Wednesday, October 1, 2014

Do Issuers and Issuer Employees and Contractors Have to Register as Brokers or Dealers? (Article 11 in a series of 14 articles about Deal-Makers)

By Jim Verdonik

I'm an attorney with Ward and Smith PA. I also write a column about business and law for American Business Journals , have authored multiple books and teach an eLearning course for entrepreneurs. You can reach me at
Or you can check out my eLearning course at
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This article is one of 14 articles in a series of articles about Deal-Makers called:


Our other articles in this series have focused on agents, because the definition of the word "broker" in Section 3 (a) (4) (a) of the Exchange Act says a broker is: "any person engaged in the business of effecting transactions in securities for the account of others." 

But agents aren't the only people who do deals.

 So, we can't fully understand deal-making if we only focus on agents.  In fact, maybe agents are fading in importance.

  • What if the biggest change to deal making isn't related to changing the definition of brokers or providing more exemptions for brokers?
  • What if the real action in deal making relates to the brokers little brothers: "dealers" and investment advisers?
If you are not an agent in a securities transaction, you are either a principal or a service provider.

In Article (5) of this series of articles, we explained why the people who operate technology platforms should be treated like other media service providers. 

Lawyers, accountants, appraisers and technology platform operators all provide services that help securities transactions occur.  These professionals are neither agents nor principals in the securities transaction as long as they confine themselves to providing their services that assist others people who make the decisions. 

So not everyone who helps close a securities transaction for the account of others has to register as a broker under Section 15 (a) (1) of the Exchange Act.

Now, let's examine dealers more closely.  There are two basic types of principals in securities transaction:

·         Issuers who sell their own securities.
·         Dealers who both buy and sell the securities of issuers.

Dealer Registration Issues

Merely acting as a principal and not as an agent does not necessarily determine the registration issue .  Section 15 (a) (1) of the Exchange Act also requires dealers to register.  So, who is a dealer?  Section 3 (a) (5) of the Exchange Act defines a dealer (which is required to register) as "any person engaged in the business of buying and selling securities . . . for such person's own account through a broker or otherwise." 

 Market makers who hold themselves out to the public as being in the business of buying and selling are good examples of "dealers."  They are in the market multiple times every day buying and selling like they were buying and selling any product or service.  Without dealers most markets could not exist.  The SEC offers the following guidance for people to determine whether they are a "dealer:"

*       "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."

Here are some of the 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?"

Before we examine dealers further, note how the words "in the business" appears in both the definition of a "broker" in Section 3 (a) (4) (a) and the definition of "dealer" in Section 3 (a) (5) of the Exchange Act.  Then look at how the SEC more narrowly defines being "in the business" for dealers compared to brokers.  When the SEC talks about who is a "broker," the SEC does not limit brokers to people who:

·         "hold themselves out… on a continuous basis;"
·         advertises;
·         does business with the public.

As discussed in Article (2) of this series, the SEC treats brokers and dealers differently on the issue of what constitutes being "in the business" even though the Exchange Act uses the same words "in the business" in both definitions.  Whenever a regulatory agency interprets the same language in the same statute differently it is fair to ask the question:  Has the SEC exceeded its authority under the Exchange Act when it applies the broker registration requirements:

  • To people who are only sporadically involved in securities transactions?
  • To people who do not hold themselves out as being in the securities business?
  • To people who operate technology platforms or provide other services that are useful to other people who conduct securities transactions?
A number of court cases have applied these dealers principles to brokers and reached different conclusions tyan the SEC does about whether someone is in the business of effecting securities transactions for others.
Now, let's return to "dealers."

It is clear that not everyone who buys and sells securities is "in the business" of buying and selling securities.  Investors buy and sell securities.  So, are all investors dealers?  Capturing appreciation in securities is considered to be investing and not "conducting a business of buying and selling securities," which is the key part of the definition of the term "dealer". 

Tax laws recognize this principle by giving dealers ordinary income and losses, while investors who are not "in the business" have capital gains and losses.  This distinction applies to both individuals and entities.  For example, venture funds, private equity and hedge funds and their managers are generally not considered to be "dealers" for either securities law or tax purposes.  Such investment funds invest to capture of the appreciation of the securities they purchase.  Dealers buy and sell to take advantage of temporary changes in market value.  Dealers generally do not make buy and sale decisions based on analysis of the fundamentals of the business operations of issuers.


 This distinction between investors and dealers fits into the regulatory framework of the issuer exemption from broker-dealer registration.  An issuer is usually not "in the business" of buying and selling its own securities.  Issuers sell securities to raise capital so that they can engage in their own business that is not related to securities markets, but issuers who frequently repurchase their own shares should be careful about how they do it to avoid being considered a dealer.

The SEC offers the following explanation on its website for why issuers generally are not brokers or dealers:

"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."

The SEC offers the following guidance on issuers who might be broker-dealers.

"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."

Broker-dealer registration requirements do not stop at the level of the business entity.  Individuals associated with issuers must find their own exemption.  The SEC offers the following guidance about persons associated with issuers.

"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."

Primary Differences between Issuers and Brokers

Let's go beyond the distinction between agents and principals and examine several function differences between issuers and their owners and brokers.

Do issuers have to register as brokers, because issuers will benefit from the transaction closing?  No, merely benefitting from the deal closing is not enough to make the issuer a broker.  Issuers differ from brokers in three basic ways:

  • Transaction Roles:  The nature of the roles issuers and brokers play in investment transactions are different.  Brokers are agents or service providers who provide advice and make introductions.  Issuers are principals and make decisions and exchange securities for capital.
  • Post-Transaction Roles:  The nature of the roles issuers and brokers play after investment transactions are different.  A broker's activity and relations with both issuers and investors usually ends when the investment transaction closes.  The issuer's relationship with the investors just begins when the investment transaction closes.
  • Transaction Benefits:  The benefits issuers and brokers derive from investment transactions are different.  The broker walks away from the closing table with cash (we discuss warrants and other equity compensation below) that the broker can immediately spend on anything the broker wants.  The issuer must spend the cash the issuer receives in the investment transaction to grow the issuer's business (and pay the broker's commission).  So, the issuer's benefit is longer term than the broker's benefit.  Any benefit to the owners of the issuer derives from the investment transaction will come from the increase in the value of the issuer's business, which is usually a long-term process.  Aside from timing, the other difference is that the increase in value is not automatic.  The benefit depends on the decisions the issuer makes as the issuer tries to grow its business.  If the issuer makes the wrong decisions, the issuer and the owners of the business will derive no benefit from the investment transaction.
The SEC recognizes that everyone who participates in an investment transaction is expecting to derive some benefit from the transaction.  No one would do deals, if they do not hope to benefit in some way.  So, unless you want everyone to have to register as a broker, the nature of the benefit must play a role in determining who has to register as a broker.

Persons Associated with Issuers

The issuer exemption from registration as a broker-dealer has little value, if the issuer's employees, partners, managers or officers have to register as broker-dealers.  By burdening the people who operate the issuer's business, the SEC would be indirectly placing that regulatory burden on the issuer itself.  So, let's examine the exemptions from registration for people who are associated with issuers.

SEC Rule 3a4-1 creates a "safe harbor" that protects certain "associated persons" of an issuer from broker-dealer registration requirements.  An associated person can be a partner, officer, director, employee of the issuer or of any affiliate or registered investment adviser. 

Rule 3a4-1 is a "safe harbor" provision.  You are not necessarily a broker-dealer, if you do not satisfy the requirements of the safe harbor.  The SEC's staff has indicated that they believe it would be difficult for the managers of "private funds" to qualify for this safe harbor, but most managers of venture capital, private equity, hedge funds and other private funds do not register as broker-dealers, which illustrates that the bank industry operates outside protection afforded by the safe harbor.  Despite general industry practice not to register, fund managers must be careful not to conduct activities that make them a broker-dealer.

To qualify for this "associated person" safe harbor, the person must satisfy all of the following:

·         "Is not subject to a statutory disqualification, as that term is defined in section 3 (a) (39) of the Act, at the time of his participation;
The "safe harbor" does not apply if you are a "Bad Actor" or if you receive sales commissions or if your compensation is otherwise directly or indirectly based on transactions in securities.
·         "Is not compensated in connection with his participation by the payment of commissions or other remuneration based either directly or indirectly on transactions in securities;"
·         "Is not at the time of his participation an associated person of a broker or dealer;"
If you satisfy both these requirements of Rule 3 a 4-1, you fall within the safe harbor if you satisfy any one of the following criteria.

(1)   "The associated person restricts his participation to transactions involving offers and sales of securities: (i) to certain institutional investors including registered brokers or dealers; a registered investment companies, insurance companies; a banks and registered investment advisers; or (ii) that are exempted by reason of section 3 (a) (7), 3(a)(9) or 3(a)(10) of the Securities Act of 1933 from the registration provisions of that Act; or (iii) That are made pursuant to a plan or agreement submitted for the vote or consent of the security holders who will receive securities of the issuer in connection with certain corporate transactions, including reorganizations, mergers and other acquisition transactions; or (iv) that are made pursuant to the issuer's employee benefit plans."
(2)   "The associated person meets all of the following conditions:: (i) primarily performs, or is intended primarily to perform at the end of the offering, substantial duties for or on behalf of the issuer otherwise than in connection with transactions in securities (this would cover people who primarily engage in operating the issuer's business); and (ii) was not a broker or dealer, or an "associated person of a broker or dealer", within the preceding 12 months (this provision obviously is meant to protect against an issuer hiring a broker or an employee to avoid the rules); and (iii) does not participate in selling an offering of securities for any issuer more than once every 12 months other than activity permitted by (1) above and (3) below (this would disqualify people who raise money for multiple issuers).  Associate persons of a broker or a dealer include: any partner, officer, director, or branch manager of such broker or dealer (or any person occupying a similar status or performing similar functions), any person directly or indirectly controlling, controlled by, or under common control with such broker or dealer, or any non-clerical employee of such broker or dealer and people required register under state laws, unless the only reason they must register is their affiliation with the issuer."
(3)   "The associated person restricts his participation to any one or more of the following activities: (i) Preparing any written communication or delivering such communication through the mails or other means that does not involve oral solicitation by the associated person of a potential purchaser; Provided, however, that the content of such communication is approved by a partner, officer or director of the issuer; (ii) responding to inquiries of a potential purchaser in a communication initiated by the potential purchaser; Provided, however, that the content of such responses are limited to information contained in a registration statement filed under the Securities Act of 1933 or other offering document; or (iii) performing ministerial and clerical work involved in effecting any transaction."

The three types of people who meet the last part of the "safe harbor" definition include:
·         people who sell only to designated institutional investors;
·         people who do not otherwise work for brokers who both (x) perform substantial duties for the issuer other than selling the securities of the issuer and (y) sell securities of the issuer not more often than once in any 12-month period;
·         people who only write descriptions about the issuer or its business, if what they write is approved by others;
·         people who only communicate what others write or approve;
·         people who respond to questions, if their responses quote a registration statement.
Obviously, in a private placement there is no "registration statement" to quote from.  Quoting from a private placement memorandum approved by others would be outside the specific words of the safe harbor, but would be consistent with the spirit of the types of activities that do not cause you to be broker because they merely transmit what others write or approve.
Looking at the safe harbor, issuers can protect their personnel by ensuring that people only communicate messages that are approved by management and that their personnel not communicate with investors by telephone or attend meetings with investors.
If you would like to learn more, you can reach me at
Or you can check out my eLearning course at
or read my newspaper articles at

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