Some 30 state securities regulators are urging the Securities and Exchange Commission not to move forward with its proposal to create a federal broker-dealer exemption for unregulated private placement “finders” amid growing concerns the proposal lacks adequate investor protections and is ripe for abuse.
Under the proposal, unregistered, largely unregulated sales people would be able to earn significant compensation from marketing opaque private placement securities to registered reps’ clients provided the clients had household investable assets of $1 million or more. State regulators, however, worry that sum does not indicate sophistication, especially when held by two-earner households that have dollar-cost averaged into qualified retirement plans for decades.
“This proposal runs directly counter to the public interest and will actually harm rather than protect investors,” state securities regulators said in a joint letter to the SEC. “Given both perennial concerns and recent incidents of extraordinarily harmful frauds perpetuated by persons acting as finders, the last thing state securities regulators expected to see was a commission proposal that facilitates unlicensed intermediaries in the private market.”
Just last month, the North American Securities Administrators Association (NASAA) released its 2020 Enforcement Report, in which unregistered securities once again topped the list of enforcement actions. With respect to elder fraud and exploitation in particular, unregistered securities represented a staggering 71% of state actions reported.
In fact, the common thread in many of these state unregistered securities cases is the presence of an unlicensed intermediary, the report said. States reported 738 actions against unregistered actors in 2019, an increase of 15% from the previous year.
“Many of the worst criminal securities fraud cases arise from the combination of unregistered securities offerings promoted and sold by unlicensed intermediaries. The massive Woodbridge fraud is but one recent, compelling example. Approximately 8,400 investors—mostly elderly persons who qualify as accredited investors solely due to retirement savings amassed over a lifetime—lost an estimated $1.3 billion in the Woodbridge Group of Companies private placement fraud,” state regulators said.
One of the reasons that this scheme grew so large was the involvement of persons acting as finders. “In March, the commission brought unregistered broker-dealer charges against three of the top agents who sold or assisted others in selling about $444 million in Woodbridge securities to investors in 40 different states.” regulators said.
In a separate comment letter, NASAA echoed those sentiments and maintained the SEC’s proposal threatens to harm investors by withdrawing oversight from individuals and situations regulators have found are notoriously prone to abuse.
“NASAA opposes the proposal because it seeks to expand the private markets without providing any commensurate effort to protect investors from the enhanced risk of fraud in an unregulated environment,” said Lisa A. Hopkins, NASAA president and West Virginia’s senior deputy securities commissioner.
Hopkins said NASAA believes the limited controls the SEC proposed are inadequate because they cannot ensure that finders would only solicit sophisticated investors and they are too vague to enforce. She added that the controls cannot be monitored for compliance.
Also troubling, Hopkins said, is that the proposal is not designed to achieve the SEC’s justifications for the rule—that expanding finders’ ability to target broker-dealer clients will help meet the needs of small businesses and facilitate fundraising in regions of the country that lack strong capital raising networks and that it might enhance opportunities for minority- and women-owned businesses.
“Even assuming that these rationales support exempting finders from registration, they should be viewed skeptically here because the proposal is not designed to achieve them,” Hopkins wrote. “For example, the proposal does not limit the size, location, or nature of the issuers that can work with finders, nor does it limit the amount of compensation that finders can receive. As proposed, the only factor that would motivate finders to pursue one opportunity over another would be the compensation offered by the issuer. There is therefore no reason to believe that the proposal would help capital flow to underserved areas or particular issuers."
NASAA asked the SEC to shelve the proposal and engage with state securities regulators, self-regulatory organizations and other stakeholders to determine an appropriate regulatory framework that would provide finders with clarity while establishing necessary investor safeguards.