Two cases from earlier this year once again highlight the importance of following the broker registration requirement under Rule 15(a) of the Exchange Act. Rule 15(a) requires registration for a party engaged in the business of “effecting transactions in securities for the account of others.”1 The requirement is broad, yet we continue to see many in the private equities market run afoul of it.
The Marketing Company
On January 13, 2017, the SEC filed a complaint against four sales agents for a company called XO Marketing Solutions (“XO Marketing”).2 XO Marketing was a key marketing service provider for Couch Oil and Gas, Inc. Couch Oil and Gas, together with its owner, Charles Couch, sold interests in what the SEC subsequently charged as unregistered and fraudulent oil and gas securities offerings. Additionally, several of the investors were not accredited.
The four brokers enhanced the issuer’s existing website and “created other websites, described as ‘portals’ to provide information’” about the funded projects.3 The defendants also worked to optimize the websites, including engaging in search engine optimization, and reducing internet marketing cost per lead. The defendants also made brochures more readable and attractive to prospective investors. Plus, they made recommendations about the oil and gas securities and projects even though they lacked relevant background. Ultimately, the defendants “closed” the transactions, including to non-accredited investors, and received transaction-based compensation for their work.
The SEC now seeks disgorgement of over $2 million in total commissions.
Real Estate Enterprise
On January 31, the SEC filed a complaint against Patric Baccam and two companies he controlled. According to the complaint, Baccam illegally sold promissory notes as a part of a supposed venture to flip real estate for profit. The complaint indicates this venture was actually a fraudulent real estate scheme.4 The SEC alleges Baccam told investors they would get a premium rate of return that was essentially impossible based on how he actually utilized investor funds. The SEC alleges he also made several material misstatements to induce investment and spent much of the funds for his own personal use.
Baccam “directly participated in the solicitation of funds,” and “controlled the chain of distribution throughout the solicitation and sale of all promissory note, actively identified and recruited investors advised investors as to the merits of their investment, facilitated and effectuated the transfer of investor funds, and received commissions for each sale.”5
Subsequently, the SEC seeks disgorgement of all illegally gained funds.
But I’m not committing fraud! How do these cases apply to me?
It is true that reported enforcement actions involving Section 15(a) violations generally involve patently illicit behavior. However, just because you are trying to raise capital for valid purposes does not make unregistered brokerage activity legal. Or, just because you have been conducting business a certain way for several years is not a defense against an SEC investigation. One investor claim could uncover a historic pattern of your company or its employees engaging in unregistered brokerage activity.
- Receipt of transaction-based compensation is a hallmark of illegal brokerage activity if the broker is not registered. In both of these cases, the defendants received transaction-based compensation in the form of a percentage of funds they helped raise. Even if you are not paying your employees a percentage of funds raised, are you confident that regulators will determine that all components of your employees’ compensation are unrelated to his or her securities work?
- Even without transaction-based compensation involved, an employee’s securities related duties must be limited. Even if your compensation structure is independent of securities work, an employee must (a) perform substantial duties aside from those related to securities work; and (b) not participate in the selling of a securities offering more than once in a 12-month period. Also, the key exemption to the registration requirement only applies to those associated with issuers themselves and not those performing brokerage services for third parties. If you are raising securities more often than once every twelve months or helping others to raise securities at all, you and your employees may be acting as unregistered brokers.
- You, your company, and your employees are at risk. Liability may go beyond your employees to your company. A serial issuer or a parent company manager may itself be acting as an unregistered broker-dealer. An example of this is the Blackstreet Capital case, discussed in this blog post , where the SEC sanctioned a private equity company for performing services related to securities transactions conducted in-house.
- Are you sure your activities aren’t crossing the line? The SEC likely will not view preparing and enhancing websites, pamphlets and similar marketing functions as effectuating a securities transaction. However, what other activities accompany these duties? Do your employees answer questions about the offering from prospective investors? From where do they get the answers to the question? Do they reach out to investors? Who handles investor communication and funding? Who is responsible for “closing” the transactions? In our experience, securities-related “marketing” functions tend to bleed over into what the SEC construes as brokerage activity if there are not deliberately formed procedures in place.
Related issues from these cases
- Disclosures to investors matter. How are you calculating your rate of return? Has a professional vetted this assessment? If not, are you certain the SEC will not deem these numbers fraudulent? How confident are you in the relevant industry? Can you back up claims in your offering materials? You do not want to be second guessed in retrospect by regulators or via an investor suit, particularly if you do not meet the anticipated return profile.
- There are heightened regulatory requirements for offerings that you generally solicit.How are you accrediting investors? If you are soliciting investors online, do you have a professional advising you on the appropriate steps to take? Regulators can unwind a deal and grant rescission to investors for a deal that is not conducted properly. Chances are, you will have already spent most of the investor funds.
Be sure to contact your legal advisor or a registered broker-dealer if you are unsure whether your capital raising model fits the legal and regulatory framework. If you prefer to use your own employees for securities-related functions, a registered broker-dealer may be willing to affiliate with them if your employees are willing to become registered and follow the necessary compliance protocols. The more you are out in the market, the more likely the SEC will scrutinize your selling and marketing efforts. It is important to understand the registration requirement and have procedures in place that you are comfortable with to allow you to raise capital compliantly.
 Securities Exchange Act of 1934, 15 U.S.C. § 78o (2016).
 See Complaint at 1, SEC v. Charlet, No. 3:17-cv-00139-D (N.D. Tex. Jan. 13, 2017); see Press Release, U.S. Securities and Exchange Commission, SEC Charges Four Unregistered Sales Reps Who Sold Unregistered Oil-and-Gas Offerings (Jan. 13, 2017), https://www.sec.gov/litigation/litreleases/2017/lr23720.htm.
 See Charlet, supra note 2, at 7.
 See Complaint at 2, SEC v. Baccam, No. 5:17-cv-00172 (C.D. Cal. Jan 31, 2017); see Press Release, U.S. Securities and Exchange Commission, SEC Charges Patric Ken Baccam with Fraudulent Offering and Sale of Securities (Feb. 1, 2017), https://www.sec.gov/litigation/litreleases/2017/lr23737.htm.
 See Baccam, supra note 3, at 29.
Disclaimer: WealthForge provides this information to its clients and other friends for educational purposes only. It should not be construed or relied upon as legal advice.
About the Author
Tim Boykin serves as Corporate Counsel at WealthForge with background in private practice at a full-service business law firm where he focused on transactional matters, corporate governance, and state and federal litigation. Find him on LinkedIn.