Exemption to Broker-Dealer Registration Requirements for Officers, Directors and Key Employees

The topic of using unlicensed persons to assist in fundraising activities is discussed almost daily in the small and microcap community.  For many years the SEC has maintained a staunch view that any and all activities that could fall within the broker-dealer registration requirements set forth in Section 15(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), require registration. See also the SEC Guide to Broker-Dealer Registration on the SEC website.

In my blog on February 18th, 2014  I talked about the new no-action-letter-based exemption for M&A brokers, the exemptions for websites restricted to accredited investors and for crowdfunding portals as part of the JOBS Act.   In this blog, I am focusing on the statutory exemption from the broker-dealer registration requirements found in Securities Exchange Act Rule 3a4-1, including for officers, directors and key employees of an issuer.

Exchange Act Rule 3a4-1  – Persons Associated with an Issuer that are not Required to be Licensed as a Broker-Dealer

Exchange Act Rule 3a4-1 provides a statutory exemption for persons to engage in fundraising activity on behalf of an issuer without being licensed as a broker-dealer.  The Rule acts as a safe harbor such that as long as a person meets the criteria of the rule, he or she will not be deemed to be a broker-dealer requiring registration under Section 15(b) of the Act.  The Rule is not the only means by which a person may sell an issuer’s securities without registration as a broker-dealer; the Rule does, however, provide legal certainty to those persons who meet the conditions and qualifications of the Rule.

The exemption is not available to persons who are in fact licensed as a broker-dealer or associated with a broker-dealer.  For purposes of the rule, “associated with” means a natural person (i.e., not an entity) who is a partner, officer, director, or employee of the issuer, and employees of companies or partnerships in a controlling relationship with the issuer.  Rule 3a4-1 does not cover attorneys, accountants, insurance brokers, financial service organizations, or financial consultants who for a fee assist issuers in the sale of securities.

To qualify for the exemption, the person must comply with one of the following three criteria.  I note that only one of the three criteria must be met to qualify for the exemption.  The first set of criteria involves either who the securities are being sold to or the type of transaction.  The second set involves the role of the person seeking the exemption and in particular the common officer, director or key employee exemption, and the third criteria again involve the role of the person but are limited to administrative type functions.

 Criteria 1 – Exemption Based on Transaction

A person may qualify for the Rule 3a4-1 exemption if he or she restricts his or her participation to transactions involving offers and sales of securities:

(i) to registered broker-dealer, investment companies, banks, savings and loan associations; trust companies or similar institutions supervised by a state or federal banking authority;

(ii) in transactions exempt under Sections 3(a)(7) (involving certificates issued to a trustee or issuer in a Chapter 11 bankruptcy), Section 3(a)(9) (exchanges of securities) or Section 3(a)(10) (exchange of security for other security or claim after court approval);

(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 a reclassification of securities of the issuer, a merger or consolidation or a similar plan of acquisition involving an exchange of securities, or a transfer of assets of any other person to the issuer in exchange for securities of the issuer; or

(iv) that are made pursuant to a bonus, profit sharing, pension, retirement, thrift, savings, incentive, stock purchase, stock ownership, stock appreciation, stock option, dividend reinvestment or similar plan for employees of an issuer or a subsidiary of the issuer.

Criteria 2 – Exemption for Officers, Directors and Key Employees

A person may qualify for the Rule 3a4-1 exemption if they meet all of the following conditions:

(i) the person “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”;

(ii) the person was not a broker-dealer or associated with a broker-dealer within the preceding 12 months; and

(iii) the person does not participate in selling an offering of securities for any issuer more than once every 12 months other than in reliance on one of the three criteria set forth herein.

Criteria 3 – Exemption for Administrative Assistance

A person may qualify for the Rule 3a4-1 exemption if they perform one or more of the following activities:

(i) Preparing any written communication or delivering such communication through the mail or other means that do 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 SEC prohibits the payments of commissions or other transaction based compensation to entities that raise money for companies, unless that entity is a licensed broker-dealer.  Rule 3a4-1 specifically states that persons exempted under this rule may not be “compensated in connection with his participation by the payment of commissions or other remuneration based either directly or indirectly on transactions in securities.”

Bad Actors are Disqualified

The exemption is unavailable to anyone who is statutorily disqualified from being associated with a broker-dealer for certain “bad acts.”  Section 3(a)(39) of the Exchange Act sets forth the statutory disqualification criteria, which is narrower than the new Rule 506(e) which disqualifies felons and bad actors from participating in a Rule 506 offering.  See my blog here July 31st, 2013 for a discussion of the Rule 506 SEC felon and bad actor disqualification rules.

Section 3(a)(39) disqualifies any person who (i) is or has been expelled, suspended or barred from association with a FINRA or other self-regulatory organization based on an order from such self-regulatory organization; (ii) is subject to an order from the SEC or other regulatory organization denying, suspending or barring registration as or associated with a broker-dealer; (iii) is subject to an order from the CFTC denying, suspending or revoking registration under the Commodity Exchange Act; (iv) is subject to an equivalent order as the above from a foreign governmental or regulatory authority; (v) has been found to be the “cause” of an order described above; (vi) is associated with a person who is expelled, suspended or barred as set forth above;  (vii) has been convicted of a felony or other fraud based securities law violation in the past 10 years; or (viii) has made a false or misleading statement or omission in any application to become associated with a broker-dealer or to become a broker-dealer.

Consequences for Violation

In addition to potential regulatory problems, using an unregistered person who does not qualify for either the statutory or another exemption to assist with the sale of securities may create a right of rescission in favor of the purchasers of those securities.  That is a fancy way of saying they may ask for and receive their money back.

Section 29(b) of the Securities Exchange Act of 1934, as amended (“Exchange Act”), provides in pertinent part:

“Every contract made in violation of any provision of this title or of any rule or regulation thereunder…the performance of which involves the violation of, or the continuance of any relationship or practice in violation of, any provision of this title or any rule or regulation thereunder, shall be void (1) as regards the rights of any person who, in violation of any such provision, rule or regulation, shall have made or engaged in the performance of any such contract….”

In addition to providing a defense by the issuing company to paying the unlicensed person, the language can be interpreted as voiding the contract for the sale of the securities to investors introduced by the finder.  The SEC interprets its rules and regulations very broadly, and accordingly so do the courts and state regulators.  Under federal law the rescission right can be exercised until the later of three years from the date of issuance of the securities or one year from the date of discovery of the violation.  Accordingly, for a period of at least three years, an issuer that has utilized an unlicensed finder has a contingent liability on their books and as a disclosure item.  The existence of this liability can deter potential investors and underwriters and create issues in any going public transaction.

In addition, SEC laws specifically require the disclosure of compensation and fees paid in connection with a capital raise.  A failure to make such disclosure and to make it clearly and concisely is considered fraud under Section 10b-5 of the Securities Act of 1933 (for example, see SEC vs. W.P. Carey & Co., SEC Litigation Release No. 20501).  Fraud claims are generally brought against the issuing company and its participating officers and directors.

Moreover, most underwriters and serious investors require legal opinion letters at closing, in which the attorney for the company opines that all previously issued securities were issued legally and in accordance with state and federal securities laws and regulations.  Obviously an attorney will not be able to issue such an opinion following the use of an unlicensed or non-exempted person.  In addition to the legal ramifications themselves and even with full disclosure and the time for liability having passed, broker-dealers and underwriters may shy away from engaging in business transactions with an issuer with a history of overlooking or circumventing securities laws.

Historically, it was the person who had acted in an unlicensed capacity who faced the greatest regulatory liability; however, in the past ten years that has changed.  The SEC now prosecutes issuers under Section 20(e) for aiding and abetting violations.  The SEC has found it more effective and a better deterrent to prosecute the issuing company than an unlicensed person who is here today and gone tomorrow.

The violations often go past the unlicensed broker-dealer issue.  Persons who do not comply with the statutory and regulatory requirements for assisting in fundraising generally engage in inappropriate solicitation of investors, generous representations and the like in efforts to raise money and earn a commission.

The Author

Laura Anthony, Esq.
Founding Partner
Legal & Compliance, LLC
Corporate, Securities and Going Public Attorneys

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded issuers as well as private companies going public on the NASDAQ, NYSE MKT or over-the-counter market, such as the OTCQB and OTCQX. For nearly two decades Legal & Compliance, LLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions as well as registration statements on Forms S-1, S-8 and S-4; compliance with the reporting requirements of the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; Regulation A/A+ offerings; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers, ; applications to and compliance with the corporate governance requirements of securities exchanges including NASDAQ and NYSE MKT; crowdfunding; corporate; and general contract and business transactions. Moreover, Ms. Anthony and her firm represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. Ms. Anthony’s legal team prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the OTC Market’s top source for industry news, and the producer and host of LawCast.com, the securities law network. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Las Vegas, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.

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