Business & Corporate Articles

The Unlicensed Securities Broker: Caveat Vendor
By Charles Field

Hardly a week goes by that I do not receive a call from someone wanting to raise capital either as an issuer or as an agent.  Invariably, the person wants to know whether they can pay or receive a percentage of the capital raised without the agent being registered as a securities broker. Over time you realize many start-ups struggling to survive lack the resources to engage a fully registered securities broker.  But at the same time, there are laws designed to protect investors from touts and scam artists. A tension exists.   The safe answer is to go with a registered securities broker, but, in reality the final answer can be as varied as the facts themselves.

Statutory Framework

Section 3(a)(4) of the Securities Exchange Act of 1934 (the “Exchange Act”) defines the term broker as “any person engaged in the business of effecting transactions in securities for the account of others.”  Section 15(a)(1) of the Exchange Act makes it unlawful to do business as a broker unless such person is registered with the Securities and Exchange Commission (the “SEC”).

Running afoul of Section 15 is a serious matter for both the unregistered broker and the issuer company.  Section 29(b) of the Exchange Act provides that “every contract made in violation of this chapter . . . shall be void.”    Accordingly, the unregistered broker is exposed to the risk that the issuer company with whom he or she contracted will void the agreement and refuse to pay.  The unregistered broker is also exposed to SEC enforcement.  In 2013, the SEC ordered an unregistered broker to disgorge nearly $3 million in fees and interest.  (In the Matter of William M. Stephens, Securities Exchange Act Release No. 69090, Investment Company Act of 1940 Release No. 30417, Administrative Proceeding File No. 3-15233 (March 8, 2013)).

Under Section 20(a) of the Exchange Act, issuer companies that use unregistered brokers can also be liable jointly and severally for rescission.  In 2012, an SEC inquiry into payments by Neogenix Oncology, Inc. to unregistered brokers forced the company to reserve for the contingency that it would need to reimburse investors.  The contingency was so significant that the company could not complete timely audits.  This completely derailed the company’s capital raising efforts and ultimately it filed for bankruptcy.   In a 2013 SEC enforcement case, the SEC fined Ranieri Partners and one of its principals $450,000 for using an unregistered broker.  (In the Matter of Ranieri Partners LLC and Donald W. Phillips, Securities Exchange Act Release No. 69091, Investment Advisers Act of 1940 Release No. 3563, Administrative Proceeding File No. 3-15234 (March 8, 2013)).

Unfortunately, Sections 3(a)(4) is not a model of clarity. Because the Exchange Act defines neither “effecting transactions” nor “engaged in the business,” an array of factors helps determine whether a person is acting as a securities broker. In deciding how to counsel the client, it is helpful to review how the SEC and the courts have analyzed and interpreted the importance of these factors.         

The SEC’s Position

For many years, issuer companies that sold their own securities relied on Rule 3a-4 of the Exchange Act, the so-called issuer exemption.  As long as an officer, employee or affiliate did not receive a sales commission for selling the issuer’s securities, and limited their selling activities to one offering per year, then the officer, employee or affiliate could rely on the exemption.  Over the years, SEC enforcement of the rule was lax at best. However, in 2013 an SEC lawyer, in a speech to the American Bar Association, warned the industry that the days of lax enforcement in this area were over. Accordingly, employees and officers who regularly engage in capital raising efforts and receive commissions run the risk of losing their reliance on the exemption. 

Issuer companies that used unregistered independent brokers relied for many years on the Paul Anka No-Action Letter (July 24, 1991). Again, enforcement was somewhat lax and practice began deviating from the Anka conditions. But in May 2010, the SEC surprised the business world when it denied a no-action request from the law firm of Brumberg, Mackey & Wall PLC based on Anka-like facts.  Mackey represented it would not engage in any negotiations with investors; provide potential investors any information that could be used as the basis for funding-related negotiations; be responsible for, or make any recommendation regarding, the terms, conditions, or provisions of any agreement for an investment; or provide any assistance to any potential investor regarding any transaction involving the financing. In their response, the SEC said the receipt of compensation directly tied to successful investments would give the law firm a "salesman's stake" in the proposed transactions and would create heightened incentive for the law firm to engage in sales efforts. Accordingly, they believed the proposed activities would require broker-dealer registration.

The Kramer Case

 In April 2011, a federal court in Florida in SEC v. Kramer, 778 F. Supp. 2nd, 1320 (M.D. Fla 2011) rejected the SEC’s position in Mackey as an inaccurate interpretation of the law.  Borrowing from a long line of Federal court cases, the court analyzed whether the person regularly participated in securities transactions at  ”key points in the chain of distribution.”  These key points include whether the person -

(1)  works as an employee of the issuer;

(2)  receives a commission rather than a salary;

(3)  sells or earlier sold the securities of another issuer;

(4)  participates in negotiations between the issuer and an investor;

(5)  provides either advice or a valuation as to the merit of an investment;

(6)  actively (rather than passively) finds investors;

(7)  analyzes the financial needs of an issuer;

(8)  recommends or designs financing methods;

(9)  holds one’s self out as a facilitator of securities transactions

Not all of the factors are of equal importance, however.  It would appear that receipt of a success based fee and participating in the negotiations are very significant, followed by providing investment advice, holding one’s self out, and actively finding investors.          


The no-risk approach is to either (a) register as a broker or (b) associate with a broker.  Option (a) can be impractical because it is time consuming (six months) and cost prohibitive (about $50,000).  Option (b) is easier to accomplish but requires obtaining certain FINRA licenses and locating a broker with whom to associate.  For those who seek to raise capital on a regular basis, option (a) or (b) is a must.  For those who do this as a one-off or occasionally, options (a) and (b) may prove beyond reach, but proceeding without either can be a risky proposition for both unregistered broker and issuer company.          

Those who think the compensation arrangement will go undetected should think again. The new Form D, which issuers must file with the SEC and states, requires issuers to disclose payments to agents and the agent’s FINRA CRD number. The lack of a number tips the regulators that the issuer used an unlicensed broker to raise capital.

For those willing to assume the risk, here are some ideas which may help mitigate some of that risk. The arrangement should be evidenced by an agreement between the issuer company and the agent.  More important than the duties that the agent will perform are the duties that the agent will not perform.  Here is where the factors outlined in Kramer are important. The agreement should make it clear the agent will not be:

  • Participating in any negotiations between the company and the investor
  • Actively locating investors and discussing the terms of the offer with them
  • Recommending the purchase of any security to investors
  • Handling investor funds
  • Analyzing the financial needs of the company or designing financing structures
  • Introducing investors to the company who are not sophisticated, “accredited investors”
  • Registered as a securities broker

Agents that cannot comply with these negative covenants should not be used, and any deviation cannot be tolerated. And to better manage risk exposure, the issuer company should monitor the activities of an unregistered agent regularly to ensure compliance. 


Those seeking to navigate this murky area of the law are advised to use extreme caution. The SEC does not like issuer companies paying unregistered agents a percentage of the capital raised, and will look hard for the presence of other factors that point to unlawful broker activity.  If the ultimate decision is to permit use an unregistered agent, then know the facts and know the risks.

-- Charles Field is with Sanford Heisler Kimpel, LLP.