SYNOPSIS: Broker-Dealers et al.
SYNOPSIS: Broker-Dealers et al.
THE BUSINESS
A broker-dealer is a financial firm or individual that engages in the business of buying and selling securities, such as stocks, bonds, options, and other investment products, on behalf of clients or for their own account. They act as intermediaries between buyers and sellers in financial markets and provide various services, including executing trades, offering investment advice, underwriting securities offerings, facilitating mergers and acquisitions, structuring products, and managing investment portfolios.
Broker-dealers are but one participant in an economic ecosystem consisting of numerous other businesses and their business specialties which ultimately support the function of capital formation, for example: credit rating agencies (known as Nationally Recognized Statistical Ratings Organizations or NRSROs), capital and personnel risk insurers (including monoline insurers, directors and officers policies insurers, catastrophic risk bond insurers, etc.), trust administrators, servicers, and the law firms that create the actual products.
In the U.S., the capital markets provide trillions of dollars in daily quotable, liquid securities and consists of thousands of broker-dealer participants. The trade organization SIFMA publishes a study for 2023 available at https://www.sifma.org/resources/research/statistics/fact-book/.
THE LEGAL STRUCTURE
-Synopsis-
Securities broker-dealers are regulated by financial regulatory authorities in the jurisdictions where they operate, such as the U.S. Securities and Exchange Commission. They are required to adhere to strict rules and regulations to ensure fair and transparent dealings in the financial markets and to protect the interests of investors. Additionally, they are often members of self-regulatory organizations (SROs) like the Financial Industry Regulatory Authority (FINRA) in the U.S., which provides an additional layer of surveillance and enforcement of industry standards.
-Generally-
Subject to various qualifications, The Exchange Act defines the term broker to mean, “any person engaged in the business of effecting transactions in securities for the account of others,” and the term dealer as, “any person engaged in the business of buying and selling securities for such person’s own account.”[1] A broker or a dealer must be registered[2] so as to legally transact in (or induce to same) a non-exempted security[3] unless the business is (a) exempted pursuant to a decree from the Commission,[4] or (b) otherwise limited to intrastate business and does not make use of any facility[5] of a national securities exchange.[6]
For those who might seek to avoid registration, the Commission’s staff has provided helpful guidance in understanding the scope of these rules via comment letters.[7] Brumberg, Mackey & Wall, P.L.C. (May 17, 2010) (explaining that, "[the Act] generally defines the term “broker” as any person engaged in the business of effecting transactions in securities for the account of others. Section 15(a)(l) of the Exchange Act generally provides that any broker effecting transactions in securities, or inducing or attempting to induce the purchase or sale of securities, must be registered with the Commission pursuant to Section 15(b) of the Exchange Act. A person's receipt of transaction-based compensation in connection with these activities is a hallmark of broker-dealer activity. Accordingly, any 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."); Hallmark Capital Corporation (June 11, 2007) (providing that a finder likely would need to register as a broker-dealer due to the presence of transaction based compensation); and, John W. Loofbourrow Associates, Inc. (June 29, 2006) (refusing to grant no-action assurances despite a representation of the bifurcation of any potential conflicts-of-interest concern underlying the transactions-based-compensation prong of the qualification test).
-Registration-
Form BD provides the Uniform Application for Broker-Dealer Registration. An initial decision is statutorily prescribed to occur within 45 days and any denial to be subject to process.[8] A material omission or a misleading statement of fact can lead to revocation.[9] The Commission’s authority is expansive and includes the power to suspend registrations in circumstances it deems, “necessary or appropriate in the public interest or for the protection of investors.”[10] Any changes to the data provided in the form by the registrant must be promptly reported by way of an amendment to Form BD, and such amendments are deemed to be “reports” within the meanings of Section 15(b), 17(a), 18(a), 32(a), etc.[11]
-Standards of Conduct-
Registered broker-dealers must adhere to operational standards of conduct. The Act delegates authority to the Commission to promulgate standards of operational capability and, as applicable to associated natural-persons, “standards of training, experience, competence, and such other qualifications as the Commission finds necessary or appropriate in the public interest or for the protection of investors.”[12] The Act also requires that registered broker-dealers only transact on an exchange or via a securities association of which they are members.[13] These organizations further promulgate their own rules as self-regulatory organizations, subject to surveillance by the Commission, which further ensures the integrity of the national market system.[14] For example, it is statutorily proscribed for a broker-dealer to use any means or instrumentality of interstate commerce to effect any manipulative, deceptive, or other fraudulent device or contrivance.[15] Other examples of regulated activity include the requirement for broker-dealers to provide their customers with notice and the right to opt-out of the use of their fully-paid securities from the broker-dealer’s securities lending for short sales operations.[16]
-Retail Investor Operations-
Special rules apply to broker-dealers who provide investment advice to retail investors such that the standard of conduct is the same as that applicable to an investment adviser under section 211 of the Investment Advisers Act of 1940 [15 U.S.C. 80b–11]. And in cases of certain proprietary products may require notice and consent or acknowledgement of the customer. The duty of care or loyalty to the customer does not continue past the provisioning of investment advice.[17] Other communications with retail clients are regulated pursuant to rulemaking by the Commission.[18]
-Micro-issuer M&A Broker-dealer Exclusion-
Subject to historical record checks, specialized-purpose broker-dealers defined as “mergers and acquisitions brokers” and meeting certain qualifications are exempted from the requirements of registration.[19] In addition to the very limited financial qualification requirements of the privately held companies whose ownership and control, together, transfers are contemplated by the rule, for example, the company must have EBITDA less than $25 million or revenues less than $250 million, the following prohibitions also apply.
For example, the following activities would disqualify an M&A Broker-Dealer from the statutory exemption:
Securities held by or transmitted by the broker-dealer as a part of the transaction.
Engagement made on behalf of an issuer in connection with securities subject to the reporting requirements of section 15 (d) or any offering required to be registered pursuant to section 12.
Shell company transactions other than a business combination related shell company.[20]
Financing of transfers of interests in privately held companies.
Assistance with obtaining financing from unaffiliated third-parties without fee disclosure in writing and adherence to any applicable rule and regulations (reg. T).
Joint representations in the same transaction without written disclosure and consent of the parties.
Within certain qualifications, facilitation of the acquisition of privately held companies.[21]
[1] Qualifications to these definitions include limited exclusions for certain activities undertaken by banks and certain security based swaps transactions, etc.
[2] The Exchange Act § 15(a)(1).
[3] Other exclusions include commercial paper., bankers’ acceptances, commercial bills. The Exchange Act § 15(a)(1).
[4] The Exchange Act § 15(a)(2).
[5] (2) The term ‘‘facility’’ when used with respect to an ex change includes its premises, tangible or intangible property whether on the premises or not, any right to the use of such premises or property or any service thereof for the purpose of effecting or reporting a transaction on an exchange (including, among other things, any system of communication to or from the exchange, by ticker or otherwise, maintained by or with the consent of the exchange), and any right of the exchange to the use of any property or service.
[6] The term ‘‘exchange’’ means any organization, associa tion, or group of persons, whether incorporated or unincorporated, which constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange as that term is generally understood, and includes the market place and the market facilities maintained by such exchange.
[7] The persuasive authority of the staff’s comment letters might best be a quotation from one of the leading Securities Regulation case books.
“The Commission staff also has developed a unique system of lawmaking by responding to inquires from the bar about how it interprets (or will enforce) various provisions of the federal securities laws. If the staff agrees with an interpretation proposed by an attorney with respect to a specific set of facts, it will state in its response that it will not recommend any enforcement action to the Commission if the attorney’s client proceeds along the lines indicted in the letter (and the factual statements in the letter are accurate and complete). See Securities Act Rel. No. 4553 (Nov. 6, 1962). These “no-action” letters are made publicly available by the Commission and afford an important source of guidance for the bar. However, no-action letters are not binding on the Commission, which from time to time does overrule the staff, usually prospectively, and takes a position inconsistent with the staff’s interpretation. See 17 CFR 202.1(d). Nor are they binding on private parties, who may still challenge a transaction or interpretation that the SEC’s staff has accepted. The staff may also change its views prospectively and cease to follow a position taken in an earlier no-action letter. In either case, controversy usually follows because practitioners understandably believe that the publication of no-action letters is intended to provide them with guidance which they cannot safely ignore but the Commission can. When, in 1991, the Commission reversed a long-standing staff no-action position, Commissioner Fleischman dissented sharply: ‘No matter how often the Commission repeats the mantra that no-action letters ‘only purport to represent the views of the officials who give them’ or ‘set forth staff positions only’ that ‘are not rulings of the Commission or its staff on questions of law or fact,’ the Commission’s own contrary actions, not to speak of the contrary actions of the Commission’s staff, belie that message to the practicing securities bar.’ See Securities Exchange Act Release No. 34-28990 (Mar. 20, 1991). [. . .]’
Since the SEC first made no-action letters publicly available in 1971, they increasingly have come (as Commissioner Fleischman also noted) to state more general principles of law and to offer guidance relevant to persons beyond the immediate addressee.
On several occasions in the 1990s, issues have arisen about the legal status of no-action letters. Repeatedly, courts have held that they are not judicially reviewable, finding that they amount to neither agency adjudication nor rulemaking. See New York City Employees’ Retirement System v. SEC, 45 F.3d 7 (2d Cir. 1995) (SEC not required to follow notice and comment procedures of Administrative Procedure Act in issuing no-action letter that reverses long-established prior policy [. . . .]).
Coffee, Seligman, Sale
[8] The Exchange Act § 15(b)(1) et seq.
[9] The Exchange Act § 15(b)(4) et seq.
[10] The Exchange Act § 15(b)(5) et seq.
[11] 17 CFR 240.15b3-1 Amendments to application.
[12] The Exchange Act § 15(b)(7).
[13] The Exchange Act § 15(b)(8) et seq.
[14] See also Regulation National Market System (“Reg. NMS”) (providing for a national price bidding system designed to modernize and bolster the national equities markets by ensuring nationally, equal access to best price quotations, etc.).
[15] The Exchange Act § 15(c).
[16] The Exchange Act § 15(e) (providing that fully paid securities can be forbidden from short-sales securities lending of the broker-dealer at the customer’s request).
[17] The Exchange Act § 15(l).
[18] The Exchange Act § 15(n).
[19] The Exchange Act § 15(b)(13)(A).
[20] The Exchange Act § 15(b)(13)(E)(i).
[21] The Exchange Act § 15(b)(13)(E)(iii).
See also Repo Financing, The Monoline Insurers, Risk, Other Insurance Products.