Selling Unregistered Securities Leads to Summary Judgment in Favor of the SEC
Raphael Rosenblatt | Bloomberg Law
The U.S. District Court for the Northern District of Texas granted summary judgment to the Securities and Exchange Commission (SEC) in an enforcement action brought against several defendants engaged in offering and selling unregistered securities.
Sale of Unregistered Securities
The SEC charged 11 defendants with violations of Sections 5(a) and (c) of the Securities Act of 1933 (Securities Act) and Section 15 of the Securities Exchange Act of 1934 (Exchange Act) in connection with the securities offerings of six companies as they transitioned from private to publicly traded companies. The SEC moved for summary judgment.
The Court explained that liability under Section 5 extends to “all individuals who have ‘engaged in steps necessary to the distribution of [unregistered] security issues.’” A strict liability statute, Section 5 does not require proof of scienter, but instead looks to whether without the defendant’s participation, the transaction still would have taken place. A violation of Section 5 requires proof of three elements: (1) an offer or sale of a security; (2) that was not registered pursuant to Section 5 of the Securities Act; and (3) the sellers used the mail or other facilities of interstate commerce in connection with the offer or sale.
The SEC provided evidence that defendants failed to file registration statements for any of the six securities transactions at issue. Likewise, the SEC established that all defendants except one used “the instrumentalities of interstate commerce by selling shares of Texas companies through brokerage accounts located in New York and California.” The other remaining defendant, however, also used instrumentalities of interstate commerce when he used a transfer agent in Arizona.
One defendant, Timothy Page, denied that he offered or sold a security because he did not work with the other defendants. But, as the Court explained, the inquiry depends on whether Page was a necessary participant in the offering or sale of the unregistered securities to the public. The Court found that the SEC’s undisputed evidence compelled a finding that Page, in fact, participated in the sale of a security.
— Exemption from Registration Requirement
The Court rejected defendants’ argument that they were exempt from Section 5′s registration requirements. Section 4 of the Securities Act exempts from registration transactions by any person “other than an issuer, underwriter, or dealer.” The Securities Act defines an “underwriter” as a person that has “purchased from an issuer with a view to, or offers or sells for an insurer in connection with, the distribution of any security,” or participates directly or indirectly in such an undertaking, or participates directly or indirectly in the underwriting of any such undertaking. A transaction, not an individual, falls within Section 4′s exemption, and a transaction is defined broadly as including “the entire process of a stock’s being dispersed from the issuer until it reaches the investing public.”
Defendants could not persuade the Court that they were not underwriters and thus were within the exception to the registration requirement. Because an underwriter either purchases shares “with a view” toward distributing them to the public, or sells shares for an issuer in connection with “the distribution of any security,” the Court determined that “an individual can be an underwriter merely by taking part in the transfer of the security from the issuer to the investing public, regardless of his intentions at the time he acquires the stock.” Taking part may include conducting market awareness campaigns relating to the securities offering. Subjective intent, the Court noted, need not be considered; so long as defendants took some part in the public offering of a security, they will qualify as underwriters and are subject to the registration requirement.
Considering all of the evidence presented by the SEC, the Court stated: “Because the law is clear that if a transaction involves a single underwriter it is not exempt from registration requirements, the court concludes that none of the six transactions is exempt [from] the registration requirements of [Section 5]” (emphasis in original).
— Additional Arguments Rejected
The Court rejected defendants’ additional arguments. First, the Court explained that bad legal advice—that defendants’ behavior was legal—is not a defense to Section 5′s registration requirements. Moreover, defendants could not hide behind Rule 504 of Regulation D, which exempts from registration certain limited offerings and the sale of securities not exceeding $1 million. According to the Court, no reasonable jury could conclude that any of the defendants were issuers; rather, the evidence showed only that they received the shares from issuers.
Unregistered Brokers and Dealers
As with Section 5, a violation of Exchange Act Section 15 does not require proof of scienter. Section 15 makes it unlawful for any broker or dealer to use mail or any instrumentality of interstate commerce “to effect any transactions in, or to induce or attempt to induce the purchase or sale of, any security . . . unless such broker or dealer is registered.” The Court defined a broker as any person engaged in the business of effecting securities transactions for others’ accounts, and a dealer as a person engaged in the business of buying and selling securities for his own account through a broker or otherwise, but not a person that “buys or sells securities for his own account, either individually or in some fiduciary capacity, but not as part of a regular business.”
— Engaged in the Business
While the statute does not define “engaged in the business,” the Court noted that one court has looked to the regularity of participation as the indicia of engagement in the business. With regard to a broker, a court will consider several factors, including whether the person (1) solicited investors to purchase securities, (2) was involved in negotiations between the issuer and the investor, and (3) received transaction-related compensation. The Court explained that under Section 15, brokers and dealers must register under the Exchange Act, but “finders” need not do so. Finders merely bring parties together, but they do not negotiate the price or any other terms of the transaction. However, if a finder undertakes certain actions, such as analyzing the financial needs of an issuer, recommending or designing financing methods, discussing transaction details, or making investment recommendations, the registration requirement will be triggered.
The Court found that the SEC provided undisputed evidence that defendants acted as unregistered brokers or dealers and used instrumentalities of interstate commerce when engaging in the sale of securities. Moreover, the SEC established that defendant Page—the only defendant that contested the SEC’s claim that he was a securities dealer—regularly engaged in the purchase and sale of securities for his own account.
As a result, the Court granted the SEC’s motion for summary judgment against all defendants on the Section 5 and Section 15 claims.
This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.
©2012 Bloomberg Finance L.P. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of Bloomberg Finance L.P.