New FAQs On Broker-Dealer Registration Exemption

On February 5, 2013, the SEC released FAQs regarding Section 201 of the JOBS Act, which offers a new limited exemption from broker-dealer registration.

In addition to directing the SEC to adopt rules lifting the ban on general solicitation in Rule 506 offerings to only accredited investors (provided that the issuers take reasonable steps to verify accredited investor status), Section 201(c) of the JOBS Act also made a statutory change to Section 4 of the Securities Act.  New Section 4(b) provides that a person need not register as a broker-dealer solely by reason of actions to facilitate Rule 506 offerings.  The intent is to allow third parties to operate funding portals or another platform or mechanism in order to facilitate the sale of securities in Rule 506 offerings that utlize general solicitation without becoming subject to broker-dealer registration.   While the lift of the ban on general solicitation in certain Rule 506 offerings depends upon SEC rulemaking (the SEC proposed rules in August of 2012, and there has been no action since), this new exemption from broker-dealer registration was effective immediately as a statutory change.

There are a couple of requirements that must be met in order for a person to take advantage of the exemption from broker-dealer registration provided by Section 4(b).  First, Section 4(b) is only an exemption from registration based solely on certain specified activities, which (broadly speaking) consist of operating a “platform or mechanism” to facilitate the sale of securities, co-investing with an issuer, or providing “ancillary services” such as due diligence services without investment advice or standard documentation without negotiation. 

Second, the person seeking to rely on the exemption cannot be subject to statutory bad-boy disqualifications, cannot take possession of customer funds or securities, and, most importantly, cannot receive compensation in connection with the purchase or sale of securities.

With that background information in mind, here are some of the highlights from the newly released FAQs:

  • Although the broker-dealer registration exemption is technically operative right now, it has limited utility until the SEC rulemaking progresses.  For example, a person can operate a platform or mechanism such as a funding portal without having to register as a broker-dealer right now, but it cannot allow issuers to conduct Rule 506 offerings using general solicitation on that platform until the SEC adopts the necessary rules.
  • The exemption would not be available to a platform or mechanism that facilitated the offer and sale of securities other than those offered pursuant to Rule 506.
  • Although the SEC takes a very broad view of what constitutes compensation for purposes of determining whether a person has received compensation in connection with the sale of securities (which would disqualify the person from this exemption), the SEC also notes that Congress specifically included co-investing in the issuer’s securities as a permitted activity in Section 4(b).  Therefore, profits realized as a result of a person’s investment in the issuer’s securities would not be considered compensation to the person for purposes of Section 4(b) of the Securities Act.
  • The person operating the platform or mechanism in question can be an associated person of the issuer, as long as the person otherwise qualifies for the exemption.
  • The exemption from broker-dealer registration provided by Section 4(b) is not an exemption from classification as a broker-dealer.  To the contrary, a person could qualify for the Section 4(b) exemption from broker-dealer registration but still be subject to other provisions of the securities laws that are applicable to broker-dealers, independent of registration requirements. “Whether someone is a broker or dealer requires a separate analysis based on the particular facts and circumstances presented.”
  • The Section 4(b) exemption does not provide any relief from state registration requirements.

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