SEC Enforcement Actions against Small Violations in Broker/Dealer Relationships
Yi Song, Esq.
The Securities and Exchange Commission (SEC) expressed deep concerns in small violations in the broker/dealer relationships, which is prevalent in the EB-5 industry. The SEC Chair Mary Jo White stated in a speech at a conference last week about SEC enforcement issues: “Minor violations that are overlooked or ignored can feed bigger ones, and, perhaps more importantly, can foster a culture where laws are increasingly treated as toothless guidelines.”
“Broken Window” in the Market
In terms of commencing enforcement action against the small violations, White adopted the “Broken Windows” theory that former New York City Mayor Rudy Giuliani applied to crackdown on crime in the city, the same theory should also be applied to the SEC’s enforcement program. Under that theory, maintaining a good urban environment and fixing all the broken windows helps to deter more serious crimes. “We are looking for the ‘broken windows’ in our market and not overlooking the small violations to avoid breeding an environment of indifference to our rules,” White stated.
Why do We Need Registered Broker/Dealer in EB-5?
In August 2013, in responding to an inquiry from a brokerage firm, Financial Industry Regulatory Authority (FINRA) confirmed that the FINRA rules 2111.05(a) regarding broker/dealer relationship does apply to EB-5 program.
Under the rule, the broker/dealer has obligations to the investors based on reasonableness and customer-specific suitability for the EB-5 projects or a type of privately offered securities.
Under the reasonable basis obligation, the broker-dealer must perform the following tasks:
- Perform reasonable diligence to understand the nature of a recommended security
- Investment strategy involving a security
- Advise the investment’s potential risks and rewards
- Determine whether there is a reasonable basis to believe the recommended security
- Whether investment strategy is suitable for at least some investors
- A reasonable investigation concerning the issuer and its management
- The business prospects of the issuer
- The assets held by or to be acquired by the issuer
- The claims being made
- The intended use of proceeds of the offering
In the context of a private placement related to the EB-5 Program in which a broker-dealer intends to recommend to foreign nationals seeking investment returns and U.S. residency, these same issues should be explored, issues that address the legitimacy and viability of the issuer’s enterprise. A broker-dealer should also analyze whether the private placement is consistent with the requirements of the EB-5 Program, such as whether it constitutes an investment in a domestic project that will create or preserve at least 10 jobs for U.S. workers.
As to the customer-specific obligation, a broker-dealer must have a reasonable basis to believe that a recommended security or the investment strategy involving a security is suitable for a particular customer based on the customer’s investment profile.
A customer’s investment profile includes:
- the customer’s age
- other investments
- financial situation and needs
- tax status
- investment objectives
- investment experience
- investment time horizon
- liquidity needs
- risk tolerance
- particular goals with respect to an investment
SEC’s Enforcement Actions in Non-Fraud Related Broker/Dealer Violations
It is a common misconception in the EB-5 industry that the SEC enforcement actions regarding the broker-dealer violations only involve fraud.
Two recent SEC enforcement actions show that the SEC is actively pursuing unregistered broker-dealer claims in small transactions that do not involve allegations of fraud at all.
In March 2013, the SEC found that Ranieri Partners LLC, a private equity firm, violated the broker-dealer registration requirements by paying transaction-based compensation to a consultant, who was not registered as a broker or associated with a registered brokerage firm, for soliciting potential investors in mortgage opportunity funds sponsored by the firm. The consultant’s activities went beyond accepted practices for finders. Similar transaction in the EB-5 practice is rather common.
On June 5, 2013, the SEC filed a civil injunctive action charging Banc de Binary Ltd., a Cyprus-based company, with illegally selling binary option contracts to U.S. investors. The SEC alleged that the binary options were sold in violation of securities registration requirements and that, through its online trading platform, Banc de Binary was effecting securities transactions for its customers’ accounts without being registered as a broker-dealer.
There were no allegations of fraud, deception or other illegal conduct in either incident.
About the author:
Yi Song, Esq. is an attorney at Mona Shah & Associates in New York City. She is also licensed to practice law in People’s Republic of China. Before joining Mona Shah & Associates, she worked at a securities litigation firm in Manhattan. She clerked at China’s high court – the Supreme Court of People’s Republic of China. At Mona Shah & Associates, Yi practices EB-5 law and securities law and works on many successful EB-5 capital raising projects. She obtained her LL.B. degree from Beijing Foreign Studies University and she is a graduate from Georgetown University Law Center in Washington, DC. Her articles on EB-5 and securities law are published by LexisNexis, AILA, eb5info.com, ILW. Yi is a native speaker of mandarin Chinese. She speaks fluent English and basic French.
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