Laws to Immigrant Investors, EB-5 Regional Centers and their Advisors (hereinafter "Relevance of SEC to EB-5").[1] The authors argued that EB-5 investment projects are securities within the meaning of Section 2(a)(1) of the Securities Act of 1933 (as well as similar definitions in virtually all state securities laws) and that SEC precedents strongly suggest that issuers of securities, such as the regional centers, may not pay, and finders may not accept, “transaction-based compensation” unless the attorney is either a “broker-dealer”, or associated person thereof, [2] or, failing that, the attorney or consultant provides the client with nothing more than “name and contact information” of the regional center(s[l1] ).

It’s critically important to understand that the Relevance of SEC to EB-5 authors were discussing neither a novel problem nor offering a novel analysis of an older problem. Rather, they were simply restating the consensus view held by securities law attorneys with long experience with the finder problem from their work in the mergers & acquisitions and private placement fields. These attorneys held the nearly uniform view that most business finders are, in fact, acting as broker-dealers, and that the consequences of such activity include possible rescission of the subscription agreement by the investor, possible loss of the issuer’s Regulation D exemption, and the potential civil and even criminal liability of the issuer and its principals. [3]

What’s more, a June 19, 2009 settled SEC administrative proceeding, Ram Capital Resources, LLC (“Ram Capital”) and a May 17, 2010 SEC no-action letter, Brumberg, Mackey & Wall PLC, SEC No- Action Letter (“Brumberg, Mackey & Wall”), have substantially reduced the ambit of acceptable unregistered finder conduct. I discuss both below, as well as reviewing some other recent developments which impact the finder issue.

Ram Capital: Unregistered Finder Activity as the Sole Basis for SEC Enforcement Action

Finders in the mergers & acquisitions field had long persisted in finder activity without registering because for a very long time the SEC had not brought an enforcement action based solely on unregistered finder activity.[4] Enforcement actions by the SEC against unlawful finder activity had typically been multiple count lawsuits driven primarily by allegations of fraud and misrepresentation.[5] The finders’ view seemed to have been that if they otherwise conduct themselves lawfully they would not have to worry about an apparent Section 15(a) violation.[6] The SEC changed the status quo decisively, however, when it instituted an enforcement action against two finders and their firm, Ram Capital, LLC, solely because they "willfully violated Section 15(a) of the Exchange Act," i.e., they carried on the business of finding money, in this case investors in PIPE (“private investments in public equity”) transactions, without registering as broker-dealers. The final consent order that settled the case included suspensions of both principals from broker or finder activity, for 6 months for one principal and 12 months for the other, as well as disgorgement of profits, pre-judgment interest and fines totaling in excess of $500,00 for each individual charged.[7]

Narrowing the Finder Exception: Paul Anka to Brumberg, Mackey & Wall

A central difficulty for anyone attempting to decide who is a finder and who is a broker is that the so-called “finder’s exception"[8] does not exist in SEC law. Rather it has been inferred from behavior that the Securities and Exchange Commission has not (yet) condemned in SEC “no-action letters”.[9] What’s more, given that the exception is a creature of SEC Staff interpretation, what the SEC Staff giveth, the SEC Staff may taketh away, as well.[10]

At the time of the publication of Relevance of SEC to EB-5, the Paul Anka no-action letter provided a narrow exception to the general rule contained in Section 15(b)(1) of the Securities Exchange Act of 1934 (“Exchange Act”) requiring broker-dealers to register with the SEC.[11] In Paul Anka, the famous singer provided a Canadian hockey team with a list of investors whom Anka regarded as favorably disposed to investing in the hockey team. Anka would receive 10% of all moneys invested by the identified investors in the team. The SEC decided that Mr. Anka did not have to register with the SEC as a broker-dealer. The SEC staff identified the following saving graces in the Anka business proposal:

1. Anka had a bona fide, pre-existing business or personal relationship with the prospective investors;
2. He did not advertise, endorse or solicit investors;
3. He had no personal contact with prospective investors;[12]
4. He did not provide due diligence on issuer’s offering;
5. He did not advise on valuation; and
6. He did not regularly engage in the securities business, it was a “one time deal.”[13] [14]

In the nearly 20 years since Anka was decided, the SEC had focused on five factors, derived from Paul Anka and subsequent cases, in determining whether the finder should be registered:

1. Finder participates in the negotiations surrounding the transaction;
2. Finder makes recommendations or gives advice concerning the transaction;
3. Finder receives transaction-based compensation in connection with the transaction;
4. Finder has engaged in previous securities transactions; and
5. Finder takes physical possession of the securities or monies to be transferred.

The SEC had stated on numerous occasions that no one factor would be determinative of broker-dealer status.

Enter the Roanoke, Virginia law firm Brumberg, Mackey & Wall P.L.C. (“BMW”), which sought a no-action letter from the SEC for proposed fundraising activities by the firm on behalf of a business, Electronic Magnetic Power Solutions, Inc., (“EMPS”). BMW stated that its activities “would be limited to the introduction of EMPS to a limited number of its contacts who may have an interest in providing funds for financing the operations and development of EMPS.” BMW would receive transaction-based financing – a “cash referral fee” based on the percentage of the financing provided to EMPS by the BMW-identified contacts - but would otherwise not implicate any of the other five factors previously identified by the SEC as requiring broker-dealer registration. Specifically, BMW would not be involved in negotiations, would not make recommendations or give advice, and would not hold any securities for either party. The firm also had no history in the securities market.

Undermining its own previous position that no one factor is determinative of finder-broker status, the SEC Staff asserted that transaction-based compensation is “a hallmark of broker-dealer activity” without ever mentioning the Paul Anka letter or discussing any of the other factors besides compensation cited earlier by the SEC as being relevant to the question of whether a finder must be registered as a broker-dealer. Instead, the Staff focused on BMW’s description of its role as introducing EMPS to a limited number of its potential investors to conclude that these activities implied that BMW was anticipating both “pre-screening” potential investors for eligibility and “pre-selling” the securities to gauge their interest.  Such activity “would give BMW a ‘salesman’s stake’ in the proposed transactions and would create heightened incentive for BMW to engage in sales efforts.” Noting that “[a] person receiving transaction-based compensation in connection with another person’s purchase or sale of securities typically must register as a broker-dealer or be an associated person of a registered broker-dealer,” the Staff concluded that BMW’s proposed activities would require broker-dealer registration.

The BMW decision was widely interpreted by securities law attorneys as indicating that the payment of transaction based compensation is now the primary, if not the sole, criterion for deciding whether a finder is in fact a broker and must therefore be registered.[15] [16] [17] [18] [19]

OTHER RECENT DEVELOPMENTS

Form D – Recent Revisions Make it Easier to Discover Unlawful Payment of Finder’s Fees

Any business seeking Regulation D exemption to the SEC registration requirement must file a Form D – Notice of Exempt Offering of Securities within 15 days after the first sale of securities in the offering. Revisions to Form D in 2008 included a requirement that all the issuers disclose the name, address and broker-dealer number of each person who has been or will be paid or given any sales commission or similar remuneration for soliciting purchasers for the offering. Since all Form D filings are publicly accessible through the SEC’s EDGAR (Electronic Data-Gathering, Analysis, and Retrieval) System, state securities regulators and the public may track payments to finders, and using the Financial Industry Regulatory Authority (“FINRA”)’s BrokerCheck may easily determine whether the finders are licensed. It has been estimated that approximately one-third of the state regulatory agencies review Form D notices to determine if persons listed as receiving commissions on Forms D are registered as brokers. [20] [21]

Attorneys as “Gatekeepers” Under Sarbanes-Oxley and Dodd-Frank

In the wake of the Enron and other scandals and the passage of the Sarbanes-Oxley Act of 2002, the SEC initiated dozens of enforcement actions against attorneys for failing to adequately monitor and report securities violations.[22] The SEC concept that attorneys, and others such as accountants and financial analysts, should act as “gatekeepers” was strengthened by the Dodd–Frank Wall Street Reform and Consumer Protection Act (Pub.L. 111-203, H.R. 4173) in two respects. First, and most significantly, Dodd Frank changed the required state of mind for aiding and abetting claims from one requiring actual knowledge to only permitting mere “recklessness” as the basis for the action. In addition, the Act gave the SEC the right to bring “aiding and abetting” claims and to seek civil penalties against aiders and abettors under the Securities Act of 1933 and the Investment Company Act of 1940 in addition to its previously existing authority to bring such claims under the Securities Act of 1933. [23] The easing of the standard for aiding and abetting raises the theoretical possibility at least that an attorney in the EB-5 field who refers clients to an unregistered finder for financial due diligence may be deemed to aid and abet the finder by failing to properly monitor and report unlicensed finder activity.

Conclusion

Few recipients of finder’s fees in the EB-5 field, whether they be attorneys or business consultants, would have survived SEC or state securities scrutiny at the time that Relevance of SEC to EB-5 was published nearly two years ago. It's unlikely that any of these finders could have claimed that they had no prior securities experience (which would include making previous regional center referrals), or that they had no personal contact with the investors, two key components of the Paul Anka grant of no-action. Now the narrow exception to the Section 15(a)(l) rule requiring broker registration that was carved out by Paul Anka has given way to Brumberg Mackey, where we see the Section 15(a)(l) rule all but swallowing the finder exception. In Ram Capital, the SEC shows its willingness to bring an enforcement action based solely on unregistered finder activity, thereby upsetting the finder community’s previous insouciance with regard to possible exposure to a Section 15 enforcement action. Dodd-Frank makes attorneys and other gatekeepers more susceptible to an aiding and abetting charge, even if they did not accept finder’s fees, but were merely aware that unregistered finder conduct was present in the transaction. In an era of heightened SEC enforcement due to the Madoff scandal and others, the trend toward increasingly strict enforcement of Section 15 can only be expected to continue.