Do You Need A Broker-Dealer For Regulation A?
Those who have worked with me on JOBS Act and Regulation A+ offerings often call me “the least lawyer-like lawyer you will ever meet.” I also realize this article will, unfortunately, read like it was written by a lawyer. My apologies in advance, but this is a topic that requires a bit more in-depth analysis than my typical writing style allows. Bear with me, because anyone considering a Regulation A+ offering to raise capital needs to be aware of this important information. I have to put on my attorney costume for this one.
I am frequently asked if a company that wishes to pursue a Regulation A+ offering must hire a broker-dealer for the offering. Regulation A+ of the JOBS Act is silent as to whether an issuer must hire a broker-dealer in order to sell unregistered securities to the general public under the JOBS Act exemption. Given this silence, most legal authorities agree that the law and SEC rules related to Regulation A+ do not require an issuer to hire a FINRA licensed broker-dealer to sell their unregistered securities. However, the text of Regulation A+ and the federal regulations related to the statute are not the sole consideration in this matter given that securities are being sold. Other state and federal laws and regulations that regulate who may sell securities may prevent an issuer from selling their own Regulation A+ securities without a licensed broker-dealer. At the time this article is published, this question of law remains unsettled. I feel strongly that moving forward with a Regulation A+ offering without a broker-dealer attached is a dangerous move for an issuer, as will be illustrated below.
So the safe, simple answer to the title question of this article is “Yes, you should have a broker-dealer involved.” The more risky, complicated answer is “No, but you have a lot of hoops to jump through and I hope you can sleep at night with all the uncertainty and risk you are taking.”
The primary argument made for not having to hire a licensed broker-dealer is that Regulation A+ of the JOBS Act preempts state securities law when it comes to Blue Sky review. Before the JOBS Act, if a company wanted to run a Regulation A offering under the old Regulation A statutes, it had to go through Blue Sky review of the offering with every state in which it wished to sell securities. In some states, this involved a merit review, meaning the state regulators could make comments and request changes to the potential offering documents. This meant an issuer needed to satisfy not only the SEC at the federal level, but also 50+ mini-SECs at the state level — some of whom may have vastly different requirements. This could be a never-ending and very expensive process of revision for an offering. No wonder Regulation A was rarely used until it was amended in the JOBS Act. Under the JOBS Act version of Regulation A (sometimes called “Regulation A+,” “Reg A+” or a “Mini-IPO” in its JOBS Act updated version) this state Blue Sky review is done away with, and only the SEC has a review process at the federal level.
However, this waiver of state Blue Sky review does not prevent the states from regulating who can sell Regulation A+ securities in their state. Because each state has its own set of laws related to who is allowed to sell securities, who must be registered to do so, and under what circumstances securities can be sold by that entity, there are valid concerns that a state regulator could impose significant penalties on an issuer who chooses to sell its Regulation A+ securities within that state, without a broker-dealer licensed in that state.
In order to analyze this complex area of the law, let’s start with the basics.
What is a “dealer?”
This question is significant because under Federal law, if a company is a “dealer” they may be required to register as such and become regulated by FINRA or another regulatory body. So the first question in this complex analysis is: Is a company that sells its own Regulation A+ securities without a registered broker-dealer considered a “dealer” under federal law?
From the SEC’s website:
“Section 3(a)(5)(A) of the Act generally defines a “dealer” as any person engaged in the business of buying and selling securities for his own account, through a broker or otherwise.”
Sometimes you can easily tell if someone is a dealer. For example, a firm that advertises publicly that it makes a market in securities is obviously a dealer. Other situations can be less clear. For instance, each of the following individuals and businesses may need to register as a dealer, depending on a number of factors:
· a person who holds himself out as being willing to buy and sell a particular security on a continuous basis;
· a person who runs a matched book of repurchase agreements; or
· a person who issues or originates securities that he also buys and sells.
It seems that “a person who issues or originates securities that he also buys and sells” would include a company selling its own Regulation A+ securities.
Here are some of the other questions you should ask to determine whether you are acting as a dealer:
· Do you advertise or otherwise let others know that you are in the business of buying and selling securities?
· Do you do business with the public (either retail or institutional)?
· Do you make a market in, or quote prices for both purchases and sales of, one or more securities?
· Do you participate in a “selling group” or otherwise underwrite securities?
· Do you provide services to investors, such as handling money and securities, extending credit, or giving investment advice?
· Do you write derivatives contracts that are securities?
A “yes” answer to any of these questions indicates that you may need to register as a dealer. Again, a company selling its own Regulation A+ offering, without a licensed broker-dealer, would seem to have to answer “yes” to several of the questions listed above. As such, it is likely that an issuer selling its own Regulation A+ securities could be considered a “dealer” under federal law.
If you are a dealer, you must register as a dealer under federal law.
Registration as a broker or a dealer under federal law is extremely time consuming and expensive, and not something an issuer would undertake just for a Regulation A+ offering. In addition, if this path was taken, the issuer would also have to register as a dealer in every state where it wishes to sell securities, adding even more time and expense. Registering as a broker-dealer is a significant undertaking and subjects the entity to extensive and time-consuming compliance, regulation and reporting requirements by the SEC, FINRA and state securities regulators.
The SEC makes it clear that an issuer cannot sell its own unregistered securities without being properly registered:
“Note: If you will be acting as a “broker” or “dealer,” you must not engage in securities business until you are properly registered. If you are already engaged in the business and are not yet registered, you should cease all activities until you are properly registered.”
Section 15(a)(1) of the Securities Exchange Act of 1934 generally makes it unlawful for any broker or dealer to use the mail (or any other means of interstate commerce, such as the telephone, facsimile, or the Internet) to “effect any transactions in, or to induce or attempt to induce the purchase or sale of, any security” unless that broker or dealer is registered with the Commission in accordance with Section 15(b) of the Act.”
Despite these registration requirements, an issuer may sell its own unregistered securities if it meets the “issuer exemption” under federal and state law.
From the SEC website:
“Issuers generally are not “brokers” because they sell securities for their own accounts and not for the accounts of others. Moreover, issuers generally are not “dealers” because they do not buy and sell their securities for their own accounts as part of a regular business. Issuers whose activities go beyond selling their own securities, however, need to consider whether they would need to register as broker-dealers. This includes issuers that purchase their securities from investors, as well as issuers that effectively operate markets in their own securities or in securities whose features or terms can change or be altered. The so-called issuer’s exemption does not apply to the personnel of a company who routinely engage in the business of effecting securities transactions for the company or related companies (such as general partners seeking investors in limited partnerships). The employees and other related persons of an issuer who assist in selling its securities may be “brokers,” especially if they are paid for selling these securities and have few other duties.”
Two potential problems arise from this federal law if an issuer sells Regulation A+ securities without hiring a registered broker-dealer, or without the issuer registering as a broker-dealer:
1. If an issuer is selling its own securities on its own website, it could be considered by the SEC to be “effectively operating markets in their own securities” and therefore be required to register as a broker-dealer. Failing to register could subject the issuer to enforcement actions by the SEC.
2. If an issuer is selling its own securities through a funding platform or other website, the issuer could be considered a broker-dealer as above, and the funding platform or website could also be considered a broker-dealer if the funding platform or website was “paid for selling these securities.” As above, the issuer or funding platform or website failing to register as a broker-dealer could subject the issuer and the platform to enforcement actions by the SEC.
Understanding the issuer exemption under federal law
If an issuer chooses not to hire a broker-dealer to sell its Regulation A+ securities, some believe that an issuer may sell its own securities if it meets the “issuer exemption” of federal and state laws. Use of the issuer exemption is the most common argument made by companies that do not wish to hire a broker-dealer to sell their Regulation A+ securities to the public.
In practice, violations of the “issuer exemption” are typically enforced against individual employees or agents of the issuer rather than the issuer itself. Persons acting on behalf of the issuer engaged in distributing its securities, including the issuer’s own directors, officers or employees, may be either “brokers” or “dealers” under Section 3(a) of the Exchange Act.
To understand the possible legal ramifications of the federal “issuer exemption” on an issuer’s directors, officers or employees, one must look to Rule 3a4–1 of the Exchange Act, which provides a safe harbor for “associated persons” of an issuer from broker dealer registration if strict criteria are met. In order for an issuer’s associated person to qualify for the issuer exemption under federal law, and to be allowed to assist the issuer in selling its own Regulation A+ securities, the following must apply (keep in mind, this is just to comply with federal law — a discussion of state law requirements which also must be met comes later):
“People associated with an issuer who participate in the sale of the issuer’s securities, including officers and employees of the issuer, or a company affiliated with the issuer (a) may not be compensated by payment of commissions or other remuneration based on securities transactions, (b) may not be associated with a broker-dealer; and © must limit sales activities either (i) to one offering per 12-month period and perform other substantial duties, (ii) to soliciting only certain financial institutions or (iii) to passive or clerical duties not involving solicitation of investors.”
Breaking this down, any company that has held a private offering within the 12-month period of the Regulation A+ offering would not qualify for the federal issuer exemption, and thus must hire a broker-dealer and associated persons of the issuer must limit their “sales activities” to “passive or clerical duties not involving solicitation of investors.”
Thus, the use of general solicitation or advertising associated with a Regulation A+ offering could, subject to interpretation by the SEC, not be allowed if an issuer is using the issuer exemption to avoid hiring a registered broker-dealer for the Regulation A+ offering.
What happens if the SEC finds that an issuer did not meet the issuer exemption and sold securities under Regulation A+?
In such a case, the SEC could find that the company or individual was acting as an unregistered broker-dealer in violation of applicable registration requirements and the company or any associated individuals could face possible government enforcement action, monetary penalties and investor lawsuits seeking rescission of all investments and recovery of the purchase price paid. As one commentator noted:
“SEC enforcement actions have serious consequences for acting as an unregistered broker and selling securities. This SEC regulatory focus is likely to continue, and could increase, with the use of general solicitation and general advertising permitted by the Jumpstart Our Business Startups (JOBS) Act.”
For examples of the penalties imposed by the SEC for unlicensed broker-dealer activity, read this article entitled “The SEC Gets Aggressive With Unregistered Brokers.”
Each state has its own “Mini-SEC” in the form of state securities regulators, so there are also 50+ state “issuer exemptions” to qualify for in order to not use a licensed broker-dealer to sell Regulation A+ securities, in addition to the federal regulations noted above.
Assuming an issuer meets the federal criteria for the issuer exemption, it must also meet the state law issuer exemption in each jurisdiction where it plans to sell securities. Failure to do so could result in a state securities regulator filing an enforcement action against an issuer selling Regulation A+ securities in their state. If that happens, an issuer faces the expensive proposition of hiring local counsel to deal with the state law issue, and possibly having to pay fines and offer rescission to all investors in that state, and perhaps elsewhere. Kat Cook is the Chief Compliance Officer for Keystone Capital Corporation, a FINRA licensed broker-dealer with experience in Regulation A+ arena and other areas of the rapidly emerging FinTech industry. Cook believes that this threat is very real of having to rescind all subscriptions agreements and return capital raised if a state securities regulator finds that local laws were not complied with. “Compliance with Reg. A+ means that the issuer should hire a very knowledgeable JOBS Act securities attorney and retain a supporting broker-dealer to help…or prepare to give the funds raised back to the investors,” warns Cook.
Definitions of broker and dealer in many state laws are similar to those in the federal Exchange Act, and many state laws provide similar exemptions from those definitions. However, several states have laws that raise concerns about whether an issuer, or an associated person of an issuer, can legally sell Regulation A+ securities in those states without having a FINRA licensed broker-dealer. A few examples are listed below. The laws cited below are state laws that are subject to change from the date this article is published, so readers would be wise to consult the actual laws in their most recent form after reading this article, as well as to rely on the advice of an attorney with expertise in these laws at a state or local level.
Example of State Securities Law Issues #1: New York
New York has securities laws that require any issuer to register in the state as a “dealer” before selling securities in a “public offering” to residents of that state. This law does not apply if the issuer is selling the securities through a licensed broker-dealer. While this law has not as of the date of this article been applied to a Regulation A+ offering, it has been used against an issuer and its officers offering or selling interests in a hedge fund in New York, where the officer or “general partner” of the issuer must file, among other things, a “broker-dealer statement.” This statement generally requires information regarding business history for the last five years, criminal record and educational background of the general partner and its partners, officers, directors or other principals. The broker-dealer statement is effective for four years from the date of filing. A general partner that fails to file the broker-dealer statement before offering hedge fund interests in New York could be subject to penalties and other disciplinary action assessed or prosecuted by the New York attorney general.
From the New York State Bar Association:
“New York State’s securities statute, Article 23-A of the General Business Law (“GBL”), known as the Martin Act, is unique among state securities laws in two important respects. First, the Martin Act does not require the registration of securities, other than securities sold in real estate offerings, theatrical syndications or intra-state offerings. Instead, it requires some issuers to register as dealers in their own securities.
Second, the laws of every other state and the federal Securities Act of 1933 (“Securities Act”) require the registration of all securities offerings, and then provide an exemption for non-public offerings if certain conditions are met. In contrast, the Martin Act requires registration (whether of brokers, dealers or special categories of offerings) only for offers and sales to, and purchases and offers to purchase from, the public. The Martin Act is silent with respect to private or non-public offerings, thus requiring no dealer registration filings, and no filing exemptions, for private offerings (other than intra-state offerings). The differences between the Martin Act and other state securities laws, particularly the first, have resulted in the use of registration and exemption forms and procedures that are unique among the states. Concerns about lack of uniformity are not academic. The capital markets in this country depend upon raising money in private placements, and New York is at the center of this market. Yet the manner in which the Office of the New York State Attorney General (“OAG”) regulates private offerings exempt from registration under (a) § 4(2) of the Securities Act, the “classic” private placement exemption, and (b) Rule 506 of Regulation D under the Securities Act, the safe harbor exemption adopted by the Securities and Exchange Commission (“SEC”) under § 4(2), is in conflict with the federal law and the laws of other states.”
In essence, this New York state law seems to say that an issuer claiming the issuer exemption in New York for a Regulation A+ offering (which involves an offer and sale to the general public) must register with the state as a “dealer.” This could require hiring New York securities counsel, great expense and a delay in the Regulation A+ offering, in addition to the substantial time and expense of the dealer registration process.
This is just one of many state laws that must be complied with and that is waived if the securities are being sold through a licensed broker-dealer. Also note that New York has 19,700,000 residents, and is the 4th most populated state in the country  and certainly a state that most Regulation A+ issuers would want to sell their securities in.
Example of State Securities Law Issues #2: California
California Corporations Code Section 25110 states:
“It is unlawful for any person to offer or sell in this state any security in an issuer transaction (other than in a transaction subject to Section 25120, whether or not by or through underwriters, unless such sale has been qualified under Section 25111, 25112 or 25113 (and no order under Section 25140 or subdivision (a) of Section 25143 is in effect with respect to such qualification) or unless such security or transaction is exempted…”
Corporations Code section 25102(f) is the state’s issuer exemption:
“California Corporations Code section 25102(f) exempts from the provisions of section 25110:
Any offer or sale of any security in a transaction (other than an offer or sale to a pension or profit-sharing trust of the issuer) that meets each of the following criteria:
Sales of the security are not made to more than 35 persons, including persons not in this state.
All purchasers either have a preexisting personal or business relationship with the offeror or any of its partners, officers, directors or controlling persons, or managers (as appointed or elected by the members) if the offeror is a limited liability company, or by reason of their business or financial experience or the business or financial experience of their professional advisers who are unaffiliated with and who are not compensated by the issuer or any affiliate or selling agent of the issuer, directly or indirectly, could be reasonably assumed to have the capacity to protect their own interests in connection with the transaction.
The offer and sale of the security is not accomplished by the publication of any advertisement.”
Obviously, any Regulation A+ offering would not meet these criteria for the exemption under California state law.
This is another of many state laws that must be complied with and that is waived if the securities are being sold through a licensed broker-dealer. Also note that California has 39,000,000 residents, and is the most populated state in the country. Regulation A+ issuers would not want to miss out on this audience of potential investors.
Example of State Securities Law Issues #3: Texas
Texas defines an issuer who sells its own securities as a “dealer” and requires them to comply with all provisions of the Texas Securities Act:
“Any issuer other than a registered dealer of a security or securities, who, directly or through any person or company, other than a registered dealer, offers for sale, sells or makes sales of its own security or securities shall be deemed a dealer and shall be required to comply with the provisions hereof; provided, however, this section or provision shall not apply to such issuer when such security or securities are offered for sale or sold either to a registered dealer or only by or through a registered dealer acting as fiscal agent for the issuer; and provided further, this section or provision shall not apply to such issuer if the transaction is within the exemptions contained in the provisions of Section 5 of this Act.”
Section 5 precludes an issuer from being exempt if the securities being sold use any form of advertisement or general solicitation, which would eliminate the exemption from being claimed by a Regulation A+ issuer.
This seems to mean, in essence, that an issuer (in Texas, a “dealer”) now must comply with hundreds of pages of Texas securities law in transacting sales of their securities in that state. Please note that Texas has nearly 29,000,000 residents, and is the second most populated state in the country.
Example of State Securities Law Issues #4: Florida
In Section 517.061, Florida defines the securities that may be sold in its state without registration through their securities regulators and specifically allows an issuer to sell its own securities under the state’s issuer exemption. Unfortunately for a Regulation A+ issuer, the law specifically forbids any issuer who wants to market their offering to the general public, a hallmark of Regulation A+. The statute reads, in relevant part:
“[T}he exemption for each transaction listed below is self-executing and does not require any filing with the office before claiming the exemption. Any person who claims entitlement to any of the exemptions bears the burden of proving such entitlement in any proceeding brought under this chapter. The registration provisions of s. 517.07 do not apply to any of the following transactions;
(11)(a) The offer or sale, by or on behalf of an issuer, of its own securities, which offer or sale is part of an offering made in accordance with all of the following conditions:
1. There are no more than 35 purchasers, or the issuer reasonably believes that there are no more than 35 purchasers, of the securities of the issuer in this state during an offering made in reliance upon this subsection or, if such offering continues for a period in excess of 12 months, in any consecutive 12-month period.
2. Neither the issuer nor any person acting on behalf of the issuer offers or sells securities pursuant to this subsection by means of any form of general solicitation or general advertising in this state.”
This Florida statute seems to preclude anyone using general solicitation or advertising, or selling to more than 35 investors, from using the issuer exemption. The use of a registered broker-dealer, however, makes this statute irrelevant.
Note that Florida has more than 20,000,000 residents, and is the third most populated state in the country.
Other examples of potentially relevant state laws:
According to one commentator deeply involved in the equity crowdfunding and Regulation A+ space:
· In Maryland, if you use any form of “general solicitation” you lose the issuer exemption unless you have a licensed broker-dealer.
· In Texas, if you use any form of “general solicitation” you lose the issuer exemption unless you have a licensed broker-dealer.
· In New York, if you use any form of “general solicitation” you lose the issuer exemption unless you have a licensed broker-dealer.
· In California, if you or any person associated with you are involved in more than one capital raise per year, then you are a serial issuer and lose the exemption unless you have a licensed broker-dealer.
· In Florida, if you or any person associated with you are involved in more than one capital raise per year, then you are a serial issuer and lose the exemption unless you have a licensed broker-dealer.
These five states combined constitute 35% of the United States population. If an issuer without a broker-dealer wanted to try to raise capital using the issuer exemption, it may have to eliminate sales in these 5 states (and more that are beyond the scope of this article) and give up more than one-third of the possible investors available to fund the offering.
Steven Capozza, Chief Executive Officer of Keystone Capital Corporation, a broker-dealer licensed in all 50 states and the District of Columbia, notes, “State securities regulators have a job to do, and that job is to enforce their state’s securities laws and regulations. Why would anyone take the risk of not using a licensed broker-dealer in every state that requires it? Is it really worth it for an issuer to save a few dollars up front if they later risk having to hire local counsel in faraway states to fight enforcement actions that they very likely will lose?”
In an excellent article on this topic written by securities lawyers, the authors noted the significant risk of selling securities without a broker-dealer:
“If an issuer violates a state law by selling securities directly to investors, the issuer could be subject to state enforcement action, i.e., fines and penalties.
The greater risk, in my opinion, is the risk of claims from investors. If a widow in Texas loses money she might not accept her loss graciously. She (or her heirs, or the trustee in her Chapter 7 bankruptcy case) might look for a way to recoup her loss. And if she can show that the issuer violated Texas law, the court may find a right of rescission, i.e., the right to get her money back. The court might even extend that right against the principals of the issuer personally, especially if they were engaged in selling activities.
I imagine the widow on the stand, asking for recourse against the New York based issuer, backed by an amicus curiae brief filed by the Texas Board of Securities and the National Association of State Securities Administrators. Given the room for ambiguity in the statute, I’m not thrilled with my odds.
And even if you win, there’s the time and cost of defending yourself, and the sleeping-well-at-night factor, also.”
The authors conclude that there are four possible methods of approaching this problem from an issuer’s standpoint:
1. Sell securities only through a broker-dealer,
2. Sell securities through a broker-dealer only in states that require it, or
3. Do not sell securities in the states that require a broker-dealer, or
4. Through guidance of counsel, live with the uncertainty of the law and sell securities without a broker dealer — making sure you have insurance in place to cover investor claims and other possible ramifications of this choice.
I agree with these conclusions.
Dealing with Tier II of Regulation A+, which went into effect in mid-2015, involves making certain decisions without much legal precedent, SEC guidance or state securities regulatory guidance. At the time this article is published, there is no definitive answer as to how the SEC, FINRA, or any of the 50 state securities regulators would treat an issuer that sells its own Regulation A+ securities without a licensed broker-dealer. This is an unsettled area of the law and I have seen examples of issuers not using broker-dealers when selling Regulation A+ securities as a result. But these issuers are taking big risks. Prudent securities counsel would advise his or her issuer clients that the most conservative and safest way to avoid civil liability, administrative charges and possibly even criminal prosecution in some states, would be to hire a FINRA licensed broker-dealer who is also licensed to sell securities in all 50 states, rather than relying on the issuer exemption of federal and state laws, and taking the risks involved with an issuer selling its own securities.
Kendall Almerico is an attorney based in Washington DC whose practice involves JOBS Act related securities offerings such as those involving Regulation A+ or Regulation CF. This article should not be considered as legal advice, and the opinions expresses in the article are personal opinions of Mr. Almerico and should not be relied upon by anyone as legal advice. Other lawyers may have different opinions. The topics covered in this article are very complex, and any company considering using Regulation A+ or selling securities in any manner should seek the advice of competent and experienced legal counsel before making any decisions related to the matters set out in this article.
 David A. Lipton, Broker-Dealer Regulation §1:8 (noting that registration of employees of an issuer, as opposed to registration of the issuer itself, typically warrants a case-by-case analysis)
 “SEC cracks down on unregistered broker-dealers in private offerings,” Dinsmore & Shohl LLP, http://www.lexology.com/library/detail.aspx?g=b3fc9cc9-822b-4a29-938b-b48278adece4, July 2013.
 “The SEC Gets Aggressive With Unregistered Brokers.” https://www.law360.com/articles/674710/the-sec-gets-aggressive-with-unregistered-brokers, July 2015.
 The issue that remains undetermined is whether a Regulation A+ offering is a “public offering” or a private offering. Given the lack of guidance to date on this issue, an issuer that is exercising caution may be wise to assume that Regulation A+ offerings, which involved the sale of securities to the general public, would be considered a “public offering” and not a “private offering.”
 “Can Issuers Raise Money without Using a Broker-Dealer?” Scott Purcell, https://www.equities.com/news/can-issuers-raise-money-without-using-a-broker-dealer, June 2016.
 “Can A Crowdfunding Issuer Sell Its Own Securities?” Mark Roderick, https://crowdfundattny.com/2016/06/17/can-a-crowdfunding-issuer-sell-its-own-securities/, June 2016.