Thursday, April 4, 2013

The SEC’s Frequently Asked Questions Regarding the Broker-Dealer Registration Exemption


 The legal world is patiently waiting for the Securities and Exchange Commission (the “SEC”) to enact rules implementing Title II of the JOBS Act.  One of the recent developments in this field is the issuance by the SEC Staff of frequently asked questions (FAQs) regarding the broker-dealer registration exemption found in Section 201(c) of Title II of the JOBS Act that adds a new paragraph (b) to Section 4 of the Securities Act. 

Generally, intermediaries are required to register with the SEC as broker-dealers when they are engaging in certain matchmaking activities between the issuers and the investors.  This Guide provides an overview of the activities that may require registration as a broker-dealer.  The JOBS Act introduced an exception to this general rule when it directed the SEC to eliminate the ban on general solicitation and advertising for Rule 506 offers and sales where all investors are accredited.  The exemption is very limited and applies only in Rule 506 offerings and only in the three circumstances listed below.  So, according to the new Section 4(b) of the Securities Act, a person will not be required to register as a broker-dealer solely because:

·         “that person maintains a platform or mechanism that permits the offer, sale, purchase or negotiation of or with respect to securities, or permits general solicitations, general advertisements, or similar or related activities by issuers of such securities, whether online, in person or through any other means;”

·         “that person or any person associated with that person co-invests in such securities”, or

·         “that person or any person associated with that person provides ancillary services with respect to such securities.”  Ancillary services are defined as providing due diligence services (but not investment advice or recommendations for separate compensation) and providing standard deal documents (as long as such person does not negotiate these documents and the issuers are not required to use these documents as a condition of using the service.

Importantly, such person may not receive compensation in connection with the purchase or sale of such securities and may not have possession of customer funds or securities in connection of such transactions, and they are not subject to statutory disqualification.   

What types of entities would be likely to rely on such exemption?  These would most likely be VC funds and their advisers.   Actually, the SEC Staff noted that the compensation prohibition “makes it unlikely that a person outside the venture capital area would be able to rely on the exemption from broker-dealer registration.”  But practical use of this exemption still remains to be seen.
As I have previously written, the SEC had three months from April 5, 2012 to issue rules implementing the elimination of the ban on general solicitation and advertising in Rule 506 offerings.  However, such rules have not yet been implemented, which means that the general solicitation and advertising in Rule 506 offerings to accredited investors are not yet permitted.  Interestingly, the broker-dealer exemption addressed in Section 201 of the JOBS Act went into effect immediately upon adoption of the JOBS Act. 

To clarify the situation, on February 3, 2013 the SEC issued the FAQ regarding this broker-dealer exemption.  It consists of 10 questions.  Below is the summary:

1.       The Staff explained that although the exemption from broker-dealer registration contained in Section 4(b) of the Securities Act is now in effect, the elimination of the ban on general solicitation and advertising in Rule 506 offerings is not.
2.       The scope of the exemption is very narrow: it is only available in connection with the offerings conducted under Rule 506 of Regulation D.
3.       Persons who are eligible for exemption can maintain an Internet website or a social media site and still use the exemption (no need for a more formal portal).
4.       Persons who want to avail themselves of this exemption cannot be compensated in connection with the purchase or sale of these securities.  Here, the Staff interprets “compensation” broadly to include direct or indirect economic benefits. 
5.       The exemption permits co-investing in the securities offered by the platform.  Any economic or financial benefits derived from such investments are not considered impermissible “compensation”.
6.       Someone who is associated with the issuer can maintain a platform to sell the issuer’s securities, as long as no compensation is paid in connection with the purchase or sale of these securities.
7.       The exemption in Section 4(b) does not exempt from state registration requirements.
8.       The exemption is not an exclusion from the definition of the term “broker” or “dealer”, so some federal securities laws would still apply to the exempt persons regardless of registration.


The adoption of the SEC rules regarding the elimination on the ban of general solicitation and advertising, coupled with this exemption from broker-dealer registration, is set to drastically change the way Rule 506 offerings are conducted.  All we have to do now is patiently wait for the enactment of the SEC rules.

This article is not a legal advice, and was written for general informational purposes only.  If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga.  Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.

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