M&A Broker vs. Broker-Dealer

SEC issues M&A Advisor interpretations.

Securities and Exchange Commission
SEC issues M&A Advisor interpretations.

I have written in the past about the challenges of people looking to facilitate deals without a broker-dealer license. Short answer: You probably can’t get paid.

However, there is an entire industry of business brokers and M&A advisors that seem to get close to the line. In January 2014, the SEC outlined when an M&A advisor could assist in the sale of a privately held company without registering as a broker-dealer. Its been hanging out there for a while, but I figured this was a good enough time to write about it.

First, it defined “M&A Broker” as “a person engaged in the business of effecting securities transactions solely in connection with the transfer of ownership and control of a privately-held company (as defined below) through the purchase, sale, exchange, issuance, repurchase, or redemption of, or a business combination involving, securities or assets of the company, to a buyer that will actively operate the company or the business conducted with the assets of the company.”

In addition, a “privately-held company” is not an SEC filing company

The SEC provided a list of several conditions:

  • The M&A Broker will not have the ability to bind a party to an M&A Transaction.
  • An M&A Broker will not directly, or indirectly through any of its affiliates, provide financing for an M&A Transaction.
  • The M&A Broker may not have custody, control, or possession of or otherwise handle funds or securities issued or exchanged in connection with an M&A Transaction or other securities transaction for the account of others.
  • No M&A Transaction will involve a public offering.
  • Any offering or sale of securities will be conducted in compliance with an applicable exemption from registration under the Securities Act of 1933.
  • No party to any M&A Transaction may be a shell company, other than a business combination related shell company.
  • To the extent an M&A Broker represents both buyers and sellers, it will provide clear written disclosure as to the parties it represents and obtain written consent from both parties to the joint representation.
  • An M&A Broker will facilitate an M&A Transaction with a group of buyers only if the group is formed without the assistance ofthe M&A Broker.
  • The buyer, or group of buyers, in any M&A Transaction will, upon completion of the M&A Transaction, control and actively operate the company or the business conducted with the assets of the business.
  • Any securities received by the buyer or M&A Broker in an M&A Transaction will be restricted securities within the meaning of Rule 144(a)(3) under the Securities Act.

There are more details in the SEC’s letter, which we may cover in another post. It will be interesting over time to see if the SEC focuses on one or more elements of the interpretation.

Penny Stock Fraud – Why Penny Stock Email Promotions Are Bad For You

SEC Logo
SEC cracks down on microcap securities fraud.

Like me, you may get bombarded with long email ads for some penny stock.  They always tout how the stock is about to break out from $0.01/share to $0.05 or $10.00/share.

Did you ever get the sense that these may be scams.  Gadzooks!  Say it ain’t so!

The SEC today announced fraud charges and an asset freeze against the promoter of AwesomePennyStocks.com, a frequent trash dumper into my email accounts.

It charges that John Babikian used his sites for a “scalping” scam with the stock of America West Resources Inc. (AWSRQ).  AWSRQ was low priced and thinly traded.  Babikian fired off about 700,000 emails touting the stock.  However, he failed to disclose that he owned 1.4 million shares of AWSRQ and was ready to sell them through a Swiss bank.  The stock took off, and he made “ill-gotten” gains of more than $1.9 million.

The Babikian case is another example of the SEC’s focus on microcap stock fraud.

“The Enforcement Division, including its Microcap Fraud Task Force, is intensely focused on the scourge of microcap fraud and is aggressively working to root out microcap fraudsters who make their living by preying on unwitting investors,” said Andrew J. Ceresney, Director of the SEC’s Division of Enforcement.

Proving that the SEC has some teeth when it needs them,

The court’s order, among other things, freezes Babikian’s assets, temporarily restrains him from further similar misconduct, requires an accounting, prohibits document alteration or destruction, and expedites discovery.  Pursuant to the order, the SEC has taken immediate action to freeze Babikian’s U.S. assets, which include the proceeds of the sale of a fractional interest in an airplane that Babikian had been attempting to have wired to an offshore bank, two homes in the Los Angeles area, and agricultural property in Oregon.

 

SEC Due Diligence Alert Released For Investment Advisers

SEC due diligence alert regarding processes for selecting alternative investments is released.



Link: SEC Risk Alert – Investment Advisor Due Diligence Processes for Selecting Alternative Investment and their Respective Managers

The SEC has been reviewing due diligence processes for investment advisers for alternative investments and is getting concerned. After all, assets under management, or “AUM” in industry talk, reached $6.5 trillion for alternative investments. The SEC issued an alert reminding advisers to perform due dilience to determine whether the investment:

  • Meets the clients’ investment needs; and
  • Is consistent with disclosed investment strategies.

According to the SEC, “alternative investments” include hedge funds, private equity, venture capital, real estate and funds of private funds.

The SEC conducted examinations of registered advisers and noted the following trends in alternative investment due diligence to identify risk indicators:

  1. Advisers are seekeing more information directly from alternative investment managers
  2. Advisers are using third parties to supplement their analyses and verify data
  3. Advisers are performing additional quantitative analysis of performance returns and risk measures
  4. Advisers are expanding their due diligence processes and focus areas

The SEC then used the alert to remind advisers about their obligations to adopt and review their compliance programs and codes of ethics.

 

SEC Logo
SEC Office of Compliance Inspections and Examinations issues risk alert for due diligence processes by investment advisers

 

 

 

 

 

 

 

New Twist On Old SEC Enforcement Tool: Deferred Prosecution Agreements for Individuals

The SEC announced that it entered into a deferred prosecution agreement with an individual, a first for the agency.

Enforcement officials often use DPAs to encourage targets to come forward with information about illegal activities and to cooperate with investigations.  The agency agrees not to prosecute, and the target agrees to behave.

In this case, the deferree, a hedge fund administrator, spilled the beans about his boss regarding misuse of about $1.5 million and lying to investors about the fund’s performance.  The DPA discusses overstatements of fund returns and discrepancies in the net asset value, or NAV, used for internal and external purposes.

The SEC froze the fund’s and the boss’ assets and is preparing to distribute about $6 million to injured investors.

SEC Rolls Out Market Structure Website

It is actually a part of their sec.gov website, but it is a new part.

MIDAS Website here.
SEC Press Release here.

The SEC released its new MIDAS site to “promote better understanding of our equity markets and equity market structure through the use of data and analytics.”  This is a fancy way of saying that you can make charts of market info that you usually don’t see in traditional stock tickers rolling across your t.v. screen.

I am still combing through it to see what it does and how it can be useful.  It seems to provide some very detailed information relating to trading activity.  We are not talking about mere buy-sell-bid-ask information for stocks, but information that generates pretty charts purporting to show how the market functions.

It seems aimed at understanding (or providing the premise for going after) the high frequency trading (HFT) crowd and flash crashes.

The SEC believes it will help it to monitor and understand mini-flash crashes, reconstruct market events, and develop a better understanding of long-term trends.  To this end, MIDAS collects:

  • posted orders and quotes on national exchanges;
  • modifications/cancellations of those orders;
  • trade executions against those orders; and
  • off-exchange trade executions.

The SEC’s new website will be making available broadly:

  • ratios related to the number and volume of orders that are canceled instead of traded;
  • percentage of on-exchange trades and volume that are not disseminated on the public tape (odd-lot trades);
  • percentage of on-exchange trades and volume that are the result of hidden orders; and
  • quarterly distributions analyzing the lifetime of quotes ranging from one millionth of a second to one day.

The website can be used to:

  • compare and contrast data series according to the type of security, market capitalization, volatility, price, and turnover; and
  • explore detailed quote-life distributions, and download data series and quote-life distributions.

It is not immediately clear to me how this will be used as a policy-making tool, but you can expect charts generated from MIDAS to be displayed in some very exciting Congressional hearings.

SEC To Remain Open During Government “Shutdown”

The SEC has assured the markets that it “will remain open and operational in the event the federal government undergoes a lapse in appropriations on October 1.”

Any changes to the SEC’s operational status after October 1 will be announced on www.sec.gov.

If you want more juicy details of the SEC’s operational plan in the event of a government shutdown, enjoy this link:

Plan of Operations During an SEC Shutdown

Do Section 10(b) and Rule 10b-5 Apply Outside of the U.S.?

Spoiler Alert: No, and this applies to civil and criminal matters, according to the Second Circuit.

Link:  U.S. v. Vilar 

Amid a selection of evidentiary and litigation-y claims, the recent 2nd Circuit case of U.S. v. Vilar did have some interesting nuggets for securities professionals.  Looking at an open issue following the U.S. Supreme Court case of Morrison v. National Australia Bank Ltd., the court looked at whether criminal liability under the Securities Exchange Act of 1934 extended to conduct outside the U.S.

Morrison was a civil case that limited Exchange Act Section 10(b) and Rule 10b-5 to domestic transactions in securities.

Background

The defendants were investment managers and advisers managing up to $9 billion before the tech bubble burst.  They offered select clients the opportunity to invest in securities that paid a high, fixed rate of interest, which were backed primarily by high quality, short-term deposits.  However a portion was invested in publicly traded emerging growth stocks.  See where this is going?

The bubble burst and the defendants were not able to meet the interest payments.  They created another investment vehicle and sold it to an investor, using the proceeds to settle a portion of the previous securities and for various personal expenses.  This investor complained to the SEC after demands to return her funds were met with questionable responses.

The defendants were convicted on a variety of securities, mail and wire fraud counts.

The Argument

Relying on Morrison, he defendants argued that their convictions should be reversed since their conduct was extraterritorial, or outside the U.S.

The court agreed and quoted Morrison for the proposition that when a statute gives no clear indication of an extraterritorial application, it has none.  Although Section 10(b) clearly forbids a variety of fraud, its purpose is to prohibit crimes against private individuals or their property, which is the sort of statutory provision for which the presumption against extraterritoriality applies (responding to the government’s examples of cases broadly applying statutes extraterritorially where the victims were government actors).  A statute either applies exterritorially or it does not, and once it is determined that  a statute does not apply extraterritorially, the only relevant question is whether the conduct occurred in the territory of a foreign sovereign.  In such a case, the court’s test is:

A securities transaction is domestic when the parties incur irrevocable liability to carry out the transaction within the United States or when title is passed within the United States.  More specifically, a domestic transaction has occurred when the purchaser has incurred irrevocable liability within the United States to take and pay for a security, or the seller has incurred irrevocable liability within the United States to deliver a security.

The Upshot

The conviction stands.  The conduct at issue was conducted in the United States, with ties to New York and Puerto Rico, which counts for the court’s purposes.

The defendants claimed that they structured the transaction carefully to avoid U.S. jurisdiction.  However, the court declined to “rescue fraudsters when they complain that their perfect scheme to avoid getting caught has failed.”

The Takeaway

The court summarized its conclusion on the relevant (to us) point as follows:

  • Section 10(b) and Rule 10b-5 do not apply to extraterritorial conduct, regardless of whether liability is sought criminally or civilly.
  • A defendant may be convicted of securities fraud under Section 10(b) and Rule 10b-5 only if he has engaged in fraud in connection with:
    1. a securities listed on a U.S. exchange; or
    2. a security purchased or sold in the United States.

SEC Issues Stop Order For “IPO”

Here’s something you don’t see everyday.

Typically, when going through the SEC registration process, you file a registration statement, the SEC comments, you respond and file an amendment, lather, rinse and repeat until all comments are resolved and the issuer is ready to go effective.

However, the SEC can issue a stop order to prevent the use of a registration statement if the registration statement is somehow deficient. This brings us to Counseling International, Inc.

Counseling International originally filed a Form S-1 in August 2012. It filed various amendments through June 2013. There does not seem to be an order declaring it effective, and the comment letters and responses are not yet posted on EDGAR (which occurs some time after effectiveness).

It seems to be a stretch to call this an IPO as the Form S-1 covers the resale of the shares by selling shareholders, there is no underwriter, there is no securities exchange listing and the company’s assets consist of about $21,000.  However, it is the initial filing by a non-reporting company.

On August 22, 2013, the SEC issued a stop order after it determined that the registration statement contained false and misleading information, identified by the SEC as:

  • failure to disclose the identity of control persons and promoters; and
  • false description of the circumstances of the departure of the former chief executive officer.

The prospectus provides the following language, which we guess missed some crucial details:

“The Company was founded by Layla Stone, who served as the director and chief executive officer of the Company until she sold all of her equity interest in the Company to Maribel Flores on October 19, 2012, and resigned from such positions on the same date. On October 19, 2012, Ms. Flores became the sole director and officer of the Company.”

Until the comment and response letters are posted, it will be difficult to know exactly what went on, but it must have been a serious situation for the SEC to take this drastic measure. How drastic, you ask?

First, the registration statement had a typical delaying amendment, so it would not have gone effective without SEC action in any case.

Second, Counseling International agreed to penalties, which include ineligibility to conduct a Rule 506 offering for five years or occupy any position with, ownership of or relationship to the issuer enumerated in Rule 506(d)(1). [Ed. Note: This second clause seems to apply to an individual, but the “Respondent” described in the stop order seems to be limited to Counseling International. Please let me know in the comments if I just missed something, but I had trouble making sense of this. It may be a boilerplate clause, but it is difficult to tell from the stop order document alone. The press release only refers to the ineligibility for the use of Rule 506 as a penalty.]

The SEC had the following to say, which highlights how they viewed the situation:

“Rarely do we have the opportunity to prevent investor harm before shares are even sold, but this stop order ensures that Counseling International’s stock cannot be sold in the public markets under this misleading registration statement.”

Links:
Most recent amendment to Form S-1
Stop Order
SEC Press Release

SEC Pounces on Bitcoin Ponzi Scheme – In Securities Fraud, Everything Old Is New Again

Movie critics would call the scheme cliched and hackneyed.
Link:  SEC Charges Texas Man With Running Bitcoin-Denominated Ponzi Scheme

This week, the SEC charged McKinney, Texas-based Trendon T. Shavers with defrauding investors in a Ponzi scheme involving Bitcoin.  He may have raised more than $4.5 million in the scheme, but due to the Bitcoin-denominated transactions and vague SEC release, it is hard to tell.  The SEC also says that in more recent dollars, the 700,000 Bitcoin raised exceeds $60 million, which screams “We Want Headlines!!!!” to me.

Shavers’ vehicle was called Bitcoin Savings and Trust and he used the names “Pirate” and “pirateat40” to sell his dirty wares.  Despite the scary name, Shavers is probably just a Jimmy Buffet fan.

Jimmy Buffet, A Pirate Looks At Forty

The SEC claims Shavers claimed that investors would have no risk and huge profits over the Internet.  It appears that Shavers took in Bitcoin investments and then sent them out in withdrawals and interest payments while losing money in his investments and siphoning off funds for himself.  This is classic Ponzi scheme.  Nothing new or notable other than the Bitcoin angle, which isn’t that interesting considering other schemes that are far more imaginative.